PAGETable ---- PART I -- FINANCIAL INFORMATION Item 1. Financial Statements: Condensed Consolidated Balance Sheets as of September 30, 2003 (unaudited) and December 31, 2002............................................ 3 Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2003 and 2002 (unaudited)................... 4 Condensed Consolidated Statements of Cash Flows for the nine months ended 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....................... 11 Item 3. Quantitative and Qualitative Disclosures About Market Risk............................................... 19 Item 4. Controls and Procedures............................. 19 PART II -- OTHER INFORMATION Item 1. Legal Proceedings................................... 20 Item 6. Exhibits and Reports on Form 8-K.................... 20 Signature................................................... 21Contents

~~SEPTEMBER~~ UNITED 30, DECEMBER 31, 2003 2002* ------------- ------------ (UNAUDITED) ASSETS Current assets: Cash and cash equivalents................................. $ 91,634 $ 94,593 Short-term marketable investments......................... 14,764 25,323 Accounts receivable, net.................................. 27,746 25,673 Other current assets...................................... 6,652 8,457 --------- --------- Total current assets................................... 140,796 154,046 Long-term marketable investments............................ 24,998 15,107 Property and equipment, net................................. 12,877 20,159 Goodwill and other assets, net.............................. 4,453 4,355 --------- --------- Total assets........................................... $ 183,124 $ 193,667 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable.......................................... $ 3,544 $ 4,063 Accrued incentive compensation............................ 5,301 7,536 Accrued restructuring charges............................. 2,726 119 Other current liabilities................................. 18,707 21,608 Current portion of long-term debt......................... 1,151 1,502 --------- --------- Total current liabilities.............................. 31,429 34,828 Accrued restructuring charges, net of current portion....... 2,375 -- Long-term debt.............................................. 358 1,328 --------- --------- Total liabilities...................................... 34,162 36,156 --------- --------- Commitments and contingencies Stockholders' equity: Common stock.............................................. 424 424 Additional capital........................................ 588,827 575,043 Unearned stock-based compensation......................... (37) (104) Stock purchase warrants................................... 76,388 76,388 Accumulated other comprehensive loss...................... (85) (1) Accumulated deficit....................................... (516,555) (494,239) --------- --------- Total stockholders' equity............................. 148,962 157,511 --------- --------- Total liabilities and stockholders' equity............. $ 183,124 $ 193,667 ========= =========STATES

~~THREE~~ SECURITIES ~~MONTHS~~AND ~~ENDED~~EXCHANGE NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------ ---------------------- 2003 2002 2003 2002 ------- ------- --------- --------- Revenues................................................... $36,022 $40,388 $ 105,175 $ 128,165 ------- ------- --------- --------- Operating costs and expenses: Cost of revenues......................................... 16,633 18,701 52,781 56,883 Research and development................................. 6,100 6,953 18,801 19,011 Sales and marketing...................................... 7,952 10,677 27,297 34,589 General and administrative............................... 4,935 5,429 16,506 18,003 Stock compensation and warrant costs..................... 1,974 1,989 5,952 6,008 Investment write-down.................................... -- 371 -- 5,111 Restructuring charges.................................... 3,207 (278) 7,926 (278) ------- ------- --------- --------- Total operating costs and expenses......................... 40,801 43,842 129,263 139,327 ------- ------- --------- --------- Operating loss......................................... (4,779) (3,454) (24,088) (11,162) Interest and other income, net............................. 559 611 2,613 2,387 ------- ------- --------- --------- Loss before taxes and change in accounting............. (4,220) (2,843) (21,475) (8,775) Provision for income taxes................................. 334 181 841 527 ------- ------- --------- --------- Loss before change in accounting....................... (4,554) (3,024) (22,316) (9,302) Cumulative effect of accounting change for goodwill........ -- -- -- (5,327) ------- ------- --------- --------- Net loss............................................... $(4,554) $(3,024) (22,316) $ (14,629) ======= ======= ========= ========= Basic and diluted earnings per share before accounting change................................................... $ (0.11) $ (0.07) $ (0.53) $ (0.22) ======= ======= ========= ========= Basic and diluted earnings per share after accounting change................................................... $ (0.11) $ (0.07) $ (0.53) $ (0.35) ======= ======= ========= ========= Shares used in computing basic and diluted earnings per share.................................................... 42,055 41,798 41,920 41,364 ======= ======= ========= =========COMMISSION

~~NINE MONTHS ENDED SEPTEMBER 30~~ Washington, ~~------------------- 2003 2002 -------- -------- Cash flows from operating activities: Net loss~~D.C.~~................................................~~ $(22,316) $(14,629) Adjustments to reconcile net loss to net cash from operating activities: Depreciation and amortization............................. 10,162 14,809 Provision for bad debts................................... 1,435 1,125 Stock compensation and warrant costs...................... 5,952 6,008 Investment write-down..................................... -- 5,111 Cumulative effect of accounting change for goodwill....... -- 5,327 Non-cash restructuring costs.............................. 89 -- Cash from changes in: Accounts receivable....................................... (2,571) 3,681 Other assets.............................................. 1,696 (1,063) Accounts payable.......................................... (519) (1,123) Other liabilities......................................... (131) (4,918) -------- -------- Net cash from operating activities................... (6,203) 14,328 -------- -------- Cash flows from investing activities: Purchases of marketable investments....................... (46,853) (18,614) Maturities of marketable investments...................... 47,414 11,221 Capital expenditures, net................................. (2,958) (5,032) -------- -------- Net cash from investing activities................... (2,397) (12,425) -------- -------- Cash flows from financing activities: Repayment of debt......................................... (1,821) (1,171) Proceeds from debt........................................ 500 -- Proceeds from customer fees applied to warrant............ 7,500 10,313 Proceeds from issuance of common stock.................... 1,040 2,202 Payments to acquire and retire stock...................... (3,581) -- Options exercised......................................... 2,003 3,521 -------- -------- Net cash from financing activities................... 5,641 14,865 -------- -------- Net change in cash and cash equivalents..................... (2,959) 16,768 Cash and cash equivalents at beginning of period............ 94,593 80,482 -------- -------- Cash and cash equivalents at end of period.................. $ 91,634 $ 97,250 ======== ======== Supplemental non-cash disclosure: Amounts due from customer characterized as payment for warrant................................................ $ 3,750 $ 1,875 ======== ========20549

~~THREE MONTHS NINE MONTHS ENDED ENDED SEPTEMBER 30, SEPTEMBER 30,~~ Form 10-~~------------- -------------- 2003 2002 2003 2002 ----- ----- ----- ----- Stock options (treasury method)............. 3,804 2,319 3,166 3,706~~Q

~~THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------- -------------------- 2003 2002 2003 2002 -------- -------- -------- -------- Net loss, as reported............ $~~ (~~4,554)~~Mark ~~$ (3,024~~One) $(22,316) $(14,629) Add: Stock-based 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............... $(14,178) $(16,279) $(50,638) $(54,357) ======== ======== ======== ======== Earnings per share: As reported...................... $ (0.11) $ (0.07) $ (0.53) $ (0.35) Pro forma........................ $ (0.34) $ (0.39) $ (1.21) $ (1.31)

~~THREE~~[X] ~~MONTHS~~Quarterly ~~ENDED~~Report ~~NINE~~Pursuant ~~MONTHS~~to ~~ENDED~~Section ~~SEPTEMBER~~13 ~~30,~~or ~~SEPTEMBER 30, ------------------- --------------------- 2003 2002 2003 2002 ------- ------- -------- -------- Net loss........................ $~~15(~~4,554~~d) ~~$(3,024)~~of ~~$(22,316)~~the ~~$(14,629)~~Securities ~~Change~~Exchange inAct ~~unrealized~~of value on investments, net.............. 56 (48) (107) (8) Translation adjustment, net..... 59 (243) 23 (693) ------- ------- -------- -------- $(4,439) $(3,315) $(22,400) $(15,330) ======= ======= ======== ========1934

~~SEPTEMBER~~ For ~~30,~~the ~~DECEMBER~~quarterly ~~31,~~period ~~2003~~ended ~~2002 ------------- ------------ (IN THOUSANDS) Unrealized (losses) gains on investments~~March 31, ~~net......................................... $(59) $ 48 Cumulative translation adjustments............ (26) (49) ---- ---- $(85) $ (1) ==== ====~~2004

BALANCE AT INITIAL CHARGE AMOUNTS UTILIZED SEPTEMBER 30, 2003 -------------- ---------------- ------------------ WORKFORCE REDUCTION PLAN: Employee severance and termination benefit costs... $1,754 $1,692 $ 62 FACILITY REDUCTION PLAN: Lease costs................... 2,876 169 2,707 Asset write-offs.............. 89 89 -- EUROPEAN RESTRUCTURING PLAN: Employee severance and termination benefit costs... 3,132 875 2,257 Implementation costs.......... 75 -- 75 ------ ------ ------ Total......................... $7,926 $2,825 5,101 ====== ====== Less current portion.......... 2,726 ------ Restructuring accrual, net of current portion............. $2,375 ====== OR

~~THREE~~[ ~~MONTHS~~] ~~ENDED~~Transition ~~NINE~~Report ~~MONTHS~~Pursuant ~~ENDED~~to ~~SEPTEMBER~~Section ~~30,~~13 ~~SEPTEMBER~~or ~~30,~~15(d) ~~-------------------~~of ----------------- 2003 2002 2003 2002 ------- ------- ------ ------ Research and development............. $ 2 $ 17 $ 12 $ 77 Sales and marketing.................. 1,972 1,972 5,940 5,931 ------ ------ ------ ------ $1,974 $1,989 $5,952 $6,008 ====== ====== ====== ======the

~~THREE~~ Securities ~~MONTHS~~Exchange ~~ENDED~~Act ~~NINE~~of MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------- --------------------- 2003 2002 2003 2002 ------- ------- -------- -------- Revenues and fees.............. $38,835 $43,201 $113,613 $136,603 Less fees characterized as payment for warrant.......... (2,813) (2,813) (8,438) (8,438) ------- ------- -------- -------- Revenues....................... $36,022 $40,388 $105,175 $128,165 ======= ======= ======== ========1934

~~THREE~~ For ~~MONTHS~~the ~~ENDED~~transition NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------- ----------------- 2003 2002 2003 2002 ------- ------- ------ ------ Revenues............................ 100% 100% 100% 100% Operating costs and expenses: Cost of revenues.................. 46 46 50 44 Research and development.......... 17 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 -- 4 Restructuring charges............. 9 (1) 8 (0) ----- ----- ----- ----- Operating loss................. (13) (9) (23) (9) Interest and other income, net...... 1 2 3 2 ----- ----- ----- ----- Loss before taxes and change in accounting................... (12) (7) (20) (7) Provision for income taxes.......... 1 0 1 0 ----- ----- ----- ----- Loss before change in accounting................... (13) (7) (21) (7) Cumulative effect of accounting change for goodwill............... -- -- -- (4) ----- ----- ----- ----- Net loss....................... (13%) (7%) (21%) (11%) ===== ===== ===== =====period from to

~~THREE~~ Commission ~~MONTHS~~File ~~ENDED~~Number ~~THREE MONTHS ENDED NINE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, 2003 SEPTEMBER 30, 2002 SEPTEMBER 30, 2003 SEPTEMBER 30, 2002~~ 000-------------------- -------------------- --------------------- --------------------- $ % OF TOTAL $ % OF TOTAL $ % OF TOTAL $ % OF TOTAL ------- ---------- ------- ---------- -------- ---------- -------- ---------- FullSource........... $24,009 67% $32,113 80% $ 73,410 70% $104,907 82% All other............ 12,013 33 8,275 20 31,765 30 23,258 18 ------- --- ------- --- -------- --- -------- --- Total revenues....... $36,022 100% $40,388 100% $105,175 100% $128,165 100% ======= === ======= === ======== === ======== ===27913

~~THREE MONTHS ENDED THREE MONTHS ENDED NINE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30~~ FreeMarkets, 2003 SEPTEMBER 30, 2002 SEPTEMBER 30, 2003 SEPTEMBER 30, 2002 -------------------- -------------------- --------------------- --------------------- $ % OF TOTAL $ % OF TOTAL $ % OF TOTAL $ % OF TOTAL ------- ---------- ------- ---------- -------- ---------- -------- ---------- FullSourceInc........... $26,822 69% $34,926 81% $ 81,848 72% $113,345 83% All other............ 12,013 31 8,275 19 31,765 28 23,258 17 ------- --- ------- --- -------- --- -------- --- Total revenues and fees............... $38,835 100% $43,201 100% $113,613 100% $136,603 100% ======= === ======= === ======== === ======== ===

~~SEPTEMBER 30, DECEMBER 31, 2003 2002 CHANGE ------------- ------------ -------~~ ($Exact INName THOUSANDS) Cash and cash equivalents................. $ 91,634 $ 94,593 $(2,959) Marketable investments.................... 39,762 40,430 (668) -------- -------- ------- Total cash and investments.............. $131,396 $135,023 $(3,627) ======== ======== ======= Percentage of ~~total~~Registrant ~~assets..............~~as ~~72%~~Specified ~~70%~~in ~~2 pts. Working capital........................... $109,367 $119,218 $(9,851~~its Charter) ~~Current ratio............................. 4.5 to 1 4.4 to 1 Days sales outstanding (DSO).............. 58 51~~

NINE MONTHS ENDED SEPTEMBER 30, ------------------ 2003 2002 CHANGE ------- -------- -------- ($ IN THOUSANDS) Cash flows from operating activities........... $(6,203) $ 14,328 $(20,531) Cash flows from investing activities........... (2,397) (12,425) 10,028 Cash flows from financing activities........... 5,641 14,865 (9,224)






	Delaware				04-3265483
	(State or Other Jurisdiction of Incorporation or Organization)				(I.R.S. Employer Identification No.)





	FreeMarkets Center
	210 Sixth Avenue
	Pittsburgh, PA				15222
	(Address of Principal Executive Offices)				(Zip Code)

~~EXHIBIT~~ Registrant’s ~~NUMBER~~telephone ~~DESCRIPTION~~number, ~~-------~~including ~~-----------~~area ~~99.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes~~code: (412) 434-Oxley Act of 2002. 99.2 Certification of Chief Financial 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 Statements0500

~~EXHIBIT~~ Registrant’s ~~NUMBER~~URL: ~~DESCRIPTION ------- ----------- 31~~http://www.~~1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002~~freemarkets. 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32 Certification by the Chief Executive Officer and Chief Financial Office Relating to a Periodic Report Containing Financial Statementscom

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 [ü] No [ ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes [ü] No [ ]

The number of shares of the registrant’s common stock outstanding as of the close of business on March 31, 2004 was 42,975,011.

FreeMarkets, Inc.

Form 10-Q

For the Quarterly Period Ended March 31, 2004

Index


		Page

PART I — FINANCIAL INFORMATION




Item 1. Financial Statements:




	Condensed Consolidated Balance Sheets as of March 31, 2004 (unaudited) and December 31, 2003		3




	Condensed Consolidated Statements of Operations for the three months ended March 31, 2004 and 2003 (unaudited)		4




	Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2004 and 2003 (unaudited)		5




	Notes to Condensed Consolidated Financial Statements		6





Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			12





Item 3. Quantitative and Qualitative Disclosures About Market Risk			22





Item 4. Controls and Procedures			22

PART II — OTHER INFORMATION





Item 1. Legal Proceedings			23





Item 6. Exhibits and Reports on Form 8-K			23





SIGNATURE			24
Exhibit 10.3(F)
Exhibit 31.1
Exhibit 31.2
Exhibit 32

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

FreeMarkets, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

($ in thousands)


			March 31,			December 31,
			2004			2003*

			(unaudited)




Assets




Current assets:




	Cash and cash equivalents		$	60,850		$	102,935




	Short-term marketable investments			11,265			8,663




	Accounts receivable, net			27,743			25,039




	Other current assets			6,847			6,399

		Total current assets		106,705			143,036




Long-term marketable investments				35,635			25,076




Property and equipment, net				9,324			10,571




Goodwill and other intangible assets, net				18,838			2,579




Other assets				2,020			1,887

		Total assets	$	172,522		$	183,149


Liabilities and Stockholders’ Equity




Current liabilities:




	Accounts payable		$	2,901		$	4,757




	Accrued incentive compensation			1,811			6,915




	Accrued restructuring charges			2,681			2,676




	Other current liabilities			20,444			19,020




	Current portion of long-term debt			486			818

		Total current liabilities		28,323			34,186




Accrued restructuring charges, net of current portion				5,638			4,404




Long-term debt				309			342

		Total liabilities		34,270			38,932

Commitments and contingencies




Stockholders’ equity:




	Common stock			430			423




	Additional capital			599,239			592,343




	Unearned stock-based compensation			(12	)		(24	)




	Stock purchase warrants			76,388			76,388




	Accumulated other comprehensive income			438			220




	Accumulated deficit			(538,231	)		(525,133	)

		Total stockholders’ equity		138,252			144,217

		Total liabilities and stockholders’ equity	$	172,522		$	183,149


*	Summarized from audited December 31, 2003 balance sheet.

The accompanying notes are an integral part of the condensed consolidated financial statements.

FreeMarkets, Inc. and Subsidiaries

Condensed Consolidated Statements of Operations

(unaudited; amounts in thousands, except per share amounts)



			Three Months Ended
			March 31,

			2004			2003

Net revenues			$	29,997		$	34,520




Operating costs and expenses:




	Cost of revenues			16,878			18,399




	Research and development			5,812			6,490




	Sales and marketing			8,313			9,369




	General and administrative			4,019			6,051




	Stock compensation and warrant costs (1)			2,210			1,989




	Ariba merger-related costs			2,108			—




	Restructuring charges			4,131			4,719

Total operating costs and expenses				43,471			47,017

		Operating loss		(13,474	)		(12,497	)




Interest and other income, net				691			989

		Loss before taxes		(12,783	)		(11,508	)




Provision for income taxes				315			291

		Net loss	$	(13,098	)	$	(11,799	)

Basic and diluted earnings per share			$	(0.31	)	$	(0.28	)

Shares used in computing basic and diluted earnings per share				42,575			41,998


(1)	Stock compensation and warrant costs are attributable to the following operating expense categories:



	Three Months Ended
	March 31,

	2004		2003

Research and development	$	8	$	5




Sales and marketing		2,202		1,984

	$	2,210	$	1,989

The accompanying notes are an integral part of the condensed consolidated financial statements.

FreeMarkets, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(unaudited; $ in thousands)



				Three Months Ended
				March 31,

				2004			2003

Cash flows from operating activities:




	Net loss			$	(13,098	)	$	(11,799	)




	Adjustments to reconcile net loss to net cash from operating activities:




		Depreciation and amortization			2,858			3,767




		Provision for bad debts			249			750




		Stock compensation and warrant costs			2,210			1,989




		Non-cash restructuring (benefit)/costs, net			(286	)		89




	Cash from changes in assets and liabilities, net of acquisition:




		Accounts receivable			(1,314	)		6




		Other assets			(581	)		1,505




		Accounts payable			(1,856	)		(433	)




		Other liabilities			(3,884	)		(2,438	)

			Net cash from operating activities		(15,702	)		(6,564	)

Cash flows from investing activities:




	Acquisition, net of cash acquired of $2,150				(14,847	)		—




	Purchases of marketable investments				(18,815	)		(6,659	)




	Maturities of marketable investments				5,782			24,279




	Capital expenditures				(1,204	)		(219	)

			Net cash from investing activities		(29,084	)		17,401

Cash flows from financing activities:




	Repayment of debt				(365	)		(874	)




	Proceeds from debt				—			500




	Proceeds from customer fees applied to warrant				938			3,750




	Payments to acquire and retire stock				—			(3,581	)




	Options exercised				2,128			170

			Net cash from financing activities		2,701			(35	)

Net change in cash and cash equivalents					(42,085	)		10,802




Cash and cash equivalents at beginning of period					102,935			94,593

Cash and cash equivalents at end of period				$	60,850		$	105,395

Supplemental non-cash disclosure:




	Amounts due from customer characterized as payment for warrant			$	4,654		$	1,875

The accompanying notes are an integral part of the condensed consolidated financial statements.

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, 2004. 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, 2003, included in the Company’s Annual Report on Form 10-K/ A filed with the SEC on April 29, 2004.

Note 2. Merger with Ariba

In January 2004, the Company announced a definitive agreement to merge with Ariba, Inc. (“Ariba”), a provider of Enterprise Spend Management products and services. Under terms of the agreement, shareholders of the Company’s common stock will receive 2.25 Ariba common shares and $2.00 in cash for each outstanding share of FreeMarkets. The transaction is subject to customary closing conditions, including regulatory review and approval by the stockholders of each company, and is expected to close in the latter part of the second quarter. Because the merger is subject to factors beyond the parties’ control, however, the Company cannot predict whether or when the merger will be completed. The Company has incurred to date merger-related costs of approximately $2.1 million related to financial advisor and other professional fees, which were all expensed in Q1 2004. Upon closing of the merger we become obligated to pay $2.5 million in merger-related investment banking fees.

Note 3. Earnings Per Share

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



	Three Months Ended
	March 31,

	2004		2003


	(in thousands)




Stock options (treasury method)		3,236		2,070

Options and warrants to purchase 9.6 million and 14.3 million shares of common stock were outstanding as of March 31, 2004 and 2003, 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.

FreeMarkets, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements — (continued)

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”:



			Three Months Ended
			March 31,

			2004			2003


			(in thousands, except
			per share amounts)




Net loss, as reported			$	(13,098	)	$	(11,799	)




Add: Stock-based employee compensation expense included in reported net income				12			28




Less: Total stock-based employee compensation expense determined under fair value method for all awards				(5,182	)		(9,366	)

Pro forma net loss			$	(18,268	)	$	(21,137	)

Earnings per share:
	Basic and diluted




		As reported	$	(0.31	)	$	(0.28	)

		Pro forma	$	(0.43	)	$	(0.50	)

Note 4. Stockholders’ Equity

The components of comprehensive loss were as follows:



	Three Months Ended
	March 31,

	2004			2003


	(in thousands)




Net loss	$	(13,098	)	$	(11,799	)




Change in unrealized value on investments, net		128			(140	)




Translation adjustment, net		90			61

	$	(12,880	)	$	(12,000	)

The components of accumulated comprehensive income were as follows:


	March 31,		December 31,
	2004		2003


	(in thousands)




Unrealized gains (losses) on investments, net	$	47	$	(81	)




Cumulative translation adjustments		391		301

	$	438	$	220

Note 5. Acquisition, Goodwill and Other Intangible Assets

In January 2004, the Company acquired the auction and services business of Covisint, an independent e-business provider for the global automotive industry for $16.3 million. The acquisition of Covisint is complimentary to the Company’s existing service offering. In accordance with SFAS No. 141, “Business Combinations,” the acquisition was accounted for as a purchase business combination. Accordingly, the purchase price allocations have been based upon an estimated fair value of net assets acquired. Covisint’s operating results

FreeMarkets, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements — (continued)

have been included in the Company’s Consolidated Results of Operations since the date of the acquisition. The purchase price of $17.0 million, including transaction costs of $697,000, was allocated as follows (in thousands):






Fair value of assets acquired	$	19,147




Fair value of liabilities assumed		(2,150	)

Total purchase price		16,997




Less: cash acquired		(2,150	)

Cash paid for acquisition	$	14,847

The Company’s methodology for allocating the purchase price to the customer contracts and technology acquired is based on a valuation performed by an independent third party. Goodwill will not be amortized, but will instead be subject to an annual impairment test. Goodwill resulting from the acquisition is expected to be tax deductible, but will be subject to a full valuation allowance as a result of the Company’s history of losses. Amortization of the technology acquired is being amortized over its estimated useful life of six months in cost of revenues in the Statement of Operations. Amortization of the customer contracts acquired is being amortized over the estimated useful lives of three to four years and is recorded as a reduction to gross revenues in the Statement of Operations.

The following unaudited pro forma financial information presents the Company’s results of operations as if the acquisition of Covisint occurred at the beginning of the period presented. The unaudited pro forma financial information does not necessarily reflect the results of operations that would have occurred had the Company and Covisint constituted a single entity during such period.


	Three Months Ended			Three Months Ended
	March 31, 2004			March 31, 2003

Revenues	$	29,997		$	41,008




Net loss		(13,098	)		(13,605	)




Basic and diluted earnings per share		(0.31	)		(0.32	)

The following table sets forth an analysis of goodwill and other intangible assets as of March 31, 2004:


		Carrying							Carrying
	Estimated Useful	Amount							Amount
	Life	December 31, 2003		Acquisition		Amortization			March 31, 2004


	(in thousands)




Goodwill	Indefinite	$	2,000	$	7,597	$	—		$	9,597




Customer contracts acquired	3 – 4 years		—		9,100		(577	)		8,523




Technology acquired	6 months		—		300		(150	)		150




Patents and trademarks	17 years		579		—		(11	)		568

		$	2,579	$	16,997	$	(738	)	$	18,838

The Company completed its annual test for impairment in Q1 2004, and concluded at that time that the Company did not have any impairment of goodwill based on the estimated fair value as determined by discounted cash flows.

FreeMarkets, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements — (continued)

Note 6. Restructuring Charge

2004 Restructuring Plan

In Q1 2004, the Company initiated two restructuring programs. These programs were focused on eliminating certain positions throughout its global workforce and re-assessing the Company’s facility needs. The following is a summary of these programs:


	*Workforce Reduction Plan*

In Q1 2004, the Company executed a restructuring plan resulting in the elimination of 69 positions in its global workforce. This represented approximately 7% of total employees. The Company recorded a restructuring charge of $2.0 million in Q1 2004 covering these severance costs. The remaining liability for employee severance and termination benefit costs of $131,000 will be paid in Q2 2004.


	*Facility Reduction Plan*

Also in Q1 2004, the Company re-assessed its global headquarters office space in Pittsburgh, Pennsylvania, and ceased using one of the floors it leases through May 2010, as well as closed two domestic offices. The Company recorded a restructuring charge of $2.8 million in Q1 2004. The Company intends to sub-lease the floor in its global headquarters, and estimated sublease income based on current real estate market conditions.

The Company is continuing to evaluate its office space requirements at its headquarters, and as a result, the Company may incur additional lease-related charges in the future.

2003 Restructuring Plans

Throughout 2003, the Company 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 Q1 2003, the Company executed a restructuring plan resulting in the elimination of 79 positions in its global workforce. This represented approximately 7% of total employees. The Company recorded a restructuring charge of $1.8 million in Q1 2003 covering these severance costs. The liability for employee severance and termination benefit costs related to this activity was paid by December 31, 2003.


	*Facility Reduction Plan*

Also in 2003, the Company re-assessed its global headquarters office space in Pittsburgh, Pennsylvania, and ceased using two of the floors it leases through May 2010. The Company recorded a restructuring charge of $3.0 million and $2.0 million in Q1 2003 and Q4 2003, respectively. The Company intends to sub-lease these floors, and estimated sublease income based on prevailing real estate market conditions.

FreeMarkets, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements — (continued)


	*European Restructuring Plan*

In Q3 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 net elimination of 74 positions in its European business. There were 105 positions eliminated with the closing of the Brussels facility, offset by 31 positions added to the existing European facilities in London, Paris and Frankfurt. The Company recorded a restructuring charge of $3.2 million in Q3 2003 covering these severance costs and legal fees. As of March 31, 2004, the severance costs have been paid in accordance with local employment laws.

In Q4 2003, the Company recorded an additional charge of $4.2 million. This charge includes $847,000 of severance costs, $1.8 million of estimated future obligations for non-cancelable lease payments generated by exiting the Brussels facility, $1.2 million for the impairment of property and equipment (primarily leasehold improvements) that were no longer in use, and $308,000 for restructuring plan implementation costs, primarily comprised of legal and other professional fees. The Company intends to sub-lease the facility, and estimated sublease income based on prevailing real estate market conditions. The Company expects to pay the remaining restructuring accrual relating to severance and implementation costs in the amount of $617,000 in Q2 2004. The accrual for lease costs (net of anticipated sub-lease proceeds) will be paid over the lease term through August 2006. As of March 31, 2004, $702,000 of the $1.1 million accrual for lease costs will be paid in the next twelve months, and is therefore classified as a current liability in the Company’s consolidated balance sheet.

In Q1 2004, as a result of substantially completing the liquidation of the investment in the Belgium entity, the Company recorded a benefit of $617,000 relating to the amount accumulated in the translation component of equity.

The following table sets forth an analysis of the restructuring accrual activity for the period ended March 31, 2004:



		2004 Restructuring Plan						2003 Restructuring Plan

		Workforce			Facility			Facility			European
		Reduction			Reduction			Reduction			Restructuring
		Plan			Plan			Plan			Plan			Total

Balance as of December 31, 2003		$	—		$	—		$	4,318		$	2,762		$	7,080




Restructuring charge in Q1 2004:




	Severance and benefits		1,966			—			—			—			1,966




	Accrued lease costs		—			2,370			—			—			2,370




	Property and equipment impairment		—			331			—			—			331




	Implementation costs		—			81			—			—			81




	Liquidation of subsidiary		—			—			—			(617	)		(617	)

	Total charge in Q1 2004		1,966			2,782			—			(617	)		4,131




Cash paid			(1,835	)		(165	)		(163	)		(1,015	)		(3,178	)




Amounts utilized			—			(331	)		—			617			286

Balance as of March 31, 2004		$	131		$	2,286		$	4,155		$	1,747		$	8,319

FreeMarkets, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements — (continued)

Note 7. 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. On March 10, 2004, the court certified the case as a class action. The case is now in the discovery 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. 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. 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.


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/ A for the year ended December 31, 2003, as filed with the SEC on April 29, 2004.

Overview

FreeMarkets provides software and service solutions to help companies improve their sourcing and global supply management processes and enhance the capabilities of their supply management organizations. Our customers are buyers of industrial parts, raw materials, commodities and services. As of March 31, 2004, we serve our customers from 17 locations in 13 countries on five continents. Our team members provide service to customers in more than 35 languages through operations centers in Pittsburgh and Singapore.

Since 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 our 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 2002 and 2003, we introduced a number of new solution offerings to expand beyond sourcing to address a broader set of supply management activities. Our development of a broader set of solutions 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.

In January 2004, we announced a definitive agreement to merge with Ariba, Inc. (“Ariba”), a provider of Enterprise Spend Management products and services. Under terms of the agreement, shareholders of our common stock will receive 2.25 Ariba common shares and $2.00 in cash for each outstanding share of FreeMarkets. The transaction is subject to customary closing conditions, including regulatory review and approval by the stockholders of each company, and is expected to close in the latter part of the second quarter. Because the merger is subject to factors beyond the parties’ control, however, we cannot predict whether or when the merger will be completed.

Also in January 2004, we acquired the auction and services business of Covisint, an independent e-business service provider for the global automotive industry, for $16.3 million.

Also in January 2004, we executed a restructuring plan resulting in the elimination of 69 positions in our global workforce. Additionally, in February 2004, we evaluated our office space in Pittsburgh, Pennsylvania, and

determined that we will cease using one of the floors we currently lease in our global headquarters. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 146, we recorded a restructuring charge of $4.1 million in Q1 2004 covering these severance and lease costs.

Overview of Q1 2004 Financial Results

Our operating results during Q1 2004 should be considered within the context of our continuing transition to a provider of multiple software and service solutions, the restructuring plan implemented during the quarter and our merger announcement with Ariba in January 2004. Net revenues in Q1 2004 decreased $4.5 million, or 13% from Q1 2003 due to a combination of factors, including a change in the mix of products and services deployed by our customers, partially offset by revenue from contracts acquired from Covisint, which comprise approximately 10% of Q1 2004 net revenues. The decrease is also due to the merger announcement, which has caused a number of existing customers to either defer their contract renewal decisions or make smaller renewal commitments. We believe that the announcement has lengthened our sales cycles with potential customers, who are deferring their purchasing decisions because of concerns regarding our future solutions roadmap.

Total operating expenses in Q1 2004 declined $3.5 million, or 7% from Q1 2003 primarily due to reduced compensation costs (down $2.2 million on a 10% decrease in average number of employees), depreciation expense (down $1.7 million) and cost cutting measures in discretionary spending such as marketing and advertising (down $1.4 million). The decline in operating expenses was offset by $2.1 million in Ariba merger-related costs. We ended Q1 2004 with 896 employees versus 992 at the end of Q1 2003. Finally, total cash and investments of $107.8 million at the end of Q1 2004 was $28.9 million less than the $136.7 million at the end of Q4 2003. The decrease is primarily due to the $14.8 million cash paid for the acquisition of Covisint’s auction services business and related transaction costs in January 2004 and the $13.1 million net loss in Q1 2004.

Critical Accounting Policies

The accompanying discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States of America (“US GAAP”). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. These estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. We base our estimates and judgments on historical experience and all available information. However, future events are subject to change, and the best estimates and judgments routinely require adjustment. US GAAP requires us to make estimates and judgments in several areas, including those related to recording various accruals (such as incentive compensation and restructuring costs), income taxes, the useful lives of long-lived assets such as property and equipment and potential losses from contingencies and litigation. We believe the policies discussed below are the most critical to our financial statements because they are affected significantly by management’s judgments, assumptions and estimates.


	*Revenue recognition*

We generate revenues under service and access agreements with our customers. While the vast majority of our agreements contain standard business terms and conditions, there are many agreements that contain complex terms and conditions. As a result, we are required to evaluate the scope and significance of contract provisions in order to determine the appropriate accounting. In addition, our revenue recognition policy requires an assessment as to whether the collectibility is probable, which inherently requires us to evaluate the creditworthiness of our customers.

For all offerings, the Company recognizes revenue when all of the following criteria are met as set forth in Staff Accounting Bulletin No. 101:


	(1)	Persuasive evidence of an arrangement exists (contract is signed and legally binding),

	(2)	Services have been rendered or access has been provided (with no future obligations),


	(3)	The fee is fixed and determinable (amount is known and not contingent upon future events), and

	(4)	Collectibility is probable (high degree of confidence that the customer will pay).

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. The customers related to the acquisition of Covisint are served using legacy technology that will be transitioned over to FreeMarkets technology during 2004. The services provided are similar in nature to that of our FullSource offering, and therefore, substantially all of their revenues are allocated to FullSource and recognized in a manner consistent with our FullSource service contracts.

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 hosted technology 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 ES, Spend Visibility and Supplier Implementation solutions 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.

The majority of our customer agreements include multiple service offerings. Each service offering consists of a single element. In determining the appropriate amount of revenue to be recognized for each offering, we evaluate whether these arrangements contain separate units of accounting. This determination is based on whether: the delivered item has value to the customer on a standalone basis (that is, if it is sold separately by any vendor or the customer could resell the deliverable); there is objective and reliable evidence of fair value of the undelivered items in the arrangement; and if the arrangement includes a general right of return relative to the delivered item, delivery or performance of the undelivered item(s) is considered probable and substantially in the control of the vendor. In instances where all of these conditions are satisfied, we recognize revenue for the offerings that have been delivered to the customer based on the relative fair value of the delivered item when compared to the total arrangement considered, subject to certain limitations. The fair value for each element is established based on the sales price charged when the same element is sold separately.

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 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 economic conditions worsen, additional allowances may be required in the future.


	*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.


	*Lease abandonment costs*

Lease abandonment costs for abandoned facilities are estimated to include the impairment of leasehold improvement and remaining lease liabilities, offset by estimated sublease income, if appropriate. Estimates related to sublease costs and income are based on assumptions regarding the period required to locate and contract with suitable sub-lessees. Each quarter, we review these estimates, and to the extent that our assumptions change, the ultimate restructuring expenses for these abandoned facilities could vary from current estimates. In 2003, we recorded a $6.5 million charge for the closing of our Brussels facility and abandonment of two leased floors in our global headquarters office space in Pittsburgh. In Q1 2004, we recorded a $2.4 million charge for the abandonment of one additional leased floor in our Pittsburgh facility, as well as closed two domestic offices.

Treatment of Visteon Fees

In April 2000, we entered into a five-year agreement with Visteon under which we agreed to provide our FullSource technology-enhanced services, and Visteon agreed to pay us fixed monthly fees plus the possibility of additional variable fees based on performance. We have also received marketing and public relations benefits as a result of our relationship with Visteon. At the time we executed this service agreement, we granted to Visteon a warrant for 1.75 million shares of our common stock, with an exercise price of $.01 per share. The warrant was valued at $95.5 million using the Black-Scholes pricing model at the date of the grant in April 2000. We exclude from our revenues the fees we earn under our service agreement with Visteon; however, our cost of revenues includes the costs that we incur in serving Visteon under this agreement.

The service agreement with Visteon expires in April 2005, and because we have classified the fees we earn under this agreement as payment for the warrant, we do not expect to recognize revenues under this agreement during the remainder of its term.

Below is a reconciliation of net revenues under generally accepted accounting principles with net revenues plus the fees we earn under our service contract with Visteon:



		Three Months Ended
		March 31,

		2004			2003


		(in thousands)




Net revenues and fees		$	32,573		$	37,333




	Less fees characterized as payment for warrant		(2,576	)		(2,813	)

Net revenues		$	29,997		$	34,520

Treatment of Covisint Acquisition

In January 2004, we acquired the auction and services business of Covisint, an independent e-business service provider for the global automotive industry, for $16.3 million. As a result of this transaction, the selling shareholders of Covisint became FreeMarkets customers through our assumption of those shareholders’ existing service agreements with Covisint. We are recording the amortization of the fair value of those customer contracts as a reduction in revenue. We recorded a $9.1 million customer intangible asset as a result of a third-party valuation of those contracts, which is being amortized over three to four years. During Q1 2004, we recorded $577,000 of amortization as a reduction in revenue.

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,

		2004			2003

Net revenues			100	%		100	%




Operating costs and expenses:




	Cost of revenues		56			53




	Research and development		19			19




	Sales and marketing		28			27




	General and administrative		13			18




	Stock compensation and warrant costs*		8			6




	Ariba merger-related costs		7			—




	Restructuring charge		14			13

	Operating loss		(45	)		(36	)




Interest and other income, net			2			3

	Loss before taxes and change in accounting		(43	)		(33	)




Provision for income taxes			1			1

	Net loss		(44	)%		(34	)%


*	Stock compensation and warrant costs have not been allocated to research and development and sales and marketing.

Three Months Ended March 31, 2004 and 2003

All references to “Q1 2004” and “Q1 2003” are for the three months ended March 31, 2004 and 2003, respectively.

Net revenues

Net revenues decreased 13% from $34.5 million in Q1 2003 to $30.0 million in Q1 2004. The decrease in net revenues is due to a combination of factors, including a change in the mix of products and services deployed by our customers, partially offset by revenue from contracts acquired from Covisint, which comprise approximately 10% of Q1 2004 net revenues. The decrease is also due to the merger announcement, which has caused a number of existing customers to either defer their contract renewal decisions or make smaller renewal commitments. We believe that the announcement has lengthened our sales cycles with potential customers, who are deferring their purchasing decisions because of concerns regarding our future solutions roadmap.

In 2003 and early 2004, several large customers renewed their FullSource service agreements at lower market volumes than the volumes provided in previously existing agreements, resulting in 34% lower net revenues from our FullSource offering in Q1 2004 compared to Q1 2003. In addition, with the introduction of our less-costly QS solution in early 2001 and several other new offerings in late 2002 and early 2003, many FullSource-only customers have expanded their use of our solutions to include a broader mix of FullSource, QS and related offerings. 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 solutions to existing customers have resulted in lower total net revenues due to this migration to our self-service technologies. For instance, our transition to a multiple-solutions company over the past two years is a result of leveraging our knowledge and service capabilities to grow our other solutions, most notably QS, ES and Consulting. These other solutions combined delivered 46% more net revenues in Q1 2004 compared to Q1 2003, partially offsetting the decline in FullSource.

To illustrate this migration, our top 20 customers in Q1 2003, which accounted for approximately 60% of total revenues, reduced their use of FullSource by $10.4 million in Q1 2004 as compared with Q1 2003. Those same 20 customers migrated a portion of their sourcing solutions needs to our QS and other less costly offerings over the same time period, resulting in an increase from those customers for these solutions of $1.9 million, or 66%. However, the growth in those less-costly solutions and the acquisition of Covisint in Q1 2004 did not offset the decline in revenues from our FullSource solution.

Operating costs and expenses

Cost of revenues. Cost of revenues decreased from $18.4 million, or 53% of revenues in Q1 2003 to $16.9 million, or 56% of revenues in Q1 2003. The increase in cost of revenues as a percentage of revenues from Q1 2003 to Q1 2004 was primarily the result of the 13% decrease in revenues from Q1 2003 to Q1 2004, partially offset by an 8% overall decrease in cost of revenues. The decrease in absolute dollar amounts from Q1 2003 to Q1 2004 is primarily attributable to the following: (1) decrease in compensation and benefits expense in the amount of $1.2 million, primarily due to a 9% decrease in the average number of account management, global sourcing services and market operations staff; (2) reduced overhead in the amount of $1.1 million, primarily comprised of reduced depreciation expense in the amount of $936,000; and (3) reduced bad debt expense in the amount of $501,000 due to the write-off of approximately $900,000 due from a single customer in Q1 2003. The decrease in cost of revenues in absolute dollars is partially offset by an increase in professional and consulting costs in the amount of $1.4 million associated with serving contracts acquired in the Covisint acquisition in January 2004. 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.

Research and development. Research and development costs decreased from $6.5 million, or 19% of revenues in Q1 2003, to $5.8 million, or 19% of revenues in Q1 2004. The decrease was primarily related to the following: (1) reduced overhead in the amount of $718,000, primarily comprised of reduced depreciation expense; and (2) reduced consulting fees in the amount of $329,000. The decrease in research and development costs is partially offset by a $400,000 charge in Q1 2004 associated with a legal settlement with a former vendor.

Sales and marketing. Sales and marketing costs decreased from $9.4 million, or 27% of revenues in Q1 2003, to $8.3 million, or 28% of revenues in Q1 2004. The decrease is primarily attributable to cost cutting measures in discretionary spending in Q1 2004 such as marketing and advertising in the amount of $1.4 million.

General and administrative. General and administrative costs decreased from $6.1 million, or 18% of revenues in Q1 2003, to $4.0 million, or 13% of revenues in Q1 2004. The decrease from Q1 2003 to Q1 2004 is primarily attributable to the following: (1) reduced compensation and benefits expense in the amount of $855,000 due to a 28% decrease in the average number of personnel in the areas of human resources, finance and facilities management in Q1 2004 compared to Q1 2003; and (2) reduced overhead in the amount of $761,000, primarily comprised of reduced depreciation expense in the amount of $245,000.

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 2003 and Q1 2004, $4.8 million was amortized related to this warrant, with $2.8 million and $2.6 million in Q1 2003 and Q1 2004, respectively, reflected as a reduction to our revenues (reducing the revenues under the Visteon service contract to zero) and $2.0 million and $2.2 million in Q1 2003 and Q1 2004, respectively, as stock compensation and warrant costs.

Ariba merger-related costs. In January 2004, we announced a definitive agreement to merge with Ariba, Inc. (“Ariba”), a provider of Enterprise Spend Management products and services. In Q1 2004, we incurred merger-related costs of $2.1 million related to our financial advisor and other professional fees.

Restructuring charges. Throughout 2003 and Q1 2004, we initiated several restructuring programs that 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 $19.5 million as a result of these programs, of which $17.3 million relates to compensation and benefits and $2.2 million relates to rent and depreciation. Annual savings are expected to be

realized in the following income statement line items: $9.8 million in cost of revenues; $3.5 million in research and development; $4.0 million in sales and marketing; and $2.2 million in general and administrative. The following is a summary of these programs:

2003 Restructuring plans


	*Workforce reduction plan*

In Q1 2003, 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 liability for employee severance and termination benefit costs related to this activity was paid by December 31, 2003; and therefore no incremental liquidity resources will be utilized in the future to implement this plan. Annual savings from this plan are approximately $6.4 million, of which approximately $1.6 million was realized in compensation and benefit costs of our Q1 2004 operating results. Annual savings for this plan are expected to be realized in the following income statement line items: $3.7 million in cost of revenues; $1.0 million in research and development; $1.0 million in sales and marketing; and $642,000 in general and administrative.


	*Facility reduction plan*

Also in 2003, we re-assessed our global headquarters office space in Pittsburgh, Pennsylvania, and ceased using two of the floors we lease through May 2010. We recorded a restructuring charge of $3.0 million and $2.0 million in Q1 2003 and Q4 2003, respectively. We intend to sub-lease these floors, and estimated sublease income based on current real estate market conditions.

The facility reduction plan includes $2.9 million and $1.8 million of estimated future obligations for non-cancelable lease payments generated by exiting excess leased floors in Q1 2003 and Q4 2003, respectively, and $89,000 and $282,000 for the impairment of property and equipment (leasehold improvements) that were no longer in use in Q1 2003 and Q4 2003, respectively. The accrual for lease costs (net of anticipated sub-lease proceeds) will be paid over the lease term though May 2010. As of March 31, 2004, $688,000 of the $4.2 million accrual will be paid in the twelve month period from March 31, 2004, and is therefore classified as a current liability in the Company’s consolidated balance sheet. The $688,000 current liability also represents our expected liquidity requirements in the next twelve months to continue the implementation of this plan. Annual savings from this plan are $717,000 of which $179,000 was realized in rent and depreciation costs of our Q1 2004 operating results. Annual savings for this plan are expected to be realized in the following income statement line items: $447,000 in cost of revenues; $123,000 in research and development; $123,000 in sales and marketing; and $24,000 in general and administrative.


	*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 net elimination of 74 positions in our European business. There were 105 positions eliminated with the closing of our Brussels facility, offset by 31 positions added to our existing European facilities in London, Paris and Frankfurt. We recorded a restructuring charge of $3.2 million in Q3 2003 covering these severance costs and legal fees. As of March 31, 2004, the severance costs have been paid in accordance with local employment laws; and therefore no incremental liquidity resources will be utilized in the future to implement this portion of the Europe plan.

In Q4 2003, we recorded an additional charge of $4.2 million. This charge includes $847,000 of severance costs, $1.8 million of estimated future obligations for non-cancelable lease payments generated by exiting the Brussels facility, $1.2 million for the impairment of property and equipment (primarily leasehold improvements) that were no longer in use, and $308,000 for restructuring plan implementation costs, primarily comprised of legal and other professional fees. We intend to sub-lease the facility, and estimated sublease income based on current real estate market conditions. We expect to pay the remaining restructuring accrual relating to severance and implementation in the amount of $617,000 in Q2 2004. The accrual for lease costs (net of anticipated sub-lease proceeds) will be paid over the lease term through August 2006. As of March 31, 2004, $702,000 of the

$1.1 million accrual for lease costs will be paid in the next twelve months, and is therefore classified as a current liability in our consolidated balance sheet. The $617,000 remaining payments for severance and implementation and $702,000 current liability for lease costs represents our expected liquidity requirements for the next twelve months to continue the implementation of this portion of the Europe plan. Annual savings from this plan are $5.8 million, of which approximately $750,000 was realized in compensation and benefits costs and $249,000 in rent and depreciation costs in our Q1 2004 operating results. Annual savings from this plan are expected to be realized in the following income statement line items: $3.4 million in cost of revenues; $159,000 in research and development; $1.7 million in sales and marketing; and $579,000 in general and administrative.

In Q1 2004, as a result of substantially completing the liquidation of the investment in the Belgium entity, we recorded a benefit of $617,000 relating to the amount accumulated in the translation component of equity.

2004 Restructuring plans


	*Workforce reduction plan*

In Q1 2004, we executed a restructuring plan resulting in the elimination of 69 positions in our global workforce. This represented approximately 7% of total employees. We recorded a restructuring charge of $2.0 million in Q1 2004 covering these severance costs. The remaining liability for employee severance and termination benefit costs of $131,000 will be paid in Q2 2004, which represents our expected liquidity requirements to conclude this plan. Annual savings from this plan are approximately $6.1 million, of which approximately $950,000 was realized in compensation and benefit costs of our Q1 2004 operating results. Annual savings from this plan are expected to be realized in the following income statement line items: $2.0 million in cost of revenues; $2.1 million in research and development; $1.0 million in sales and marketing; and $853,000 in general and administrative.


	*Facility reduction plan*

Also in Q1 2004, we re-assessed our global headquarters office space in Pittsburgh, Pennsylvania, and ceased using one of the floors we lease through May 2010, as well as closed two domestic offices. We recorded a restructuring charge of $2.8 million in Q1 2004. We intend to sub-lease the floor in our global headquarters, and estimated sublease income based on current real estate market conditions.

The 2004 facility reduction plan includes $2.4 million of estimated future obligations for non-cancelable lease payments generated by exiting an excess leased floor and two domestic offices, $331,000 for the impairment of property and equipment (primarily leasehold improvements) that were no longer in use and $81,000 for restructuring plan implementation costs. The accrual for lease costs (net of anticipated sub-lease proceeds) will be paid over the lease term though May 2010. As of March 31, 2004, $543,000 of the $2.3 million accrual will be paid in the twelve month period from March 31, 2004 and is therefore classified as a current liability in our consolidated balance sheet. The $543,000 current liability also represents our expected liquidity requirements in the next twelve months to continue the implementation of this plan. Annual savings from this plan are $464,000, of which $44,000 was realized in rent and depreciation costs of our Q1 2004 operating results. Annual savings from this plan are expected to be realized in the following income statement line items: $269,000 in cost of revenues; $74,000 in research and development; $74,000 in sales and marketing; and $47,000 in general and administrative.

We are continuing to evaluate our office space requirements at our headquarters, and as a result, we may incur additional lease-related charges in the future.

The following table sets forth an analysis of the restructuring accrual activity for the period ended March 31, 2004:



		2004 Restructuring Plan						2003 Restructuring Plan

		Workforce			Facility			Facility			European
		Reduction			Reduction			Reduction			Restructuring
		Plan			Plan			Plan			Plan			Total

Balance as of December 31, 2003		$	—		$	—		$	4,318		$	2,762		$	7,080




Restructuring charge in Q1 2004:




	Severance and benefits		1,966			—			—			—			1,966




	Accrued lease costs		—			2,370			—			—			2,370




	Property and equipment impairment		—			331			—			—			331




	Implementation costs		—			81			—			—			81




	Liquidation of subsidiary		—			—			—			(617	)		(617	)

	Total charge in Q1 2004		1,966			2,782			—			(617	)		4,131




Cash paid			(1,835	)		(165	)		(163	)		(1,015	)		(3,178	)




Amounts utilized			—			(331	)		—			617			286

Balance as of March 31, 2004		$	131		$	2,286		$	4,155		$	1,747		$	8,319

Interest and other income, net. Interest and other income, net decreased from $989,000 in Q1 2003 to $691,000 in Q1 2004. The decrease was primarily attributable to a decrease in average cash and marketable investments in Q1 2004 compared to Q1 2003 and a reduced weighted-average rate of return on cash and marketable investments. In Q1 2003, we earned $814,000 at a weighted-average rate of return of 2.5%, compared to $427,000 at a rate of return of 1.4% in Q1 2004.

Provision for income taxes. Provision for income taxes was $291,000 in Q1 2003 and $315,000 in Q1 2004, and is comprised of foreign income taxes.

Liquidity and Capital Resources


		March 31,			December 31,
		2004			2003			Change


		($ in thousands)




Cash and cash equivalents		$	60,850		$	102,935		$	(42,085	)




Marketable investments			46,900			33,739			13,161

	Total cash and investments	$	107,750		$	136,674		$	(28,924	)

	Percentage of total assets		62	%		75	%		13 pts




Working capital		$	78,382		$	108,850		$	30,468




Days sales outstanding (DSO)			70			63



	Three Months Ended
	March 31,

	2004			2003			Change


	($ in thousands)




Cash flows from operating activities	$	(15,702	)	$	(6,564	)	$	(9,138	)




Cash flows from investing activities		(29,084	)		17,401			(46,485	)




Cash flows from financing activities		2,701			(35	)		2,736

Net cash used in operating activities totaled $6.6 million in Q1 2003 and $15.7 million in Q1 2004. Cash used in operations in both periods is primarily due to operating losses incurred as a result of the 20% and 13% decrease in revenues from Q1 2002 to Q1 2003 and Q1 2003 to Q1 2004, respectively, and the payment of our annual incentive-based compensation of $7.5 million and $6.9 million, respectively. The use of cash in Q1 2004 is also attributable to the payment of merger-related costs of $2.1 million and an increase in DSO’s from 59 days

to 70 days in Q1 2003 and Q1 2004, respectively. Net cash from operating activities in Q1 2003 and Q1 2004 does not reflect $3.8 million and $938,000, respectively, received under our service contract with Visteon.

Net cash provided by investing activities totaled $17.4 million in Q1 2003, compared to net cash used in investing activities of $29.1 million in Q1 2004. The use of cash in investing activities in Q1 2004 is primarily attributable to $14.8 million of cash used to acquire Covisint, an independent e-business provider for the global automotive industry. See Note 5 to the consolidated financial statements. 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 inflow in Q1 2003 was $17.6 million, compared to net cash outflow of $13.0 million in Q1 2004.

Net cash used in financing activities totaled $35,000 in Q1 2003, compared to net cash provided by financing activities of $2.7 million in Q1 2004. The net cash used in financing activities in Q1 2003 primarily reflect $3.6 million to purchase common stock and $874,000 in debt repayments, partially offset by $3.8 million received under our service agreement with Visteon. The net cash provided by financing activities in Q1 2004 primarily reflects $2.1 million in proceeds from option exercises and $938,000 received under our service agreement with Visteon.

In February 2003, we entered into the sixth amendment to our revolving credit facility and term loan, which reduced the availability under the revolving credit facility from $20.0 million to $15.0 million and extended the maturity date through February 2004. Borrowings under the revolving credit facility and term loan bear interest at the lender’s prime rate and prime rate +0.50%, respectively. In December 2003, we entered into the seventh amendment, which modified the financial covenant on minimum earnings to exclude non-recurring restructuring charges relating to our Facilities Reduction Plan and the European Restructuring Plan for the quarter ended December 31, 2003. In February 2004, we entered into the eighth amendment, which extends the maturity date through the earlier of August 31, 2004 or one business day before the effective date of the anticipated merger with Ariba. In April 2004, we entered into the ninth amendment, which modified the financial covenant on tangible net worth to reflect the impact of the Covisint acquisition. As of March 31, 2004, $389,000 was outstanding under the term loan and the interest rate was 4.5%. At March 31, 2004, $14.8 million was available under the revolving credit facility based on eligible accounts receivable.

Our current bank credit facility contains restrictive covenants, including a limitation on incurring additional indebtedness and paying dividends. Our bank credit facility also includes financial covenants as to maximum capital expenditures, minimum tangible net worth, minimum earnings and minimum quick ratio. We have pledged substantially all of our tangible assets as collateral for the current credit facility. We are currently in compliance with all covenants.

In conjunction with the anticipated merger with Ariba, we have incurred $2.1 million in pretax merger-related costs through March 31, 2004. Upon closing of the merger we become obligated to pay $2.5 million in merger-related investment banking fees.

We will continue to invest in the growth of our business. In Q2 2004, we anticipate negative net cash flows as a result of operating losses in Q2 2004, with positive net cash flows in the second half of 2004. 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. We may decide to use cash resources to fund 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, 2004, our marketable investment allocation represents 44% of total cash and investments, compared to 25% at December 31, 2003. If we are unable to continue to control costs, 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.

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, 2004, we had purchased and retired 1,298,500 shares at a weighted average share price of $4.93.

In September 2003, an arbitrator ruled in our favor in proceedings against a Brazilian former 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.

There have been no material changes in our contractual obligations and commercial commitments during the quarter ended March 31, 2004 from those presented in our Annual Report on Form 10-K/ A, as filed with the SEC on April 29, 2004.

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, 2004 that would require an update to the disclosure in our Annual Report on Form 10-K, as filed with the SEC on March 1, 2004.

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 acting Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures. Based on that evaluation, the Chief Executive Officer and acting 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.

PART II — OTHER INFORMATION

Item 1. Legal Proceedings

See Note 7 to the Condensed Consolidated Financial Statements.

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits.


Exhibit
Number		Description

2		Agreement and Plan of Merger and Reorganization among Registrant, Fleet Merger Corporation and Ariba, Inc. dated as of January 23, 2004 (which is incorporated herein by reference to Exhibit 2.1 of Form 8-K dated January 27, 2004)
10.3(f)		Eighth Amendment to Credit Agreement between the registrant and the banks party thereto and PNC Bank, National Association as administrative agent, and Silicon Valley Bank, as syndication agent, dated as of February 20, 2004
31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Certification of acting Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32		Certification by the Chief Executive Officer and acting Chief Financial Officer Relating to a Periodic Report Containing Financial Statements

(b) Reports on Form 8-K.

On January 27, 2004, the Company filed a Form 8-K reporting the Plan of Merger and Reorganization with Ariba, Inc.

On February 2, 2004, the Company filed a Form 8-K, furnished under item 12, “Results of Operations and Financial Condition” (with respect to a press release relating to the Company performance in 2003).

* * * * * *

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 April 29, 2004.


	FREEMARKETS, INC.


	By:	/s/ SEAN M. ROLLMAN



	SEAN M. ROLLMAN
	Vice President, Controller, Treasurer and acting
	Chief Financial Officer
	(Principal Financial and Accounting Officer)

EXHIBIT INDEX


Exhibit
Number		Description

2		Agreement and Plan of Merger and Reorganization among Registrant, Fleet Merger Corporation and Ariba, Inc. dated as of January 23, 2004 (which is incorporated herein by reference to Exhibit 2.1 of Form 8-K dated January 27, 2004)

10.3(f)		Eighth Amendment to Credit Agreement between the registrant and the banks party thereto and PNC Bank, National Association as administrative agent, and Silicon Valley Bank, as syndication agent, dated as of February 20, 2004.

31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2		Certification of acting Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32		Certification by the Chief Executive Officer and Acting Chief Financial Office Relating to a Periodic Report Containing Financial Statements

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