FREEMARKETS INC - 10-K Annual Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT
TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

(Mark One)

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934

FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NUMBER 000-27913
FREEMARKETS, INC.
(Exact Name of Registrant as Specified in its Charter)

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

FREEMARKETS CENTER
210 SIXTH AVENUE
PITTSBURGH, PA 15222
(Address of Principal Executive Offices) (Zip Code)

Registrant's telephone number, including area code: (412) 434-0500
Registrant's URL: http://www.freemarkets.com

Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on Which Registered
----------------- ------------------------------------------
NONE NOT APPLICABLE

Securities registered pursuant to Section 12(g) of the Act:

COMMON STOCK, PAR VALUE $.01 PER SHARE
(Title of Class)

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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]

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

Aggregate market value of voting common stock held by
non-affiliates of the registrant as of June 28, 2002...... $566,768,557
Number of shares of the registrant's common stock
outstanding as of February 28, 2003....................... 41,919,663

DOCUMENTS INCORPORATED BY REFERENCE

The information called for by Part III (other than "Securities Authorized
for Issuance under Equity Compensation Plans") is incorporated by reference to
specified portions of the Registrant's definitive Proxy Statement to be provided
to stockholders in conjunction with the Registrant's 2003 Annual Meeting of
Stockholders, which is expected to be filed not later than 120 days after the
Registrant's fiscal year ended December 31, 2002.
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FREEMARKETS, INC.
FORM 10-K
INDEX

i

PART I

ITEM 1. BUSINESS

Certain statements contained in this Annual Report on Form 10-K ("Form
10-K") 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. Please refer to the risk factors set forth in
the section entitled "Additional Factors that May Affect Future Results" for a
description of some of the risk factors that could cause our results to differ
materially from our forward-looking statements.

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 18 locations in 14 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 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 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.

INDUSTRY BACKGROUND

GLOBAL SUPPLY MANAGEMENT

Global Supply Management is the set of activities that links a buyer of
goods and services with its suppliers and helps it to manage and streamline the
process through which it sources the goods and services it purchases. We believe
that a number of factors are driving the development of GSM as a strategic tool
in a company's procurement process.

- GLOBALIZATION

Market economies are expanding demand around the world, while technology is
accelerating suppliers' abilities to provide lower cost, higher quality
goods and services.

- CONSOLIDATION

Industries around the world are consolidating. Supply management is key to
realizing acquisition integration synergies.

- VELOCITY

Global competition and improved technology are shrinking new product
introduction and order-to-delivery times. These factors in turn require
companies to select the best suppliers and integrate them into their core
enterprise activities.

- OUTSOURCING

Increasingly, companies are narrowing their focus on core activities and
outsourcing non-core activities to outside suppliers. As a result, a larger
portion of the final good or service is produced by someone other than the
original manufacturer.

- PROFITABILITY

Total cost savings driven by supply management can be dramatic. As margins
decrease, either due to higher costs or lower revenues, it becomes more
critical to achieve savings on supply management costs. Importantly, in a
weak economy, savings realized as a result of effective supply management
can exceed revenue growth.

- RISK

As supply chains become more complex through globalization, consolidation
and outsourcing, the probability of supply failures increases, creating
higher levels of risks for companies in terms of product innovation,
order-to-delivery times and customer satisfaction.

As a result of these factors, effective supply management can have a
dramatic impact on profitability and has become an increasingly important
enterprise function.

THE GLOBAL SUPPLY MANAGEMENT PROCESS

GSM enables the enterprise to enhance the capabilities of its supply
management organization through effective management of its supply of goods and
services:

[Global Supply Management Graphic]

- SUPPLY ANALYSIS AND STRATEGY

An enterprise must first determine what goods and services it needs, as
well as the strategies for how, when and from whom it should buy them. To
accomplish this, a company must analyze its spend, the performance and
abilities of its current suppliers and the trends in global supply markets.
Supply managers collaborate with engineering, manufacturing and other
enterprise functions to develop supply strategies in-line with future
product plans and enterprise strategy.

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- SPEND REQUIREMENTS MANAGEMENT

Once the supply strategy is determined, supply managers gather detailed
spend requirements from in-house "users". These requirements can include
technical drawings and specifications, packaging, logistics, etc. Over
time, supply managers must analyze these spend requirements to decrease the
total cost of their supplies. Accurately gathering and maintaining these
supplies over time is a critical supply management activity.

- SOURCING

The next step is for supply managers to evaluate and select suppliers. The
sourcing process includes gathering and evaluating supplier capabilities,
communicating the necessary requirements and negotiating with suppliers
through various techniques. The sourcing process requires close
collaboration between supply managers in multiple locations and divisions
to ensure maximum bargaining power and process efficiency. We believe that
supply managers ultimately select suppliers based upon a total cost and
risk evaluation.

- SUPPLIER DEVELOPMENT

After sourcing, an entity must formally qualify suppliers in terms of their
production, quality and management practices. If approved, the supply
manager works with the supplier as well as the internal users to transition
the supply of goods or services to them. Supply managers collaborate with
internal users and suppliers to guide and improve their capabilities over
time.

- SUPPLIER RELATIONSHIP MANAGEMENT

As part of the ongoing relationship, supply managers monitor supplier
performance and activity to ensure contract compliance, acceptable quality,
delivery, etc. Monitoring contract expirations helps supply managers
proactively manage their sourcing and supplier relationships.

FREEMARKETS(R) GSM SOLUTIONS

Our solutions combine software, services and information, and are designed
to address the full range of supply management activities. These solutions are
designed to help companies lower costs and reduce their supply risks. Our
portfolio of GSM solutions includes:

FREEMARKETS(R) FULLSOURCE(TM)

FreeMarkets FullSource is a set of technology-enhanced services designed to
help companies generate savings from their sourcing activities and lower
their supply risks. FreeMarkets FullSource combines online bidding
technology with services in hundreds of spend categories, industry-specific
program management, around-the-clock global market operations services,
knowledge about specific commodities and supply market dynamics. Through
FullSource, we help our customers identify and screen global suppliers and
assemble a request for quotation that provides detailed, clear and
consistent information for suppliers to use as a basis for their
competitive bids. Since 1995, our customers have sourced over $51 billion
of goods and services through our FullSource offering. FullSource
represented 85% of our 2002 revenues, and is expected to account for a
majority of revenues in 2003.

FREEMARKETS(R) QS(TM)

FreeMarkets QS is a hosted software application that enables companies to
create and run their own sourcing projects. We offer optional add-on
services designed to enhance the use of QS, and provide our customers with
additional capabilities that they may need to create effective online
markets and achieve their strategic sourcing objectives. Our QS software is
available in English, French, German, Italian, Spanish and Portuguese.

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FREEMARKETS(R) ES(TM)

FreeMarkets ES enables companies to perform global supply management
activities effectively and efficiently to reduce their total supply costs
and supplier risk. FreeMarkets ES contains software modules that facilitate
increased communication between purchasers and the users of goods and
services, enable purchasers to re-use information, standardize sourcing
processes and evaluation criteria and facilitate the effective management
of contract compliance.

FREEMARKETS(R) SPEND VISIBILITY SOLUTION

FreeMarkets Spend Visibility Solution is an integrated offering that
combines analysis software with data collection, cleansing and enhancement
services, and provides companies visibility into what they spend globally
on goods and services.

FREEMARKETS(R) SAVINGS IMPLEMENTATION SOLUTION

FreeMarkets Savings Implementation Solution combines software and services
to help companies improve the speed and quality with which they engage and
interact with new suppliers to serve their operations.

FREEMARKETS(R) GLOBAL SERVICE SOLUTIONS

FreeMarkets offers a range of services to support its GSM solutions. These
solutions include support, consulting, sourcing and global education
services.

COMPETITION

A number of companies provide GSM software and/or services. Competition in
this market is rapidly evolving, and we expect competition to intensify in the
future, which could lead to price reductions, reduced gross margins and loss of
market share. We currently or potentially will compete with a number of other
companies, including:

- providers of enterprise software, extending their offerings to include
services or technology similar to ours;

- professional service and consulting firms, and others offering managed
sourcing and supply management services similar to ours; and

- providers of stand-alone, self-service software products that make
available to buyers point-solution GSM technology.

EMPLOYEES

As of December 31, 2002, we had 1,068 employees worldwide, including 576 in
account management, global sourcing services and market operations, 135 in
research and development, 169 in sales and marketing, 71 in technical operations
and 117 in executive leadership, administration, human resources, legal, finance
and facilities management. Our global workforce consists of 758 team members in
North America, 184 in Europe, 119 in Asia and Australia and 7 in South America.
In January 2003, we eliminated 71 positions, or 7% of our workforce to better
align our cost structure with our anticipated future revenues. None of our
employees is represented by a collective bargaining agreement, and we believe
that we have good relations with our employees.

CORPORATE HISTORY

We were originally incorporated in 1995 as "Online Markets Corporation". We
changed our name to "FreeMarkets OnLine, Inc." shortly after our formation, and
then changed our name again in September 1999 to "FreeMarkets, Inc."

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AVAILABLE INFORMATION

Our Internet address is www.freemarkets.com. We make available free of
charge through our website our annual report on Form 10-K, quarterly reports on
Form 10-Q, current reports on Form 8-K and amendments to those reports filed or
furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of
1934 as soon as reasonably practicable after we electronically file such
material with, or furnish it to, the Securities and Exchange Commission.

ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS

WE EXPECT OUR TOTAL REVENUES TO DECLINE IN 2003 DUE TO AN ANTICIPATED REDUCTION
IN THE UTILIZATION OF FULLSOURCE

We expect the revenues we receive from our FullSource offering to decline
in 2003. The reduction in revenues from FullSource is due to a combination of
factors, including a change in the mix of products deployed by our customers and
the weak macroeconomic environment, which we believe has caused customers to
postpone their purchasing decisions. In 2002, several large customers renewed
their FullSource access and service agreements at lower market volumes than the
volumes provided in their existing agreements. Since our negotiated fees reflect
the anticipated volume in our marketplace, lower market volumes will result in
lower revenues from our FullSource offering to these customers in 2003. In
addition, as certain customers gained experience with our QS solution, they
migrated a portion of their sourcing requirements from FullSource to our
lower-priced self-service technology. In some cases, increased sales of new
products resulted in lower total revenues as a result of this migration. We
acquired an insufficient number of new customers in 2002 to compensate for the
reduction in revenues from existing customers due to these factors. FullSource
represented 85% of our 2002 revenues, and is expected to account for a majority
of our revenues in 2003. However, we do not expect that sales of new products
will compensate for the reduction in revenue from our FullSource offering and
expect that total revenues for 2003 will be lower than 2002.

WE CANNOT BE CERTAIN THAT OUR NEW GLOBAL SUPPLY MANAGEMENT SOLUTIONS WILL BE
ACCEPTED IN THE MARKETPLACE

We are currently in the midst of a strategic transition from a company that
offers a single technology-enhanced service to a provider of a broader range of
software, services and information solutions. There are significant risks
associated with this strategy. The market for supply management products is
still evolving, and there can be no guarantee that our new products will gain
the market acceptance we anticipate. The technology is complex and may contain
undetected errors or defects that we may not be able to fix. Reduced market
acceptance of our services or software due to errors or defects in our
technology would reduce revenues and could damage our reputation in the
marketplace. In addition, our management has limited experience in managing a
multi-product company. The management challenges will be exacerbated by the
current weak economic environment and continued relatively low levels of
technology spending.

OUR OPERATING RESULTS ARE VOLATILE AND TRENDS ARE DIFFICULT TO PREDICT; IF WE
FAIL TO MEET THE EXPECTATIONS OF PUBLIC MARKET ANALYSTS OR INVESTORS, THE MARKET
PRICE OF OUR COMMON STOCK MAY DECLINE

Our quarterly operating results have varied significantly in the past and
will likely vary significantly in the future. For example, over the past four
quarters, our net loss has ranged from as high as $11.5 million to as low as
$87,000. Based on our transition to a new business model and the continued weak
state of the economy, you should not rely upon our past quarterly operating
results as indicators of future performance. In addition, our operating results
could fall below the expectations of securities analysts or investors in some
future quarter or quarters. As a result, the price of our common stock may fall.

OUR INDUSTRY IS HIGHLY COMPETITIVE, AND WE CANNOT ASSURE YOU THAT WE WILL BE
ABLE TO EFFECTIVELY COMPETE

The market for GSM software and service solutions is intensely competitive.
If we cannot successfully compete, our business will suffer reduced revenues and
operating results. As one of a number of companies providing GSM solutions to
market, we face the risk that existing and potential customers may choose to
purchase competitors' services or products. If they do, then our revenues and
operating results will be reduced.

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Given that barriers to entry are relatively low, we expect competition to
intensify as new competitors enter the market.

WE HAVE EXPERIENCED REVENUE AND FEE CONCENTRATION IN THE PAST; THE LOSS OF OUR
LARGEST CUSTOMERS WOULD REDUCE OUR REVENUES AND FEES AND OPERATING RESULTS, AND
COULD CAUSE OUR STOCK TO FALL

In 2001 and 2002, our top five customers comprised over 20% of our revenues
and fees. The loss of any one of these significant customers would reduce our
revenues and fees and operating results, and may cause a decrease in our stock
price.

GENERAL ECONOMIC CONDITIONS MAY ADVERSELY AFFECT OUR FUTURE OPERATIONS AND
OPERATING RESULTS

The continued slowdown in the global economy had an effect on our
operations in 2002, which partially impacted the growth of our FullSource online
market volume and contributed to a slowdown in the growth of our total customers
during the year. If the global economic slowdown continues, customers may
continue to defer or postpone their purchasing decisions. The slowdown may have
the effect of increasing the length of sales cycles for our products and
services. In addition, the amount of fixed monthly fees that we are able to
negotiate for new customers may be adversely affected based on lower anticipated
market volume from our customers. The amount of revenue we earn from variable
fees, such as performance incentive payments based on volume and/or savings, may
also decline as a result of lower volumes.

WE HAVE ACQUIRED IN THE PAST AND MAY IN THE FUTURE ACQUIRE COMPLEMENTARY
BUSINESSES OR TECHNOLOGIES; ACQUISITIONS MAY DILUTE OUR EXISTING STOCKHOLDERS
AND WE MAY NOT ACHIEVE ANY OF THE BENEFITS WE WOULD EXPECT FROM AN ACQUISITION

If appropriate opportunities present themselves, we may acquire additional
businesses, technologies, services or products that we believe are strategic,
and any such acquisitions may be material in size. We may not be able to
successfully identify, negotiate or finance any future acquisition. Even if we
do succeed in acquiring a business, technology, service or product, we have
limited experience in integrating an acquisition into our business. The process
of integrating any acquired company may produce unforeseen operating
difficulties and expenditures, and may absorb significant attention of our
management that would otherwise be available for the ongoing development of our
business. Moreover, we may not achieve any of the benefits that we might
anticipate from an acquisition. If we make acquisitions, we may issue shares of
stock that dilute other stockholders, incur debt or assume contingent
liabilities. Any financing that we might need for acquisitions may only be
available to us on terms that restrict our business or that impose additional
costs that reduce our operating results.

WE MAY WRITE-DOWN THE UNAMORTIZED GOODWILL FROM SURPLUS RECORD OR THE INVESTMENT
IN ADEXA, INC. ("ADEXA"), WHICH WOULD REDUCE OUR FINANCIAL RESULTS

We adopted the provisions of Statement of Financial Accounting Standards
("SFAS") No. 142, "Goodwill and Other Intangible Assets", on January 1, 2002,
and no longer record goodwill amortization. In connection with adopting this
standard, we determined that the carrying value of Surplus Record exceeded its
estimated fair value, as determined utilizing various valuation techniques
including discounted cash flow and comparative market analysis. We recorded an
impairment loss of $5.3 million in 2002 that was recognized as the cumulative
effect of an accounting change. The carrying value of goodwill on our
consolidated balance sheet as of December 31, 2002 was $2.0 million. 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.
The recognition of any future impairment loss could have a material effect on
our financial results.

As part of the agreement to mutually terminate our proposed merger with
Adexa in 2001, we agreed to make an investment in Adexa in the amount of $6.0
million. We concluded in 2002 that there was an other-than-temporary decline in
the value of our investment based on a valuation determined by a financing
completed by Adexa. As a result, we recorded a $5.1 million loss on our
investment in 2002. The carrying value of the investment as of December 31, 2002
was $889,000. Any further write-downs of this investment

6

based on additional other-than-temporary declines in fair value could have a
material effect on our financial results.

WE HAVE HISTORICALLY USED MORE CASH THAN WE GENERATE

Since our inception, our operating and investing activities have used more
cash than they have generated. Although we generated positive cash flows in 2002
and anticipate generating positive cash flows in the second half of 2003, we may
decide to use resources to fund acquisitions of complementary businesses and
technologies. 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 control costs, our resources may be depleted, and
accordingly, our current resources may only be sufficient for a shorter period.
In either event, thereafter, we may find it necessary to obtain additional
financing. In the event that additional financing is required, we may not be
able to raise it on terms acceptable to us, if at all.

WE HAVE HISTORICALLY GENERATED LOSSES

We achieved a modest profit in 1998, but incurred losses of $21.8 million,
$156.4 million, $295.2 million and $17.6 million in 1999, 2000, 2001 and 2002,
respectively, as a result of our efforts to invest in the actual and anticipated
growth of our business. Since our inception in 1995, we have accumulated losses
of $494.2 million. Our achievement of profitability in the future will depend on
whether we can implement the strategic transition from a company that offers a
single technology-enhanced service to one with multiple software and service
solutions and increase revenues while controlling costs. We may not achieve
profitability in the future, or sustain any future profitability.

CUSTOMERS MAY NOT PURCHASE OUR SERVICES IF WE ARE UNABLE TO GENERATE SIGNIFICANT
SAVINGS

If our software and services increase the efficiency of any particular
supply market, the future likelihood of significant savings to our customers in
that market may decrease. Factors beyond our control may limit our ability to
generate savings. If the magnitude of savings in particular product categories
decreases, we may have difficulty in the future selling our software and
services to buyers in those markets, or attracting willing suppliers in other
markets, either of which will reduce our revenues and operating results.

WE MAY NOT BE ABLE TO ADJUST OUR SPENDING QUICKLY; IF WE CANNOT, THEN OUR
OPERATING RESULTS WILL BE REDUCED

Our planned expense levels are relatively fixed in the short term and are
based on our anticipation of future revenues. We may not be able to accurately
forecast revenues. The difficulty of forecasting our revenues is increased due
to current challenging economic conditions that face many of our existing and
potential customers, and which may cause them to defer or postpone their
purchasing decisions in response to changes in their business. If we fail to
accurately predict revenues in relation to our planned expense levels, then we
may be unable to adjust our costs in a timely manner in response to
lower-than-expected revenues, and our operating results may be negatively
affected.

WE MAY NOT BE ABLE TO HIRE OR RETAIN QUALIFIED STAFF

If we cannot attract and retain adequate qualified and skilled staff, the
growth of our business may be limited. Our ability to provide software and
services to customers and grow our business depends, in part, on our ability to
attract and retain staff with college and graduate degrees, as well as
professional experiences that are relevant for sourcing, supply management,
software development and other functions we perform. Competition for personnel
with these skill sets is intense. Some technical job categories are under
conditions of severe shortage in the United States. In addition, restrictive
immigration quotas could prevent us from recruiting skilled staff from outside
the United States. We may not be able to recruit or retain the caliber of staff
required to carry out essential functions at the pace necessary to sustain or
grow our business. Our ability to recruit and retain qualified personnel may be
adversely affected by the decline in the price of our common stock. Stock
options are an important component of our overall compensation package and, in
current market conditions, may not provide appropriate incentives to our current
and prospective employees.

7

OUR SALES CYCLE IS LONG AND UNCERTAIN AND MAY NOT RESULT IN REVENUES; FACTORS
OUTSIDE OF OUR CONTROL MAY AFFECT THE DECISION TO PURCHASE OUR SOFTWARE AND
SERVICES

Our sales cycle is long, typically taking from two to six months from
initial customer contact until we sign a contract. Not every potential customer
that we solicit actually purchases our products and services. Because we offer
solutions to address the evolving GSM market, we must educate potential
customers on the use and benefits of our products and services. We need to spend
a significant amount of time with multiple decision makers in a prospective
customer's organization to sell our products and services. Other factors that
contribute to the length and uncertainty of our sales cycle and that may reduce
the likelihood that customers will purchase our solutions include:

- budgeting constraints;

- incentive structures that do not reward decision makers for savings
achieved through cost-cutting;

- the strength of pre-existing supplier relationships;

- competition from other providers of GSM solutions; and

- an aversion to new purchasing methods.

IF OUR SHORT-TERM AGREEMENTS DO NOT LEAD TO LONG-TERM CUSTOMER RELATIONSHIPS,
OUR BUSINESS MAY NOT BE PROFITABLE

Frequently, we begin a relationship with a new customer by entering into a
short-term agreement that we hope will lead to a long-term agreement. Failure to
move a sufficient number of customers from short-term to long-term agreements
could hurt our operating results. For example, our initial agreement with a
customer for our FullSource offering usually involves a period of trial and
evaluation. This initial period, in which we learn about our customer's business
and its related product categories, and educate our customer about the best use
of our products for its organization, requires a very significant expenditure of
our time and resources. A subsequent longer-term agreement is often more
productive given the parties are more familiar with each other, and typically
provides for higher gross margins. Customers may decide not to enter into a
long-term agreement with us, or may delay entering into such an agreement until
a later time. Because we invest a significant amount of time and resources early
in a customer relationship, our cost of revenues as a percentage of revenues are
typically higher at the outset of a relationship than those which we may incur
later. Further, we may be diverting personnel from higher-margin opportunities
to develop a new relationship, without any assurance that the new relationship
will endure. We expect similar purchasing patterns to occur with our more recent
offerings as customers become accustomed to our new solutions.

FACTORS OUTSIDE OUR CONTROL COULD RESULT IN DISAPPOINTING MARKET RESULTS;
DISAPPOINTED CUSTOMERS MAY CANCEL OR FAIL TO RENEW THEIR AGREEMENTS WITH US

The actual savings achieved through the use of our solutions vary widely
and depend upon many factors outside of our control. These factors include:

- the current state of supply and demand in the supply market for the
products and services being purchased;

- the past performance of our customer's purchasing organization in
negotiating favorable terms with suppliers;

- the willingness of a sufficient number of qualified suppliers to bid for
business using our solutions;

- reductions in the number of suppliers in particular markets due to
mergers, acquisitions or suppliers exiting from supply industries; and

- seasonal and cyclical trends that influence all purchasing decision
making.

Because factors outside of our control affect a customer's perception of
the value of our solutions, customers may cancel our agreements or choose not to
renew them, even if we have performed well. Any non-renewal or cancellation of
agreements may reduce our revenues and operating results.

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FAILURES OF HARDWARE SYSTEMS OR SOFTWARE COULD UNDERMINE OUR CUSTOMERS'
CONFIDENCE IN OUR RELIABILITY

A significant disruption in the availability of our technology could
seriously undermine our customers' confidence in our business. Our customers
hold us to a high standard of reliability and performance. From time to time, we
have experienced service interruptions in our technology, with the most
significant being a breakdown in the connectivity between suppliers and our
technology. This connectivity is provided to us by an outside vendor, and this
kind of interruption may occur in the future. During these disruptions,
participants may lose their online connection or we may not receive their bids
or other information in a timely manner. Any interruptions in the availability
of our software, services or other information may undermine actual and
potential customers' confidence in the reliability of our business.

Conducting online markets, as well as providing other Global Supply
Management software via the World Wide Web, requires the successful technical
operation of an entire chain of software, hardware and telecommunications
equipment. This chain includes our software, the personal computers and network
connections of suppliers and buyers, our network servers, operating systems,
databases and networking equipment such as routers. A failure of any element in
this chain can partially or completely disrupt the delivery of our solutions to
customers.

Some of the elements set forth above are not within our control, such as
Internet connectivity and software, hardware and telecommunications equipment we
purchase from others. We frequently have supplier and buyer participants from
outside North America who may use older or inferior technologies that may not
operate properly. In addition, hardware and software are potentially vulnerable
to interruption from power failures, telecommunications outages, network service
outages and disruptions, natural disasters and vandalism and other misconduct.
Our business interruption insurance would not compensate us fully for any losses
that may result from these disruptions.

THE LOSS OF OUR KEY EXECUTIVES COULD DISRUPT OUR BUSINESS

None of our executive officers or other key employees is bound by an
employment agreement. We rely on the leadership and vision of the executive
officers identified in this Form 10-K, and the loss of any of these executives
could disrupt our business.

IF WE FAIL TO CONTINUALLY IMPROVE OUR TECHNOLOGY, OUR BUSINESS WILL SUFFER

Our solutions and the GSM market are characterized by rapidly changing
technologies and frequent new product and service introductions. We may fail to
introduce new technology on a timely basis or at all. If we fail to introduce
new technology or to improve our existing technology in response to industry
developments, we could experience frustration from our customers that could lead
to a loss of revenues.

IF WE DO NOT ADEQUATELY MAINTAIN OUR CUSTOMERS' CONFIDENTIAL INFORMATION, OUR
REPUTATION COULD BE HARMED AND WE COULD INCUR LEGAL LIABILITY

Any breach of security relating to our customers' confidential information
could result in legal liability for us and a reduction in use or cancellation of
our products and services, either of which could materially harm our business.
Our personnel receive highly confidential information from buyers and suppliers
that is stored in our files and on our computer systems. For example, we often
possess blueprints and product plans that could be valuable to our customers'
competitors if misappropriated. Similarly, we receive sensitive pricing
information that has historically been maintained as a matter of utmost
confidence within buyer and supplier organizations. We enter into standard
non-disclosure and confidentiality agreements with virtually all customers with
whom we deal.

We currently have practices and procedures in place to ensure the
confidentiality of our customers' information. However, our security procedures
to protect against the risk of inadvertent disclosure or intentional breaches of
security might fail to adequately protect information that we are obligated to
keep confidential. We may not be successful in adopting more effective systems
for maintaining confidential information, so our exposure to the risk of
disclosure of the confidential information of others may grow with

9

increases in the amount of information we possess. If we fail to adequately
maintain our customers' confidential information, some of our customers could
end their business relationships with us and we could be subject to legal
liability.

IF WE ARE NOT ABLE TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, THEN
OTHERS MAY BE ABLE TO DUPLICATE OUR SERVICES

We rely in part upon our proprietary technology, including our software, to
conduct our business. Our failure to adequately protect our intellectual
property rights could harm our business by making it easier for others to
duplicate our services. We have obtained seven patents on aspects of our
technology and business processes, and have filed applications for additional
patents. However, we cannot assure you that our existing patents or any patent
that may be issued in the future will not be successfully challenged by others
or invalidated, that they will adequately protect our technology and processes,
or that they will result in commercial advantages for us. We have also obtained
and applied for United States and foreign registrations for certain trademarks,
domain names and logos, and our software, documentation and other written
materials are copyrighted, but these protections may not be adequate. Although
we require each of our employees to enter into a confidentiality agreement and
some key employees are subject to non-competition agreements, these agreements
may not satisfactorily safeguard our intellectual property against unauthorized
disclosure.

We cannot be certain that third parties will not infringe or misappropriate
our proprietary rights or that third parties will not independently develop
similar proprietary information. Any infringement, misappropriation or
independent development could harm our future financial results. In addition,
effective patent, trademark, copyright and trade secret protection may not be
available in every country where we do business. We may, at times, have to incur
significant legal costs and spend time defending our trademarks, copyrights and,
if issued, our patents. Any defense efforts, whether successful or not, would
divert both time and resources from the operation and growth of our business.

There is also significant uncertainty regarding the applicability to the
Internet of existing laws regarding matters such as property ownership, patents,
copyrights and other intellectual property rights. Legislatures adopted the vast
majority of these laws prior to the advent of the Internet and, as a result,
these laws do not contemplate or address the unique issues of the Internet and
related technologies. We cannot be sure what laws and regulations may ultimately
affect our business or intellectual property rights.

OTHERS MAY ASSERT THAT OUR TECHNOLOGY INFRINGES THEIR INTELLECTUAL PROPERTY
RIGHTS

We do not believe that we infringe the proprietary rights of others but we
may be subject to infringement claims in the future. The defense of any claims
of infringement made against us by third parties could involve significant legal
costs and require our management to divert time from our business operations.
Either of these consequences of an infringement claim could have a material
adverse effect on our operating results. If we are unsuccessful in defending any
claims of infringement, we may be forced to obtain licenses or to pay royalties
to continue to use our technology. We may not be able to obtain any necessary
licenses on commercially reasonable terms or at all. If we fail to obtain
necessary licenses or other rights, or if these licenses are too costly, our
operating results may suffer either from reductions in revenues through our
inability to serve customers or from increases in costs to license third-party
technology.

OTHERS MAY REFUSE TO LICENSE IMPORTANT TECHNOLOGY TO US OR MAY INCREASE THE FEES
THEY CHARGE US FOR THIS TECHNOLOGY

We rely on third parties to provide us with some software and hardware, for
which we pay fees. This software has been readily available, and to date, we
have not paid significant fees for its use. These third parties may
significantly increase their fees or refuse to license their software or provide
their hardware to us. While other vendors may provide the same or similar
technology, we cannot be certain that we can obtain the required technology on
favorable terms, if at all. If we are unable to obtain required technology at a
reasonable cost, our growth prospects and operating results may be harmed
through impairment of our ability to conduct business or through increased cost.

10

FUTURE GOVERNMENT REGULATION OF THE INTERNET AND ONLINE MARKET SERVICES MAY ADD
TO OUR OPERATING COSTS

Like many Internet-based businesses, we operate in an environment of
tremendous uncertainty as to potential government regulation. We believe that we
are not currently subject to direct regulation of online sourcing or supply
management, other than regulations generally applicable to all businesses.
However, the Internet has rapidly emerged as a sourcing and supply management
medium, and governmental agencies have not yet been able to adapt all existing
regulations to the Internet environment. Laws and regulations may be introduced
and court decisions reached that affect the Internet or other online services,
covering issues such as user pricing, user privacy, freedom of expression,
access charges, content and quality of products and services, advertising,
intellectual property rights and information security. In addition, because we
offer our services worldwide and globally facilitate sales of goods to
customers, foreign jurisdictions may claim that we are required to comply with
their laws. Any future regulation may have a negative impact on our business by
restricting our method of operation or imposing additional costs.

As a company that conducts a portion of our business over the Internet, it
is unclear in which jurisdictions we are actually conducting business. Our
failure to qualify to do business in a jurisdiction that requires us to do so
could subject us to fines or penalties, and could result in our inability to
enforce contracts in that jurisdiction.

Numerous jurisdictions have laws and regulations regarding the conduct of
auctions and the liability of auctioneers. We do not believe that these laws and
regulations, which were enacted for consumer protection many years ago, apply to
our GSM solutions. However, one or more jurisdictions may attempt to impose
these laws and regulations on our operations in the future.

WE MAY BECOME SUBJECT TO CERTAIN SALES AND OTHER TAXES THAT COULD ADVERSELY
AFFECT OUR BUSINESS

The imposition of sales, value-added or similar taxes could diminish our
competitiveness and harm our business. We do not collect sales or other similar
taxes for goods purchased through our online markets. Our customers are large
purchasing organizations that typically manage and pay their own sales and use
taxes. However, we may be subject to sales tax collection obligations in the
future.

OUR INTERNATIONAL OPERATIONS SUBJECT US TO RISKS AND UNCERTAINTIES

We face risks in doing business internationally. We provide our solutions
to international buyers and often have international suppliers use our solutions
and participate in our markets. We have locations in Europe, Asia, Australia and
South America that serve our customers based abroad, as well as the European,
Asian, Australian and South American operations of our multinational customers
based in the United States. We may establish similar locations in other parts of
the world. We have experienced, and expect to continue to experience,
significant costs for our international operations as we add staff and
facilities in foreign countries. These costs, together with the costs of the
overhead needed to comply with legal, regulatory and accounting requirements
that differ from those in the United States, may reduce our operating results.
Finally, our international operations are subject to disruption from political
and economic instability in the countries in which they are located, which may
interrupt our ability to conduct business and impose additional costs upon us.

OUR STOCK PRICE IS VOLATILE, WHICH COULD RESULT IN SUBSTANTIAL LOSSES FOR
STOCKHOLDERS

The market price for our common stock is highly volatile and subject to
wide fluctuations in response to the risks described above and many other
factors, some of which are beyond our control. The market prices for stocks of
Internet companies and other companies whose businesses are heavily dependent on
the Internet have generally proven to be highly volatile, particularly over the
last three years.

11

EXECUTIVE OFFICERS OF THE REGISTRANT

The following table sets forth information regarding our executive officers
as of February 28, 2003.

GLEN T. MEAKEM co-founded FreeMarkets in 1995 and has served as its
Chairman of the Board of Directors since inception. Mr. Meakem also held the
offices of President and Chief Executive Officer from FreeMarkets' inception
until June 2000 and January 2003, respectively. Prior to co-founding
FreeMarkets, from May 1994 to February 1995, Mr. Meakem was employed as a
manager in the Corporate Business Development Group of General Electric Co. From
January 1992 through April 1994, he was employed as a consultant with McKinsey &
Company, Inc. Mr. Meakem earned his B.A. degree cum laude from Harvard College
and an M.B.A. from Harvard Business School.

DAVID H. MCCORMICK has served as President since October 2002 and Chief
Executive Officer and a Director since January 2003. Before becoming President,
Mr. McCormick served as an Executive Vice President since May 2001, as Senior
Vice President and General Manager of Core Business Markets since June 2000 and
as Vice President and General Manager of Core Business Markets since December
1999. Prior to joining FreeMarkets, Mr. McCormick was a consultant with McKinsey
& Company, Inc. Mr. McCormick holds a B.S. in Mechanical Engineering from the
United States Military Academy and a Ph.D. in Public and International Affairs
from Princeton University.

DAVID J. BECKER has served as Chief Operating Officer since March 1998. Mr.
Becker also served as President from June 2000 until October 2002. Mr. Becker
has served as an Executive Vice President from March 1998 to May 2000, and again
from October 2002 to the present. From October 1996 to February 1998, Mr. Becker
served as our Vice President of Market Making. Prior to joining FreeMarkets,
from March 1992 to September 1996, Mr. Becker was employed with Dole Fresh Fruit
International, Ltd., where he worked in key financial and management positions
at Dole's Latin and South American headquarters and subsidiaries. Mr. Becker's
most recent position with Dole was as Manager, Worldwide Logistics Information
Network. Mr. Becker earned a B.S. with high distinction in Chemical and
Petroleum Refining Engineering from Colorado School of Mines, an M.S. in
Chemical Engineering from West Virginia College of Graduate Studies and an
M.B.A. from Harvard Business School.

JOAN S. HOOPER has served as an Executive Vice President since May 2001, as
Secretary since May 2000 and as Chief Financial Officer and Treasurer since
September 1999. Before becoming an Executive Vice President, Ms. Hooper served
as a Senior Vice President since June 2000. Prior to becoming Senior Vice
President, Ms. Hooper served as a Vice President from September 1999. Prior to
joining FreeMarkets, Ms. Hooper was employed by AT&T Corp. from March 1979 to
September 1999, serving in several key financial and senior management positions
within various divisions, including divisions that are now independent
companies--Lucent Technologies, Inc., US West, Inc. and NCR Corp. Ms. Hooper's
most recent position was as Financial Vice President of AT&T Business Services.
Ms. Hooper is a Certified Public Accountant and Certified Management Accountant.
Ms. Hooper holds a B.S.B.A in Finance from Creighton University and an M.B.A
from Northwestern University.

12

ITEM 2. PROPERTIES

Our corporate offices are located in leased space at FreeMarkets Center,
210 Sixth Avenue, Pittsburgh, Pennsylvania. The telephone number of our
principal executive office is (412) 434-0500.

Our headquarters in Pittsburgh, Pennsylvania currently occupy 182,000
square feet of office space under a lease that expires in May 2010. We believe
that our existing facilities in Pittsburgh, coupled with options we have to
lease additional space, are adequate for our growth needs for the next several
years. We also lease office space in four other North American metropolitan
areas, as well as four in Europe, six in Asia and Australia and one in South
America. We may add additional offices in the United States and in other
countries as growth opportunities present themselves.

ITEM 3. LEGAL PROCEEDINGS

Since April 27, 2001, eleven securities fraud class action complaints have
been filed against FreeMarkets and two executive officers in federal court in
Pittsburgh, Pennsylvania. The complaints, all of which assert the same claims,
stem from our announcement on April 23, 2001 that, as a result of discussions
with the Securities and Exchange Commission ("SEC"), we were considering
amending our 2000 financial statements for the purpose of reclassifying fees we
earned under a service contract with Visteon. All of the cases have been
consolidated into a single proceeding. On October 30, 2001, we 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 3, 2003, we filed an answer to the
complaint in which all of the claims asserted by the plaintiffs were contested.
The case is currently in the class certification phase. In addition, on
September 24, 2001, an individual claiming to be a FreeMarkets stockholder filed
a stockholder's derivative action, nominally on behalf of FreeMarkets, against
all of our directors and certain of our executive officers. We are 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 our
motion to dismiss those class actions. The parties have agreed to a continuance
of the stay until April 15, 2003. We believe that the plaintiffs' allegations
are without merit and intend 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 our December
1999 initial public offering ("IPO"). In four of the complaints, the Company and
certain of our 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 our 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, seven of its officers and/or directors and seven investment banking
firms who either served as underwriters or are successors in interest to
underwriters of our IPO. The Consolidated Complaint alleges that the prospectus
used in our 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 our
stock. Damages in an unspecified amount are sought, together with interest,
costs and attorney's fees. All 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 our motion to dismiss. We
believe that the claims asserted against us are without merit, and we intend to
defend these claims vigorously.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

13

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

MARKET FOR THE COMPANY'S COMMON STOCK

Our common stock has been quoted on the Nasdaq National Market since
December 10, 1999 under the symbol "FMKT". On February 28, 2003, the last sale
price of the common stock was $4.60 per share. The following table sets forth
the range of high and low bid prices of our common stock for the periods
indicated. Such over-the-counter market quotations reflect inter-dealer prices,
without retail mark-up, mark-down or commission and may not necessarily
represent actual transactions.

As of February 28, 2003, there were approximately 446 holders of record of
our common stock. We believe that a substantially larger number of beneficial
owners hold shares of our common stock in depository or nominee form.

DIVIDEND POLICY

We have never declared or paid cash dividends on our capital stock. We do
not anticipate paying any cash dividends in the foreseeable future, as we intend
to retain any future earnings to finance the expansion of our business.
Moreover, our bank credit facility restricts our ability to pay cash dividends.

14

ITEM 6. SELECTED FINANCIAL DATA

- ---------------

(1) As described in Note 2 to the consolidated financial statements, the Company
adopted SFAS No. 142 "Goodwill and Other Intangible Assets" on January 1,
2002.

15

ITEM 7. 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 consolidated
financial statements and related notes.

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 18 locations in 14 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 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

As discussed in Note 2 to our consolidated financial statements, 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.
16

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

As discussed in Note 2 to the consolidated financial statements, we adopted
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. In connection with adopting this standard,
we completed step one of the test for impairment, which indicated that the
carrying value of Surplus Record 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, we completed step two of the test. Based on that analysis, a
transitional impairment loss of $5.3 million was recognized in 2002 as a
cumulative effect of an accounting change. At December 31, 2002, we had $2.0
million in goodwill on our 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.

17

STOCK COMPENSATION

As discussed in Note 2 to our consolidated financial statements, 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.

DETERMINATION OF FULLSOURCE MARKET VOLUME AND ACHIEVABLE SAVINGS

Revenues from our FullSource offering represented 85% and 86% of our
revenues and revenues and fees, respectively, in 2002. Therefore, we believe
that one indicator of our market acceptance is the dollar volume of materials,
commodities and services for which we create markets on behalf of our customers
as part of our FullSource offering. We measure this market volume by multiplying
the lowest bid price per unit in each market by the estimated number of units
that our customer expects to purchase. When our customers specify multi-year
purchases in a request for quotation, we calculate volume for the estimated
term. We do not report QS volume since this is a hosted application that enables
customers to create and run their own markets, and as a result, we do not
believe that volume from these markets can be adequately validated.

FullSource market volume does not necessarily correlate with either our
revenues or our operating results in any particular period due to the
seasonality of our customers' purchasing needs, the timing of the addition of
new customers and the length of our customer contracts. We anticipate that the
continued introduction of new products will further reduce the correlation of
FullSource volume and revenues in any particular period. FullSource volume has
varied in the past, and we expect it to vary in the future. The following table
sets forth our FullSource market volume for the periods indicated:

We believe that the savings identified by customers through our FullSource
markets is an indicator of the effectiveness of our FullSource offering. To
estimate these savings, we compare the last price paid by our customer for the
items in our markets against the lowest bid price for those items. Actual
savings that our customers achieve may not equal these estimates because our
customer may not select the lowest bid price, the parties may agree to change
price terms after our market or our customer may not actually buy all or any of
the items for which bids have been received in our markets.

Many of our agreements with customers provide for incentive compensation
based on FullSource volume and/or savings. These agreements may calculate market
volume or savings differently than the methods we use to calculate market volume
and savings for the purposes described above.

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 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 customer relationship, and for all
business and operational purposes in which revenue is a factor in the decision,
including budgets, forecasts, allocation of resources, sales compensation,

18

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 this 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.

RESULTS OF OPERATIONS

The following table sets forth our consolidated statement of operations
data as a percentage of revenues for the periods indicated:

YEARS ENDED DECEMBER 31, 2002 AND 2001

REVENUES

Revenues increased 10% from $155.3 million in 2001 to $170.4 million in
2002. As discussed earlier in "Treatment of Visteon Fees", we exclude from
revenues the fees earned from our contract with Visteon, which were $11.3
million in each of 2001 and 2002. Revenues and fees increased 9% from $166.6
million in 2001 to $181.7 million in 2002. The increase in revenues and fees is
primarily attributable to the introduction

19

of our QS offering in early 2001. The increased revenues were also attributable
to an increased use of our FullSource services by existing customers, as well as
the addition of new customers for which we conducted online markets. The number
of customers served, including all of our products and services, increased 12%
from 125 in 2001 to 140 in 2002. As an indicator of our increased services, our
FullSource market volume grew 22% from $16.7 billion in 2001 to $20.3 billion in
2002.

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

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

Although customers and FullSource volume increased from 2001 to 2002,
revenues per customer have decreased over the same period. This decrease is
primarily related to a more diversified international mix of customers, as well
as a change in the mix of products and services deployed by our customers. 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 QS 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 anticipate that our FullSource offering will continue to account for a
majority of our revenues and fees in 2003, but the percentage of revenues
attributable to FullSource will decrease due to an expected reduction in the
utilization of FullSource, as well as increased sales of our new product
offerings to current and new customers. However, 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, customer share
expansion and overall revenue gains.

Also included in revenues are reimbursements of $7.7 million in 2001 and
$5.1 million in 2002. An equivalent amount of reimbursable expenses is included
in cost of revenues.

OPERATING COSTS AND EXPENSES

COST OF REVENUES. Cost of revenues decreased from $78.6 million in 2001 to
$76.1 million in 2002. As a percentage of revenues, cost of revenues decreased
from 51% in 2001 to 45% in 2002. The decrease in absolute dollar amounts and as
a percentage of revenues from 2001 to 2002 is primarily the result of increased
staff productivity as our personnel became more specialized in various sourcing
activities, as well as a decrease in incentive compensation in 2002. Also, we
have attained some operating efficiencies from our investments in information
tools to automate portions of our sourcing process, as well as organizing our
sourcing staff in such a way to take advantage of our domain expertise in
various supply markets. The decrease is also attributable to: (1) cost cutting
measures in discretionary spending such as travel and recruiting costs; (2)
reduced provision for bad debts, primarily due to improvements in days sales
outstanding; and (3) reduction in

20

incentive compensation costs. Although our provision for bad debts was lower in
2002, the allowance for doubtful accounts in our consolidated balance sheet
increased due to timing of an unusually large write-off against the allowance in
2001. 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 anticipated revenues.

RESEARCH AND DEVELOPMENT. Research and development costs increased from
$20.1 million, or 13% of revenues in 2001, to $27.0 million, or 16% of revenues
in 2002. The increase was primarily related to a 24% increase in the average
number of research and development staff and increased consulting fees to fund
ongoing investments in our product development pipeline. These increases are
partially offset by a reduction in incentive compensation costs. We expect that
our research and development costs as a percentage of revenues in fiscal year
2003 will be higher than 2002.

SALES AND MARKETING. Sales and marketing costs decreased from $51.3
million, or 33% of revenues in 2001, to $45.6 million, or 27% of revenues in
2002. The decrease is primarily attributable to cost cutting measures in
discretionary spending such as marketing and advertising, recruiting and
relocation costs. The decrease is also attributable to a slight decrease in the
average number of sales and marketing staff. 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 $32.1 million, or 21% of revenues in 2001, to $23.7 million, or 14% of
revenues in 2002. The decrease is primarily attributed to an 18% decrease in the
average number of personnel in the areas of human resources, finance and
facilities management in 2002 compared to 2001. The decrease is also
attributable to: (1) reduced tax consulting costs associated with our
international expansion in 2000 and 2001; (2) reduced legal costs incurred in
connection with the class action lawsuits filed against the Company in 2001; (3)
cost cutting measures in discretionary spending such as travel, recruiting and
relocation costs; and (4) reduced incentive compensation costs. 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. We recorded $2.0 million of unearned
stock compensation related to employee stock options granted in June and July
1999, which is being amortized over a five-year period ending June 2004. In 2001
and 2002, $253,000 and $150,000, respectively, was amortized related to these
grants. 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 2001 and 2002, $19.1 million was
amortized related to this warrant, with $11.3 million reflected as a reduction
to our revenues (reducing the revenues under the Visteon service contract to
zero) and $7.8 million as stock compensation and warrant costs. In 2001,
$470,000 of stock compensation was recorded primarily due to modifications of
stock options held by former employees.

INVESTMENT WRITE-DOWN. In Q1 2002, we recorded a $4.7 million loss on our
investment in Adexa based on our review of its financial results and general
market conditions. In Q3 2002, we recorded an additional $371,000 loss on our
investment in Adexa based on a valuation determined by financing completed by
Adexa in July 2002. We concluded after each of these reviews that there was an
other-than-temporary decline in the value of our investment in Adexa. As of
December 31, 2002, the remaining carrying value of our original $6.0 million
investment in Adexa was $889,000.

RESTRUCTURING CHARGES AND TERMINATED MERGER-RELATED COSTS. In 2001, we
recorded a $6.4 million restructuring charge covering the severance and facility
closing costs related to our Austin office, as well as severance costs
associated with other employees who were terminated. In February 2001, we signed
a merger agreement to acquire Adexa. In June 2001, the parties mutually agreed
to terminate their proposed merger without payment of any termination fees. We
incurred merger-related costs of approximately $3.4 million related to financial
advisor and other professional fees, which were all expensed in 2001. In 2002,
we re-evaluated our office space in one of our foreign offices and reduced our
future required payment for employee
21

severance and termination benefit costs. As a result of these reviews, we
reduced the restructuring reserve by $303,000.

GOODWILL AMORTIZATION AND IMPAIRMENT. In connection with our acquisitions
of iMark and Surplus Record in March 2000, we recorded goodwill of $354.3
million, of which $47.8 million was amortized in 2001. In Q2 2001, we
re-evaluated our product and technology strategy and determined that we would no
longer use the technology platform or the market strategy that we acquired with
iMark. As a result of this determination and the closing of our Austin facility,
we recorded a $204.3 million impairment charge in Q2 2001. In Q1 2002, we
adopted SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and
Other Intangible Assets", and no longer record goodwill amortization.

INTEREST AND OTHER INCOME, NET

Interest and other income, net was $2.7 million in 2001 and $3.2 million in
2002. The increase was primarily attributable to increased average cash and
marketable investment balances, partially offset by a reduced weighted-average
rate of return due to general market conditions. In 2001, we earned $4.5 million
at a weighted-average rate of return of 4.0%, compared to $3.1 million at a rate
of return of 2.6% in 2002. Interest and other income in 2001 was partially
offset by asset write-offs of $500,000.

PROVISION FOR INCOME TAXES

Provision for income taxes was $782,000 in 2001 and $712,000 in 2002. The
decrease is primarily attributable to reduced foreign income taxes in 2002
compared to 2001.

CUMULATIVE EFFECT OF ACCOUNTING CHANGE FOR GOODWILL

In Q1 2002, in connection with the implementation of SFAS No. 142,
"Goodwill and Other Intangible Assets", we tested goodwill related to Surplus
Record for impairment, and based on estimated future cash flows, recorded an
impairment charge of $5.3 million. For further discussion, see Note 2 to the
consolidated financial statements.

YEARS ENDED DECEMBER 31, 2001 AND 2000

REVENUES

Revenues increased 72% from $90.5 million in 2000 to $155.3 million in
2001. Revenues in 2000 and 2001 exclude fees of $7.9 million and $11.3 million,
respectively, from our contract with Visteon. Revenues and fees increased 69%
from $98.4 million in 2000 to $166.6 million in 2001. The increase in revenues
and fees is primarily attributable to the addition of new customers for which we
conducted online markets, as well as increased use of our FullSource offering by
existing customers. The number of customers served increased 25% from 100 in
2000 to 125 in 2001. Additionally, our FullSource market volume grew 68% from
$9.9 billion in 2000 to $16.7 billion in 2001. To a lesser extent, the increased
revenues were also attributable to the introduction of our QS offering.

Also included in revenues are reimbursements of $7.1 million in 2000 and
$7.7 million in 2001. An equivalent amount of reimbursable expenses is included
in cost of revenues.

OPERATING COSTS AND EXPENSES

COST OF REVENUES. Cost of revenues increased from $56.0 million in 2000 to
$78.6 million in 2001. As a percentage of revenues, cost of revenues decreased
from 62% in 2000 to 51% in 2001. The increase in absolute dollar amounts from
2000 to 2001 reflects a 42% increase in the average number of sourcing staff to
serve our growing customer base and a full year of the increased cost of
operations due to the expansion of our office space and services into
international locations which took place throughout 2000. 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.

22

The decrease in cost of revenues as a percentage of revenues from 2000 to
2001 is primarily the result of increased staff productivity as our personnel
became more specialized in various sourcing activities. Also, we have attained
operating efficiencies from our investments in information tools to automate
portions of our sourcing process, as well as organizing our sourcing staff in
such a way to take advantage of our domain expertise in various supply markets.

RESEARCH AND DEVELOPMENT. Research and development costs increased from
$19.1 million, or 21% of revenues in 2000, to $20.1 million, or 13% of revenues
in 2001. The increase in absolute dollars was primarily related to additional
development efforts in the first half of 2001. This period of time reflected an
increase in the number of research and development staff and associated costs
for the development of our QS software application, which was released in
February 2001, and the continued development of our BidWare software and other
web-based technology, which is designed to further improve staff productivity.
During the second half of 2001, our research and development costs were lower
than the corresponding period of 2000 due to a decrease in the number of
outsourced consulting staff and associated costs as a result of the
restructuring in Q2 2001.

SALES AND MARKETING. Sales and marketing costs increased from $41.5
million, or 46% of revenues in 2000, to $51.3 million, or 33% of revenues in
2001. The increase in absolute dollars reflects an 88% increase in average sales
and marketing staff, slightly offset by a 17% decrease in marketing and trade
show costs.

GENERAL AND ADMINISTRATIVE. General and administrative costs decreased
from $33.7 million, or 37% of revenues in 2000, to $32.1 million, or 21% of
revenues in 2001. The decrease was primarily related to less personnel in the
areas of human resources, finance and facilities management in the second half
of 2001, as well as the net effect of reducing the cost of our satellite
locations. During the first half of 2001, our general and administrative costs
were higher than the corresponding period of 2000, and related primarily to the
expansion of our office infrastructure.

STOCK COMPENSATION AND WARRANT COSTS. We recorded $2.0 million of unearned
stock compensation related to employee stock options granted in June and July
1999, which is being amortized over a five-year period ending June 2004. In 2000
and 2001, $414,000 and $253,000, respectively, was amortized related to these
grants. 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 2000 and 2001, $13.5 million and $19.1
million, respectively, was amortized related to this warrant, with $7.9 million
and $11.3 million, respectively, reflected as a reduction to our revenues
(reducing the revenues under the Visteon service contract to zero) and $5.6
million and $7.8 million, respectively, as stock compensation and warrant costs.
In 2000 and 2001, $461,000 and $470,000, respectively, of stock compensation was
recorded due to modifications of stock options held by former employees.

RESTRUCTURING CHARGES AND TERMINATED MERGER-RELATED COSTS. In 2001, we
recorded a $6.4 million restructuring charge covering the severance and facility
closing costs related to our Austin office, as well as severance costs
associated with other employees who were terminated. In February 2001, we signed
a merger agreement to acquire Adexa. In June 2001, the parties mutually agreed
to terminate their proposed merger without payment of any termination fees. We
incurred merger-related costs of approximately $3.4 million related to financial
advisor and other professional fees, which were all expensed in 2001.

GOODWILL AMORTIZATION AND IMPAIRMENT. In connection with our acquisitions
of iMark and Surplus Record in March 2000, we recorded goodwill of $354.3
million, of which $90.7 million and $47.8 million was amortized in 2000 and
2001, respectively. In Q2 2001, we re-evaluated our product and technology
strategy and determined that we would no longer use the technology platform or
the market strategy that we acquired with iMark. As a result of this
determination and the closing of our Austin facility, we recorded a $204.3
million impairment charge in Q2 2001.

WRITE-OFF OF IN-PROCESS RESEARCH AND DEVELOPMENT. In connection with our
acquisition of iMark in March 2000, we recorded a one-time write-off of
in-process research and development of $7.4 million.

23

INTEREST AND OTHER INCOME, NET

Interest and other income, net was $8.4 million in 2000 and $2.7 million in
2001. The decrease was primarily attributable to reduced interest income on
decreased cash and marketable investments in 2001 and a reduced rate of return
on investments. In 2000, we earned $10.1 million at a weighted-average rate of
return of 6.1%, compared to $4.5 million at a rate of return of 4.0% in 2001.

Interest and other income was partially offset by asset write-offs of $1.0
million in 2000 and $500,000 in 2001.

PROVISION FOR INCOME TAXES

Provision for income taxes was $361,000 in 2000 and $782,000 in 2001. The
increase is primarily attributable to higher foreign income taxes due to the
Company's international expansion in 2000 and 2001.

LIQUIDITY AND CAPITAL RESOURCES

Net cash used in operating activities totaled $40.2 million in 2000 and
$14.7 million in 2001, compared to net cash provided by operating activities of
$21.3 million in 2002. The use of cash in 2000 and 2001 related primarily to the
operating losses generated by our investment in the growth of our business,
including an increase in personnel from 376 at the end of 1999, to 968 in 2000,
and to 1,000 at the end of 2001. Improved cash provided by operating activities
in 2002 is due to cash collections on revenues that are 10% higher than 2001 and
improved DSO's in 2002 compared to 2001. Additionally, operating costs excluding
non-cash stock-based costs, investment write-down, restructuring charges,
terminated merger-related costs and goodwill-related charges have decreased $9.6
million in 2002, or 5% less than 2001. This is primarily attributable to cost
cutting measures in discretionary spending such as marketing and advertising,
travel, recruiting and relocation costs, as well as reduced incentive
compensation costs. Net cash from operating activities in 2000, 2001 and 2002
does not reflect $5.0 million, $10.3 million and $12.2 million, respectively,
received under our service contract with Visteon.

Net cash used in investing activities totaled $91.5 million in 2000 and
$24.5 million in 2002, while net cash provided by investing activities totaled
$24.4 million in 2001. During 2000, we spent approximately $39.6 million to
furnish our new facility in Pittsburgh, PA and purchase computing and
telecommunications equipment to accommodate our increase in personnel. The
increase in capital expenditures in 2000 was also attributable to the build out
of our international facilities. We also used $16.7 million related primarily to
our acquisition of Surplus Record that closed in March 2000. In 2001 and 2002,
we incurred $17.3 million and $6.9 million, respectively, of capital
expenditures primarily related to our continued expansion of information
technology hardware, and to a lesser extent certain office space improvements.
In June 2001, we also invested $6.0 million in Adexa concurrently with the
termination of our merger agreement that had been signed in February 2001. Net
cash used in investing activities in 2002 is primarily due to 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 from treasury
activities in 2000 and 2002 was $35.1 million and $17.6 million, respectively,
while our net cash

24

inflow from this activity was $45.3 million in 2001. As a result of the
significant investments we have made in our operations, infrastructure and
personnel, we expect capital expenditures will be relatively flat in future
periods.

Net cash provided by financing activities totaled $7.5 million in 2000,
$17.9 million in 2001 and $17.3 million in 2002. The positive financing cash
flows in all years primarily reflect the net proceeds from the issuance of stock
(including issuance of stock under the employee stock purchase plan, the
exercise of stock options and an equity investment of $3.0 million by Mitsubishi
Corporation in 2001). Cash provided by financing activities in 2000, 2001 and
2002 includes $5.0 million, $10.3 million and $12.2 million, respectively,
received 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.

Prior to November 2000, we had in place a $10.0 million bank facility,
consisting of a $5.0 million revolving line of credit and two equipment loans
originally totaling $5.0 million. In November 2000, we entered into a one-year
revolving credit facility with a maximum principal amount of $25.0 million. In
October 2001, we amended our bank credit facility to consist of a revolving
credit facility with a maximum principal amount of $20.0 million and a $4.0
million term loan to be paid in 36 monthly installments, $3.7 million of which
was used to retire borrowings under the 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 October 2002
and December 2002, we entered into a fourth and fifth amendment, respectively,
which extended the expiration date of the revolving credit facility through
December 2002 and February 2003, respectively. In February 2003, we entered into
the sixth amendment, which reduces the availability under the revolving credit
facility from $20.0 million to $15.0 million and extends the maturity date
through February 2004. As of December 31, 2002, $2.6 million was outstanding
under the term loan and the interest rate was 4.75%. At December 31, 2002, $14.9
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 December 31, 2002, we are in compliance
with all covenants.

We will continue to invest in the growth of our business. In Q1 and Q2
2003, we anticipate negative net cash flows as a result of the timing of our
annual incentive-based compensation payments and operational losses in the first
half of 2003, with positive net cash flows in the second half of 2003. 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 December 31, 2002, our marketable investment allocation represents
30% of total cash and investments, compared to 22% at December 31, 2001. 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 February 28, 2003, we had purchased
657,000 shares at a weighted average stock price of $4.19.

25

Our contractual obligations and commercial commitments as of December 31,
2002 are as follows (in thousands):

INCOME TAXES

The provision for income taxes consisted of foreign taxes of $361,000,
$782,000 and $712,000 in 2000, 2001 and 2002, respectively. There has been no
provision for U.S. federal or state income taxes as we have incurred a net
taxable loss in each of these periods. We recorded foreign income tax provisions
relating to taxes withheld from customer payments and remitted to foreign taxing
jurisdictions on our behalf, as well as income taxes generated in certain
foreign jurisdictions.

As of December 31, 2002, we had net operating loss carryforwards for
federal and state income tax purposes of approximately $145.3 million that will
expire beginning in years 2010 and 2005, respectively.

In addition, we had federal tax credit carryforwards of approximately $3.5
million, which expire beginning in 2010.

Utilization of our net operating loss and tax credit carryforwards may be
subject to a substantial annual limitation due to the ownership change
limitations imposed by Internal Revenue Code Section 382 and similar state
provisions. Such an annual limitation could result in the expiration of the net
operating loss and tax credit carryforwards before utilization.

EARNINGS PER SHARE

Under the provisions of SFAS No. 128, "Earnings per Share", basic earnings
per share is computed by dividing the net (loss) income for the period by the
weighted average number of common shares outstanding during the period. Diluted
earnings per share is computed by dividing the net (loss) income for the period
by the weighted average number of common and potentially dilutive common shares
outstanding during the period. Potentially diluted common shares are comprised
of the weighted average outstanding stock options and warrants during each
respective period, as determined by the treasury stock method. In 2000, 2001,
and 2002, potentially dilutive common shares of 11.0 million, 4.9 million and
3.1 million, respectively, were excluded from earnings per share because of our
net loss position.

RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS

We adopted the provisions of SFAS No. 142, "Goodwill and Other Intangible
Assets", on January 1, 2002, and no longer record goodwill amortization. In
connection with adopting this standard, we recognized in 2002 a transitional
impairment loss of $5.3 million as a cumulative effect of an accounting change.

In March 2002, the Emerging Issues Task Force ("EITF") reached a consensus
on issue No. 01-14 ("EITF 01-14"), "Income Statement Characterization of
Reimbursements Received for "Out-of-Pocket" Expenses Incurred." EITF 01-14
establishes that reimbursements received for out-of-pocket expenses should be
characterized as revenue in the income statement. We adopted the guidance
effective January 1, 2002. Prior to 2002, we recorded "out-of-pocket" expense
reimbursements as a contra to operating expenses, with no effect on net income.
Beginning in 2002, we recorded these reimbursements as revenue, and an
equivalent

26

amount is included in cost of revenues. Comparative financial statements for
prior year information have been reclassified to conform to the new
presentation.

In January 2003, the FASB issued SFAS No. 148, "Accounting for Stock-based
Compensation -- Transition and Disclosure." SFAS No. 148 amends SFAS No. 123,
"Accounting for Stock-Based Compensation" to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. Additionally, SFAS No. 148 amends the
disclosure provisions of SFAS No. 123 to require prominent disclosure about the
effects on reported net income of a company's accounting policy decisions with
respect to stock-based employee compensation. SFAS No. 148 also amends APB
Opinion No. 128, "Interim Financial Reporting" to require disclosure about the
effects on reported net income in interim financial information. SFAS No. 148
was effective for fiscal years ending after December 15, 2002. We adopted the
disclosure requirements of this standard effective December 31, 2002.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," which addresses accounting for
restructuring and similar costs. SFAS No. 146 supersedes previous accounting
guidance, primarily EITF No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." Application of SFAS No. 146 is required for
restructuring activities initiated after December 31, 2002. SFAS No. 146
requires recognition of the liability for costs associated with an exit or
disposal activity when the liability is incurred. Under Issue No. 94-3, a
liability for an exit cost was recognized at the date of a company's commitment
to an exit plan. SFAS No. 146 also establishes that the liability should
initially be measured and recorded at fair value. We expect the adoption of this
standard will not have a material impact on our consolidated financial
statements.

In November 2002, the 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. We expect the adoption of this standard will not have a material
impact on our 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. We are currently assessing the impact of this standard on
our consolidated financial statements.

In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities." This interpretation requires unconsolidated
variable interest entities to be consolidated by their primary beneficiaries if
the entities do not effectively disperse the risk and rewards of ownership among
their owners and other parties involved. The provisions of this interpretation
are effective immediately to all variable interest entities created after
January 1, 2003 and variable interest entities in which an enterprise obtains an
interest in after that date. For variable interest entities created before this
date, the provisions are effective July 31, 2003. We expect the adoption of this
standard will not have a material impact on our consolidated financial
statements.

27

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

FOREIGN CURRENCY EXCHANGE RISK

Most of our revenues recognized to date have been denominated in United
States dollars and are primarily from customers headquartered in the United
States. We have several locations in Europe, Asia, Australia and South America.
In the future, a larger portion of the revenues we derive from international
operations may be denominated in foreign currencies. We incur costs for our
overseas offices in the local currency of those offices for staffing, rent,
telecommunications and other services. As a result, our operating results are
subject to fluctuations based upon changes in the exchange rates of those
currencies in relation to the United States dollar. Furthermore, to the extent
that we engage in international sales denominated in United States dollars, an
increase in the value of the United States dollar relative to foreign currencies
could make our services less competitive in international markets.

We believe that a significant risk related to foreign currency is cash flow
risk. The majority of our foreign currency denominated cash flows relate to
funding the operations of our Belgian and Singapore subsidiaries, and those
currencies relative to the United States dollar did not materially fluctuate
during 2002. However, the Euro has strengthened by more than 10% versus the US
dollar over the last three months. If this trend continues, we may experience
foreign currency risk that could impact our earnings as our initial 2003 plan
did not contemplate such continued strength. We have and will continue to
monitor our exposure to currency fluctuations, and when appropriate, we will
continue to use financial hedging techniques to minimize the effect of these
fluctuations in the future. At December 31, 2002, we had one outstanding foreign
exchange contract to purchase 250,000 euros that had a remaining maturity of
less than one month. A hypothetical 10% change in applicable December 31, 2002
forward rates would result in a pretax gain or loss of approximately $25,000
related to this position. We cannot assure you that exchange rate fluctuations
will not harm our business in the future.

INTEREST RATE RISK

Our interest income is sensitive to changes in the general level of United
States interest rates, particularly because most of our investments are in
short-term instruments. At December 31, 2002, our cash and marketable
investments were $135.0 million and our average rate of return was 2.6%. A 10%
hypothetical change in this average rate would increase or decrease our
investment income by approximately $300,000. Based on the current market
environment, we anticipate our rate of return in 2003 to approximate 1% to 3%.

Borrowings under our existing revolving credit facility and term loan are
also interest rate sensitive, because the applicable rate varies with changes in
the prime rate of lending. We had $4.4 million and $2.8 million of debt
outstanding at December 31, 2001 and 2002, respectively. Average effective
interest rates were 6.9% in 2001 and 6.6% in 2002. A hypothetical change of 10%
in our effective interest rate from year end 2002 levels would increase or
decrease interest expense by approximately $23,000. We cannot assure you that
interest rate fluctuations will not harm our business in the future.

28

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Report of Independent Accountants........................... 30

Consolidated Balance Sheets as of December 31, 2002 and
2001...................................................... 31

Consolidated Statements of Operations for each of the three
years in the period ended December 31, 2002............... 32

Consolidated Statements of Stockholders' Equity for each of
the three years in the period ended December 31, 2002..... 33

Consolidated Statements of Cash Flows for each of the three
years in the period ended December 31, 2002............... 34

Notes to Consolidated Financial Statements.................. 35

29

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders
of FreeMarkets, Inc. and Subsidiaries:

In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, stockholders' equity and cash
flows present fairly, in all material respects, the financial position of
FreeMarkets, Inc. and Subsidiaries (the Company) at December 31, 2002 and 2001
and the results of their operations and their cash flows for each of the three
years in the period ended December 31, 2002, in conformity with accounting
principles generally accepted in the United States of America. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America, which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

As discussed in note 7 to the Consolidated Financial Statements, the
Company adopted Statement of Financial Accounting Standards No. 142, "Goodwill
and Other Intangible Assets." Accordingly, the Company changed its method of
accounting for goodwill in 2002.

/s/ PricewaterhouseCoopers LLP

Pittsburgh, Pennsylvania
January 24, 2003, except for Note 16,
as to which the date is March 7, 2003

30

FREEMARKETS, INC.

CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)

The accompanying notes are an integral part of the consolidated financial
statements.
31

FREEMARKETS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

The accompanying notes are an integral part of the consolidated financial
statements.
32

FREEMARKETS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)

The accompanying notes are an integral part of the consolidated financial
statements.
33

FREEMARKETS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

The accompanying notes are an integral part of the consolidated financial
statements.
34

FREEMARKETS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. DESCRIPTION OF BUSINESS

FreeMarkets, Inc. and Subsidiaries ("the Company") provides organizations
with software, services and information to help companies improve their sourcing
and supply management processes and enhance the capabilities of their supply
management organizations. These solutions are ultimately designed to help
companies lower costs and reduce their supply risk. The Company's customers are
buyers of industrial parts, raw materials, commodities and services. The Company
serves its customers from 18 locations in 14 countries on five continents
through operations centers in Pittsburgh, Brussels and Singapore.

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. The Company has six subsidiaries in Europe
and six subsidiaries in Asia and Australia and one in South America. There are
also four in North America, three of which are Delaware holding companies. All
material intercompany accounts and transactions have been eliminated.

CASH AND CASH EQUIVALENTS

The Company considers all unrestricted, highly liquid investments with
maturities of three months or less at the time of purchase to be cash
equivalents.

ALLOWANCE FOR DOUBTFUL ACCOUNTS

At December 31, 2002 and 2001, the allowance for doubtful accounts was $1.9
million and $1.0 million, respectively. The Company evaluates the collectibility
of accounts receivable based on a combination of factors. In cases where the
Company is aware of circumstances that may impair a specific customer's ability
to meet its financial obligations, it records a specific allowance against
amounts due. For all customers, the Company recognizes allowance for doubtful
accounts based on the length of time the receivables are past due, the current
business environment and the Company's historical experience. If the financial
condition of the Company's customers deteriorates or if the economic conditions
worsen, additional allowances may be required in the future.

MARKETABLE INVESTMENTS

As of December 31, 2002 and 2001, marketable investments consisted of
commercial paper, corporate bonds and U.S. government notes and bonds.
Short-term investments are marketable securities with maturities of greater than
three months at the time of purchase and less than one year from the balance
sheet date. The Company classifies its investments as available for sale. Such
investments are recorded at fair value based on quoted market prices, with
unrealized gains and losses, which are considered to be temporary, recorded as
accumulated other comprehensive income or loss until realized. Realized gains
and losses are recorded based on the specific identification method.

FOREIGN CURRENCY MANAGEMENT

The Company occasionally uses forward exchange contracts to reduce its net
exposures to foreign currency risks. These risks primarily relate to cash flow
risks associated with funding its Belgian and Singapore subsidiaries. The
forward foreign exchange contracts require the Company to exchange foreign
currencies for U.S. dollars or vice versa, and generally mature in three months
or less. As of December 31, 2002, the Company had one outstanding foreign
exchange contract to purchase 250,000 euros that had a remaining maturity of
less than one month. These contracts did not have a material impact on the
Company's financial condition or results of operations in 2002.

35

FREEMARKETS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:

PROPERTY AND EQUIPMENT, NET

Property and equipment are recorded at cost and depreciated on the
straight-line method over their estimated useful lives. Qualified internally
developed software costs for internal use are capitalized subsequent to both the
preliminary project stage and when management has committed to funding, in
accordance with Statement of Position 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use". Repairs and
maintenance expenditures, which are not considered improvements and do not
extend the useful life of the property and equipment, are expensed as incurred.
The cost and related accumulated depreciation applicable to property and
equipment no longer in service are eliminated from the accounts and any gain or
loss is included in operations.

GOODWILL AND OTHER ASSETS, NET

The excess of costs over net assets acquired (goodwill) was being amortized
on the straight-line method over its estimated useful life, which was three
years. Effective January 1, 2002, and in accordance with SFAS No.142, goodwill
is no longer amortized. Patents and trademarks are being amortized on the
straight-line method over the shorter of their estimated useful lives or
seventeen years. Other assets also include an investment in Adexa, Inc.
("Adexa"), which is stated at cost, reduced for other-than-temporary declines in
fair value.

IMPAIRMENT OF LONG-LIVED ASSETS

The carrying values of long-lived assets, which include property and
equipment and other assets, are evaluated for impairment whenever events or
changes in circumstances indicate the carrying amount may not be recoverable. An
impairment would be determined based on a comparison of future undiscounted cash
flows to the underlying assets. If required, adjustments would be measured based
on discounted cash flows.

LEGAL CONTINGENCIES

As discussed in Note 10, the Company is currently involved in various
claims and legal proceedings. Periodically, we review the status of each
significant matter and assess our potential financial exposure. If the potential
loss from any claim or legal proceeding is considered probable and the amount
can be estimated, we accrue a liability for the estimated loss. Because of
uncertainties related to these matters, accruals are based on the best
information available at the time.

CONCENTRATIONS OF CREDIT RISK

The majority of cash and cash equivalents is maintained with several major
financial institutions in the United States. Deposits with these banks exceed
the amount of insurance provided on such deposits; however, these deposits
typically may be redeemed upon demand and therefore, bear minimal risk.

Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of marketable investments and
trade receivables. Investment policies have been implemented that limit the
concentration of investments, as well as affix minimum standards for credit
quality. The risk of trade receivables is mitigated by credit evaluations we
perform on our customers. However, as of December 31, 2002 and 2001, amounts due
from one customer represented 11% and 12%, respectively, of total gross accounts
receivable.

36

FREEMARKETS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:

REVENUE RECOGNITION

The Company recognizes revenue from fixed monthly fees for providing
services to customers from its FullSource offering ratably as those services are
provided over the related contract periods. In the case of contracts with
performance incentive payments based on market volume and/or savings generated,
as defined in the respective contracts, revenue is recognized as those
thresholds are achieved. The Company recognizes fees for providing access to its
QS application ratably as that access is provided. Revenue excludes fees earned
under a service contract with Visteon Corporation ("Visteon").

Revenue in excess of billings is recorded as unbilled receivables and is
included in trade accounts receivable. Billings in excess of revenue are
recorded as deferred revenue until revenue recognition criteria are met.

Below is a reconciliation of revenues under generally accepted accounting
principles with revenues plus the fees the Company earns under its service
contract with Visteon:

RELATED PARTY

United Technologies invested $20.0 million in the Company in September
1999. This investment represented greater than 5% of the Company's outstanding
common stock as of December 31, 2001 and 2000. Revenues from United Technologies
were 5% and 10% of revenues in 2001 and 2000, respectively. Amount due from
United Technologies was $858,000 at December 31, 2001.

COST OF REVENUES

Cost of revenues consists primarily of the expenses related to staffing and
operation of the Company's global sourcing service organization and market
operations centers. Staffing costs include a proportional allocation of overhead
costs based on headcount.

RESEARCH AND DEVELOPMENT COSTS

Research and development costs are expensed as incurred, and include costs
to develop, enhance and manage the Company's proprietary software technology.
The fair value of purchased in-process research and development is estimated by
assessing the percentage-of-completion of the research project, costs required
to complete the project, and expected future revenues from the related products,
and discounting such amounts using an appropriate risk-weighted discount rate.
Amounts allocated to in-process research and development are expensed in the
period in which any acquisition is consummated.

ADVERTISING COSTS

Advertising costs are expensed at the time the advertisement is first aired
or the promotion is held, and amounted to $9.2 million in 2002, $10.9 million in
2001 and $13.1 million in 2000.

37

FREEMARKETS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:

START-UP COSTS

Start-up costs are expensed as incurred, and include costs to establish new
locations, operations or subsidiaries.

STOCK COMPENSATION

At December 31, 2002, the Company has four stock-based employee
compensation plans, which are described more fully in Note 13. 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". The Company has elected to continue
to apply the intrinsic value method to account for employee stock options and
discloses the pro forma effect as if the fair value method had been applied in
Note 13. The Company records unearned stock compensation for stock options
granted at exercise prices less than fair value. Such unearned stock
compensation is amortized on an accelerated basis over the vesting period of
each individual award in accordance with Financial Accounting Standards Board
("FASB") Interpretation No. 28. The following table illustrates the effect on
net loss and earnings per share if the Company had applied the fair value
recognition provisions of SFAS No. 123 to stock-based employee compensation:

The weighted average fair value per option grant to employees was $10.26 in
2002, $14.71 in 2001 and $57.49 in 2000. The fair value of each option grant was
determined using the minimum value method prior to the IPO and using the
Black-Scholes pricing model subsequent to the IPO, with the following
assumptions for all grants:

INCOME TAXES

Deferred income taxes are recorded using the liability method. Under this
method, deferred tax assets and liabilities are determined based on the
differences between the financial statement and tax bases of assets and
liabilities using enacted tax rates in effect in the years in which the
differences are expected to reverse.

38

FREEMARKETS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:

Valuation allowances are established when necessary to reduce deferred tax
assets to the amount expected to be realized.

INTERNATIONAL OPERATIONS

The local currency is the functional currency for the Company's operations
outside of the United States. Assets and liabilities are translated using the
exchange rate at the balance sheet date. Revenues, expenses, gains and losses
are translated at the exchange rate on the date those elements are recognized.

EARNINGS PER SHARE

Under the provisions of SFAS No. 128, "Earnings per Share", basic earnings
per share is computed by dividing the net (loss) income for the period by the
weighted average number of common shares outstanding during the period. Diluted
earnings per share is computed by dividing the net (loss) income for the period
by the weighted average number of common and potentially dilutive common shares
outstanding during the period. Potentially dilutive common shares consist of the
common shares issuable upon the exercise of stock options and warrants (using
the treasury stock method). Potentially dilutive common shares are excluded from
the calculation if their effect is antidilutive.

In 2002, 2001 and 2000, potentially dilutive common shares of 3.1 million,
4.9 million and 11.0 million, respectively, were excluded because their effect
was antidilutive.

USE OF ESTIMATES

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

SEGMENT REPORTING

Operating segments are defined as components of an enterprise about which
separate financial information is available that is evaluated regularly by the
chief operating decision maker in deciding how to allocate resources and in
assessing performance. The Company operates in one segment, global supply
management. The Company markets its products in the United States and in foreign
countries through its sales personnel and its subsidiaries.

The Company serves its customers from locations in the United States and 13
foreign countries. Many of the Company's customers are multi-national companies.
Over 90% of the Company's revenues in each of 2002, 2001 and 2000 were derived
from customers whose headquarters are located in the United States. In addition,
over 90% of the Company's assets are located in the United States.

RECLASSIFICATION

Certain prior year amounts have been reclassified to conform with the
current presentation.

RECENT ACCOUNTING PRONOUNCEMENTS

The Company adopted the provisions of SFAS No. 142, "Goodwill and Other
Intangible Assets" on January 1, 2002, and no longer records goodwill
amortization. As discussed in Note 7, in connection with

39

FREEMARKETS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:

adopting this standard, a transitional impairment loss of $5.3 million was
recognized as the cumulative effect of an accounting change.

The following unaudited pro forma financial information presents our
results of operations and earnings per share ("EPS") as if goodwill had not been
amortized or impaired in 2000 and 2001:

In March 2002, the Emerging Issues Task Force ("EITF") reached a consensus
on issue No. 01-14 ("EITF 01-14"), "Income Statement Characterization of
Reimbursements Received for "Out-of-Pocket" Expenses Incurred." EITF 01-14
establishes that reimbursements received for out-of-pocket expenses should be
characterized as revenue in the income statement. The Company adopted the
guidance effective January 1, 2002. Prior to 2002, the Company recorded
"out-of-pocket" expense reimbursements as a contra to operating expenses, with
no effect on net income. Beginning in 2002, the Company recorded these
reimbursements as revenue and an equivalent amount is included in cost of
revenues. Comparative financial statements for prior year information have been
reclassified to conform to the new presentation.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," which addresses accounting for
restructuring and similar costs. SFAS No. 146 supersedes previous accounting
guidance, primarily EITF No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." Application of SFAS No. 146 is required for
restructuring activities initiated after December 31, 2002. SFAS No. 146
requires recognition of the liability for costs associated with an exit or
disposal activity when the liability is incurred. Under Issue No. 94-3, a
liability for an exit cost was recognized at the date of the Company's
commitment to an exit plan. SFAS No. 146 also establishes that the liability
should initially be measured and recorded at fair value. The Company does not
expect the adoption of this standard will have a material impact on its
consolidated financial statements.

In November 2002, the 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

40

FREEMARKETS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:

effective for financial statements of both interim and fiscal years ending after
December 15, 2002. The Company does not expect the adoption of this standard
will have a material impact on its consolidated financial statements.

In January 2003, the FASB issued SFAS No. 148, "Accounting for Stock-based
Compensation -- Transition and Disclosure." SFAS No. 148 amends SFAS No. 123,
"Accounting for Stock-Based Compensation" to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. Additionally, SFAS No. 148 amends the
disclosure provisions of SFAS No. 123 to require prominent disclosure about the
effects on reported net income of a company's accounting policy decisions with
respect to stock-based employee compensation. SFAS No. 148 also amends APB
Opinion No. 128, "Interim Financial Reporting" to require disclosure about the
effects on reported net income in interim financial information. SFAS No. 148
was effective for fiscal years ending after December 15, 2002. The Company
adopted the disclosure requirements of this standard effective December 31,
2002.

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 has not yet determined what effect the adoption
of this standard will have on its consolidated financial statements.

In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities." This interpretation requires unconsolidated
variable interest entities to be consolidated by their primary beneficiaries if
the entities do not effectively disperse the risk and rewards of ownership among
their owners and other parties involved. The provisions of this interpretation
are effective immediately to all variable interest entities created after
January 1, 2003 and variable interest entities in which an enterprise obtains an
interest in after that date. For variable interest entities created before this
date, the provisions are effective July 31, 2003. The Company does not expect
the adoption of this standard will have a material impact on its consolidated
financial statements.

NOTE 3. ACQUISITIONS

In March 2000, the Company acquired iMark.com, Inc. ("iMark"), a
business-to-business online marketplace for surplus equipment and inventory. The
Company issued 1.6 million shares of its common stock and assumed 176,000
options with an aggregate total value of $333.6 million in exchange for all of
the outstanding shares and options of iMark. The acquisition was accounted for
as a purchase business combination, and the purchase price was $339.7 million
including transaction costs of $6.0 million. The purchase price was allocated as
follows (in thousands):

Goodwill and other intangible assets........................ $336,334
In-process research and development......................... 7,397
Liabilities assumed in excess of the fair value of assets
acquired.................................................. (4,047)
--------
Total purchase price...................................... $339,684
========

At the time of the acquisition of iMark, there was one in-process research
and development project. The software applications resulting from this
development project have subsequently been integrated into the Company's
products. The efforts required to complete the acquired in-process research and
development project included the completion of all planning, designing and
testing activities that were necessary to establish

41

FREEMARKETS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

NOTE 3. ACQUISITIONS, CONTINUED:

that the product can be produced to meet its design requirements, including
functions, features and technical performance requirements. The value of the
acquired in-process research and development was computed using a discount rate
of 34% on the anticipated cash flow stream from sales of the related product
revenues, less the estimated costs to complete the development efforts. At the
time of the acquisition, the product was approximately 70% complete. The
majority of the costs to complete the project were incurred in 2000. The value
assigned to the in-process research and development was $7.4 million, and was
charged to expense during Q1 2000 when the acquisition was consummated. As
discussed in Note 4, the Company recorded an impairment charge in Q2 2001
related to the iMark acquisition.

Also in March 2000, the Company purchased substantially all of the assets
of Surplus Record, Inc. and SR Auction, Inc. (collectively, "Surplus Record")
for $18.0 million in cash. Surplus Record consists of a directory and network of
dealers and buyers and an online surplus asset trade site for business surplus,
new and used industrial equipment, machinery and machine tools. The acquisition
was accounted for as a purchase business combination, and the excess of the
purchase price over the fair value of the net assets acquired of $17.9 million
was allocated to goodwill, which was being amortized on a straight-line basis
over 36 months prior to the adoption of SFAS No. 142.

The following unaudited pro forma financial information presents the
Company's results of operations as if the acquisitions of iMark and Surplus
Record occurred at the beginning of each period presented. The write-off of
in-process research and development has been excluded because it is
non-recurring. The unaudited pro forma financial information does not
necessarily reflect the results of operations that would have occurred had the
Company, iMark and Surplus Record constituted a single entity during such
periods.

NOTE 4. RESTRUCTURING CHARGES AND TERMINATED MERGER-RELATED COSTS

During Q2 2001, the Company recorded $9.8 million of restructuring charges
and terminated merger-related costs and $204.3 million for goodwill impairment.

In April 2001, the Company closed its Austin, Texas office, formerly the
headquarters of its 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.

42

FREEMARKETS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

NOTE 4. RESTRUCTURING CHARGES AND TERMINATED MERGER-RELATED COSTS, CONTINUED:

The restructuring reserve and terminated merger-related cost activity for
the period ended December 31, 2002 was:

The Company recorded initial restructuring charges in Q2 2001 based on
assumptions and related estimates that it deemed appropriate for the economic
environment that existed at the time. In 2002, the Company re-evaluated its
office space in one of the Company's foreign offices and reduced its future
required payment for employee severance and termination benefit costs. As a
result of these reviews, the Company reversed $303,000 of the accrual through
results of operation.

In addition, in February 2001, the Company signed a definitive agreement to
acquire Adexa, a provider of software products that enable collaborative supply
chain management and optimization. However, in June 2001, the Company and Adexa
mutually agreed to terminate their proposed merger without payment of any
termination fees. The Company incurred merger-related costs of approximately
$3.4 million related to financial advisor and other professional fees, which
were all expensed in Q2 2001.

NOTE 5. MARKETABLE INVESTMENTS

Marketable investments consisted of the following:

As of December 31, 2002, the amortized cost and estimated fair values of
short-term and long-term marketable investments (excluding cash and cash
equivalents) by contractual maturity were as follows (in thousands):

Investment income included in interest and other income, net was $3.1
million in 2002, $4.5 million in 2001 and $10.1 million in 2000.

43

FREEMARKETS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

NOTE 6. PROPERTY AND EQUIPMENT, NET

Property and equipment, net (and their related useful lives) consisted of
the following:

Depreciation expense was $19.4 million in 2002, $18.3 million in 2001 and
$9.6 million in 2000.

NOTE 7. GOODWILL AND OTHER ASSETS, NET

Goodwill and other assets, net consisted of the following:

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 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 as a cumulative effect of an
accounting change.

Furthermore, the Company re-evaluated its product and technology strategy,
and decided that the Company would no longer use the technology platform or the
market strategy that it acquired with iMark. As a result of this decision to
abandon the technology and strategy acquired with iMark, the Company recorded a
$204.3 million impairment charge in Q2 2001 to fully write-off the remaining
unamortized goodwill balance.

Concurrently with the termination of its proposed merger, the Company made
a $6.0 million investment in Adexa in June 2001. This investment represented
approximately 3% of the outstanding shares of Adexa. In the first quarter of
2002, the Company recorded a $4.7 million loss on its investment in Adexa based
on a review of Adexa's financial results and general market conditions. Also, in
the third quarter of 2002, the Company recorded a $371,000 loss on its
investment in Adexa based on a valuation determined by financing completed by
Adexa in July 2002. The Company concluded after each of these reviews that there
was an other-than-temporary decline in the value of its investment in Adexa.

44

FREEMARKETS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

NOTE 8. ACCRUED LIABILITIES

Accrued liabilities consisted of the following:

NOTE 9. DEBT

Debt consisted of the following:

(A) In October 2001, the Company entered into a third amendment to its bank
credit facility agreement, consisting of a one-year 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. In October 2002
and December 2002, the Company entered into a fourth and fifth amendment,
respectively, which extended the maturity date of the Revolving Credit
Facility through December 2002 and February 2003, respectively. As
discussed in Note 16, the Company entered into the sixth amendment to the
Revolving Credit facility in February 2003. Proceeds from the Term Loan
were used to retire the $3.7 million outstanding under the old Revolving
Credit Facility. At December 31, 2002, $14.9 million was available under
the Revolving Credit Facility based on eligible accounts receivable, which
is reduced by $529,000 in outstanding letters of credit. The Revolving
Credit Facility bears interest at the lender's prime rate, which was 4.25%
at December 31, 2002. The Term Loan bears interest at the lender's prime
rate +0.50%.

(B) In connection with the acquisition of iMark, the Company assumed Equipment
Term Notes. The Equipment Term Notes bore interest at a rate of 8%.

The Revolving Credit Facility and the Term Loan contain restrictive
covenants, including a limitation on incurring additional indebtedness and
paying dividends. The Company is also required to satisfy monthly minimum
tangible net worth, minimum earnings and minimum quick ratios, as defined in the
underlying agreement. The Company has pledged substantially all of its tangible
assets as collateral for the Revolving Credit Facility.

Interest expense was $228,000 in 2002, $300,000 in 2001 and $478,000 in
2000. The weighted average interest rate was 6.6% in 2002, 6.9% in 2001 and 9.9%
in 2000.

45

FREEMARKETS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

NOTE 9. DEBT, CONTINUED:

Scheduled maturities of debt for each of the years ending December 31 are
as follows (in thousands):

2003........................................................ $1,502
2004........................................................ 1,328
------
$2,830
======

NOTE 10. COMMITMENTS AND CONTINGENCIES

The Company leases office space and equipment under operating leases
expiring through 2010. In October 1998, the Company entered into an Office Lease
Agreement (the "Lease"), as amended in March and June 1999 and March 2000, that
significantly expands the Company's office space within the City of Pittsburgh,
Pennsylvania. The Lease, which currently provides for 182,000 square feet and
the option for additional expansion within the same building, expires in May
2010.

Operating lease rental expense amounted to $7.3 million in 2002, $7.5
million in 2001 and $4.5 million in 2000. The following is a schedule of future
minimum lease payments under all operating leases through December 31 of each of
the following years (in thousands):

2003........................................................ $ 6,428
2004........................................................ 5,346
2005........................................................ 5,042
2006........................................................ 4,992
2007........................................................ 5,126
Thereafter.................................................. 11,710

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 parties have agreed to a continuance of the stay until April
15, 2003. 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

46

FREEMARKETS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

NOTE 10. COMMITMENTS AND CONTINGENCIES, CONTINUED:

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. For further discussion, see Note 16 to the
Consolidated Financial Statements. The Company believes that the claims asserted
against it are without merit, and it intends to defend these claims vigorously.

The Company is also subject to various other legal proceedings and claims,
either asserted or unasserted, which arise in the ordinary course of business.
While the outcome of these claims cannot be predicted with certainty, management
does not believe that the outcome of any of these legal matters will have a
material adverse effect on the Company's consolidated results of operations or
financial position.

NOTE 11. INCOME TAXES

The provision for income taxes consisted of the following:

There has been no provision for U.S. federal or state income taxes as the
Company has incurred a net taxable loss in each of these periods. The Company
recorded foreign income tax provisions relating to taxes withheld from customer
payments and remitted to foreign taxing jurisdictions on the Company's behalf,
as well as income taxes generated in certain foreign jurisdictions.

Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets are as follows:

47

FREEMARKETS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

NOTE 11. INCOME TAXES, CONTINUED:

The realization of deferred tax assets is dependent upon future earnings,
if any, while the timing and amount of which are uncertain. Accordingly, the net
deferred tax assets have been fully offset by a valuation allowance. The
valuation allowance increased by approximately $11.8 million during 2002.

As of December 31, 2002, the Company had net operating loss carryforwards
for federal and state income tax purposes of approximately $145.3 million, which
will expire beginning in years 2010 and 2005, respectively. Included in the
deferred tax asset related to net operating loss carryforwards is a tax benefit
attributable to employee stock options of approximately $19.6 million at
December 31, 2002, which, when realized, will be a credit to additional capital.
In addition, the Company had federal tax credit carryforwards of approximately
$3.5 million, which expire beginning 2010.

Utilization of the Company's net operating loss and tax credit
carryforwards may be subject to a substantial annual limitation due to the
ownership change limitations imposed by Internal Revenue Code Section 382 and
similar state provisions. Such an annual limitation could result in the
expiration of the net operating loss and tax credit carryforwards before
utilization.

NOTE 12. STOCKHOLDERS' EQUITY

The following is a summary of share activity for all classes of stock:

PREFERRED STOCK

The Company's Board of Directors has the authority, without further action
by the stockholders, to issue up to 5.0 million shares of preferred stock in one
or more series and to designate the rights, preferences, privileges and
restrictions of each series.

48

FREEMARKETS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

NOTE 12. STOCKHOLDERS' EQUITY, CONTINUED:

COMMON STOCK

In December 2001, the Company sold 194,000 shares of common stock to
Mitsubishi Corporation at a price of $15.46 per share (based on the average of
the closing prices of our common stock over the 20 trading days prior to the
sale) for a total purchase price of $3.0 million.

STOCK PURCHASE WARRANTS

In April 2000, the Company entered into a five-year service contract with
Visteon. Under the terms of the contract, Visteon pays the Company a fixed
monthly fee for access to the Company's sourcing technology and services, and
may pay the Company variable fees if specified volume thresholds are exceeded.
At the time the Company entered into the service contract, the Company granted a
warrant to Visteon, with an exercise price of $.01 per share, to purchase 1.75
million shares of the Company's common stock. The Company receives ongoing
marketing and public relations benefits as a result of its relationship with
Visteon. The warrant was valued at $95.5 million using the Black-Scholes pricing
model. This value is being amortized on a straight-line basis over the five-year
term of the contract, of which $19.1 million, $19.1 million and $13.5 million
was amortized in 2002, 2001 and 2000, respectively. This amortization has been
reclassified as a reduction to revenues to the extent of the $11.3 million,
$11.3 million and $7.9 million in fees earned from Visteon in 2002, 2001 and
2000, respectively, and the remaining $7.8 million, $7.8 million and $5.5
million as stock compensation and warrant costs in 2002, 2001 and 2000,
respectively. Visteon exercised 350,000 warrants in July 2001, resulting in
total proceeds of $3,000 and a $19.1 million transfer from stock purchase
warrants to additional capital.

ACCUMULATED OTHER COMPREHENSIVE (LOSS)

The following is a summary of the components of accumulated other
comprehensive (loss) income, net of income taxes:

NOTE 13. EMPLOYEE BENEFIT PLANS

401(K) SAVINGS PLAN

The Company maintains a savings plan (the "Savings Plan") that qualifies as
a deferred salary arrangement under Section 401(k) of the Internal Revenue Code.
Under the Savings Plan, eligible employees may contribute a certain percentage
of their pre-tax earnings up to the annual limit set by the Internal Revenue
Service. The Company is not required to contribute to the Savings Plan, and
prior to 2002 had made no contributions since its inception. In 2002, the
Company expensed approximately $500,000 as a discretionary contribution to the
Plan. The Company's contributions to the Savings Plan vest 100% upon completion
of one year of service. The current investment options under the Savings Plan do
not include the Company's common stock.

49

FREEMARKETS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

NOTE 13. EMPLOYEE BENEFIT PLANS, CONTINUED:

EMPLOYEE STOCK PURCHASE PLAN

The Company maintains an employee stock purchase plan ("ESPP"), under which
500,000 shares have been reserved for issuance, subject to increases as provided
in the ESPP. The ESPP is intended to qualify under Section 423 of the Internal
Revenue Code. Under the ESPP, eligible employees may purchase common stock each
year in an amount not to exceed 20% of the employee's annual cash compensation.
The purchase price per share is 85% of the lowest fair value at certain dates
defined in the ESPP. The Company issued approximately 337,000, 227,000 and
67,000 shares of common stock in 2002, 2001 and 2000, respectively, under the
ESPP. At December 31, 2002, approximately 163,000 shares of common stock
remained available for future issuance.

STOCK OPTION PLANS

Prior to March 1998, the Company maintained a stock incentive plan (the
"1996 Option Plan"), which provided for the issuance of stock options and stock
appreciation rights to employees. Under the 1996 Option Plan, options were
granted at prices determined by the Board of Directors. The options granted are
exercisable in accordance with a vesting schedule, not to exceed 10 years. No
further stock options may be granted under the 1996 Option Plan.

In March 1998, the Company adopted the 1998 Stock Option Plan (the "1998
Option Plan"). All available options in the 1996 Option Plan were transferred
into the 1998 Option Plan. All options outstanding under the 1996 Option Plan as
of the termination date continue in effect under their original terms. The 1998
Option Plan provides for the issuance of stock options to employees, directors,
consultants and advisors, which are granted at prices determined by the Board of
Directors. The options granted are exercisable in accordance with a vesting
schedule, not to exceed 10 years. Options held by certain executives immediately
vested 30% in connection with the IPO.

In June 1999, the Company adopted an Amended and Restated Stock Incentive
Plan (the "Stock Incentive Plan"). The Stock Incentive Plan amended the 1998
Option Plan to increase the amount of shares reserved for the future issuance of
stock options and added certain change-of-control provisions, as well as made
other minor modifications. In January 2001, the Company's Board of Directors
amended and restated the Stock Incentive Plan to eliminate certain
change-of-control provisions. The amendment did not affect options previously
granted under the plan.

In May 2001, the Board adopted the 2001 Broad Based Equity Incentive Plan
(the "2001 Option Plan"). The 2001 Option Plan provides for the issuance of
stock options to employees who are not directors or officers of the Company.

As of December 31, 2002, a total of 20.1 million stock options were
authorized under all of the Company's stock option plans, of which 10.9 million
were outstanding and 4.1 million remained available for future grants.

50

FREEMARKETS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

NOTE 13. EMPLOYEE BENEFIT PLANS, CONTINUED:

The following is a summary of stock option activity:

The following is a summary of the options outstanding as of December 31,
2002 (in thousands):

All options were granted at exercise prices determined by the Board of
Directors. In 1999, the Company recorded $2.0 million of unearned stock
compensation related to employee stock option grants with exercise prices lower
than the deemed fair value of the underlying shares at the time of grant, of
which $150,000, $253,000 and $414,000 was amortized in 2002, 2001 and 2000,
respectively.

In April 2000, 3,000 options were granted to a consultant. In accordance
with SFAS No. 123, the Company recorded unearned stock compensation of $196,000,
of which $49,000 and $147,000 was amortized in 2001 and 2000, respectively, as
determined using the Black-Scholes pricing model with the following assumptions:
weighted average risk-free interest rate of 6.2%, expected life of one year and
volatility of 125%.

In July 2001, the Company offered option holders who were current employees
(excluding the Board of Directors, executive officers and employees located
outside of the United States) the opportunity to exchange outstanding options
with an exercise price of $20.00 per share or more for new options. The number
of shares subject to new options would be determined by application of an
exchange ratio based upon the exercise price of the options. The offer expired
on August 3, 2001. The exchange resulted in the voluntary cancellation of

51

FREEMARKETS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

NOTE 13. EMPLOYEE BENEFIT PLANS, CONTINUED:

employee stock options to purchase 181,000 shares of common stock in exchange
for the granting of 37,000 employee stock options in February 2002 with an
exercise price of $21.62, which was the fair market value of the Company's
common stock on the grant date. There was no compensation expense recorded as a
result of this exchange.

NOTE 14. STOCK COMPENSATION AND WARRANT COSTS

Stock compensation and warrant costs includes charges resulting from stock
options and warrants granted at exercise prices less than fair value, as well as
certain modifications made to stock options of former employees. The following
table shows the amounts of stock compensation and warrant costs that would have
been recorded by category had stock compensation and warrant costs been
separately stated on the consolidated statements of operations:

NOTE 15. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

The Company's quarterly results for 2002 and 2001 are as follows:

- ------------------------
(1) Exclude service fees from Visteon of $2.8 million for each quarter in 2002
and 2001.

52

FREEMARKETS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

NOTE 16. SUBSEQUENT EVENTS

In January 2003, in response to the continued economic slowdown, the
Company executed a restructuring plan resulting in the elimination of 71
positions in its global workforce. Additionally, in February 2003, the Company
evaluated its office space in Pittsburgh, Pennsylvania, and determined that it
will cease using one of the floors it currently leases in its global
headquarters. In accordance with SFAS No. 146, the Company will record a
restructuring charge of approximately $4.7 million in the first quarter of 2003,
covering these severance and lease costs.

Also in January 2003, the Board of Directors of the Company authorized the
repurchase of up to an aggregate of 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 February 28, 2003, the Company had purchased 657,000 shares
at a weighted average stock price of $4.19.

In February 2003, the Company entered into the sixth amendment to its bank
credit agreement, which reduces the availability under the revolving credit
facility from $20.0 million to $15.0 million and extends the maturity date
through February 2004. Funds borrowed under the line of credit may be used for
working capital requirements and general corporate purposes. As with the
previous facility, the new credit facility contains restrictive covenants and
other financial reporting requirements.

With respect to the Consolidated Complaint described in Note 10 to the
Consolidated Financial Statements, 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.

On March 7, 2003, the Board of Directors 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, 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.

53

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

Not applicable.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information set forth under the caption "Election of Directors" and the
subcaption "Section 16 Reporting Compliance" in the Proxy Statement and set
forth herein in Item 1, "Business--Executive Officers" is incorporated herein by
reference in response to this Item 10.

ITEM 11. EXECUTIVE COMPENSATION

The information set forth under the captions "Executive Compensation and
Related Information" in the Proxy Statement is incorporated herein by reference
in response to this Item 11.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS

The information set forth under the caption "Beneficial Ownership of Common
Stock" in the Proxy Statement is incorporated herein by reference in response to
this Item 12.

SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS

The following table provides information as of December 31, 2002 regarding
compensation plans and arrangements under which equity securities of FreeMarkets
are authorized for issuance. Certain of our equity compensation plans provide
for the issuance of restricted stock. Footnote (7) to the table sets forth
information with respect to such restricted stock. The table does not include
information with respect to outstanding options that were assumed by us in
connection with our acquisition of iMark in March 2000. Footnote (8) to the
table sets forth information with respect to such assumed options.

- ---------------

(1) Consists of the 1996 Stock Incentive Plan, the Second Amended and Restated
Incentive Plan and the Amended and Restated Employee Stock Purchase Plan.

(2) Consists of the 2001 Broad Based Equity Incentive Plan.

(3) Consists of warrant issued to Visteon Corporation.

(4) Excludes purchase rights under the Amended and Restated Employee Stock
Purchase Plan.

(5) The number of shares of common stock that may be subject to grants under the
Amended and Restated Incentive Plan is automatically increased on the first
day of each fiscal year ending on or before December 31, 2008 by a number
equal to the lesser of (i) 1,500,000 shares, (ii) 3% of the shares

54

outstanding on the last day of the immediately preceding fiscal year, or
(iii) such lesser number of shares as is determined by the Board.

(6) The maximum number of shares of common stock that may be subject to grants
under the 2001 Broad Based Equity Incentive Plan is automatically increased
on the first day of each fiscal year ending on or before December 31, 2010
by a number equal to the lesser of (i) 250,000 shares, (ii) 1% of the
shares outstanding on the last day of the immediately preceding fiscal
year, or (iii) such lesser number of shares as is determined by the Board.

(7) Under the Amended and Restated Incentive Plan and the 2001 Broad Based
Equity Incentive Plan, the Company may grant shares of stock which are
subject to forfeiture risks and restrictions on transferability
("restricted stock"). The restrictions on the restricted stock lapse, and
the shares vest, in accordance with the schedule set forth in the
individual holder's restricted stock agreement. During the period in which
shares are subject to restriction, the holder may not sell or otherwise
dispose of the restricted stock. In the event that the holder's employment
is terminated prior to the lapse of restrictions, the shares subject to
restriction are forfeited in exchange for the purchase price paid, if any,
for such shares. The restrictions of shares of restricted stock will lapse
in the event of a change of control of FreeMarkets in which the acquiring
corporation does not assume or replace the shares of restricted stock. As
of December 31, 2002, no shares of restricted stock had been granted under
the Amended and Restated Incentive Plan or the 2001 Broad Based Equity
Incentive Plan.

(8) As of December 31, 2002, there were 156 shares issuable upon exercise of
options assumed by us in connection with our acquisition of iMark in March
2000. The weighted average exercise price of those options is $32.54 per
share. No additional options may be granted under the iMark option plan.

2001 Broad Based Plan

The 2001 Broad Based Plan was adopted by the Board of Directors on May 16,
2001. The 2001 Broad Based Plan has not been approved by our stockholders.
Options to purchase shares of our common stock and shares of restricted stock
may be awarded under the 2001 Broad Based Plan to employees of FreeMarkets and
its subsidiaries other than employees who are directors or officers (as defined
in Rule 16a-1(f) under the Securities Exchange Act of 1934, as amended). The
maximum number of shares of common stock that may be subject to grants under the
2001 Broad Based Plan is 2,000,000, plus an automatic annual increase beginning
on or after January 1, 2002 and ending on or before December 31, 2010 as
described in footnote (6) above. Options are granted at an exercise price and
subject to such vesting schedule and other terms as may be determined by the
Board or the committee of the Board administering the plan. All options are non-
qualified stock options under federal tax laws. The vesting of options will
accelerate in the event of a change-of-control of FreeMarkets in which the
acquiring corporation does not assume or replace the options. See footnote (7)
for a description of restricted stock that may be issued under the 2001 Broad
Based Plan.

Warrant Issued to Visteon Corporation

In April 2000, the Company issued a warrant to Visteon, with an exercise
price of $.01 per share, to purchase 1,750,000 shares of the Company's common
stock. The warrant was issued to Visteon concurrently with the execution of a
five-year access and services agreement that provides for fixed monthly fees in
return for FullSource software and services. The Company granted the warrant in
consideration of the marketing and public relations benefits that it would
receive as a result of its ability to publicize its relationship with Visteon.
The shares subject to the warrant are exercisable by Visteon, in whole or in
part, at any time and from time to time during the period beginning on May 1,
2008 and ending on May 1, 2009, subject to the right of Visteon to exercise the
warrant in annual increments during the five-year term of the access and
services agreement, if certain revenue and market volume targets significantly
beyond the amounts committed in the access and services agreement are met.
Visteon purchased 350,000 shares of Common Stock upon partial exercise of the
warrant in July 2001.

55

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information set forth under the caption "Certain Relationships and
Related Transactions" in the Proxy Statement is incorporated herein by reference
in response to this Item 13.

ITEM 14. CONTROLS AND PROCEDURES

(a) As of a date (the "Evaluation Date") within 90 days prior to the filing
of this Form 10-K, 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.

56

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(A) DOCUMENTS FILED AS PART OF THIS REPORT:

1. Financial Statements and Supplementary Data. The following Financial
Statements of the Company are filed with this Form 10-K:

Report of Independent Accountants........................... 30
Consolidated Balance Sheets as of December 31, 2002 and
2001...................................................... 31
Consolidated Statements of Operations for each of the three
years in the period ended December 31, 2002............... 32
Consolidated Statements of Stockholders' Equity for each of
the three years in the period ended December 31, 2002..... 33
Consolidated Statements of Cash Flows for each of the three
years in the period ended December 31, 2002............... 34
Notes to Consolidated Financial Statements.................. 35

2. Financial Statement Schedules. The following financial statement
schedule is filed as part of this Annual Report on Form 10-K:

Schedule II--Valuation and Qualifying Accounts

3. Exhibits. The Exhibits listed below are filed or incorporated by
reference as part of this Form 10-K. Where so indicated by footnote,
exhibits which were previously filed are incorporated by reference.

- ---------------

++ Portions of this exhibit have been omitted based on a request for
confidential treatment filed with the SEC. The omitted portions of the
exhibit have been filed separately with the SEC.

(1) Incorporated by reference to exhibit filed with the registrant's
Registration Statement on Form S-8, as filed with the SEC on May 26, 2000.

(2) Incorporated by reference to exhibit filed with the registrant's
Registration Statement on Form S-8, as filed with the SEC on July 10, 2001.

(3) Incorporated by reference to exhibit filed with the registrant's Form 10-K
for the year ended December 31, 2000, as filed with the SEC on February 23,
2001.

(4) Incorporated by reference to exhibit filed with the Registration Statement
as filed with the SEC on September 8, 1999.

(5) Incorporated by reference to exhibit filed with Amendment No. 2 to the
Registration Statement, as filed with the SEC on November 1, 1999.

(6) Incorporated by reference to exhibit filed with the registrant's Form 10-K
for the year ended December 31, 2001, as filed with the SEC on March 12,
2002.

(7) Incorporated by reference to exhibit filed with the registrant's
Registration Statement on Form S-4, as filed with the SEC on February 23,
2001.

(8) Incorporated by reference to exhibit filed with the registrant's Annual
Report on Form 10-K for the year ended December 31, 1999, as filed with the
SEC on March 16, 2000.

(9) Incorporated by reference to exhibit filed with Amendment No. 5 to the
Registration Statement, as filed with the SEC on November 18, 1999.

(10) Incorporated by reference to exhibit filed with Amendment No. 6 to the
Registration Statement, as filed with the SEC on November 23, 1999.

(11) Incorporated by reference to exhibit filed with the registrant's Quarterly
Report on Form 10-Q for the quarter ended June 30, 2000, as filed with the
SEC in August 2, 2000.

(12) Incorporated by reference to exhibit filed with the registrant's
Registration Statement on Form S-4/A, as filed with the SEC on May 10,
2001.

(B) REPORTS ON FORM 8-K

The Company did not file any Reports on Form 8-K during the quarter ended
December 31, 2002.

* * * * * *

58

SIGNATURES

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.
FREEMARKETS, INC.

Dated: March 14, 2003 By: /s/ JOAN S. HOOPER
------------------------------------
Joan S. Hooper
Executive Vice President,
Chief Financial Officer, Secretary
and Treasurer

Each person whose signature appears below hereby appoints David H.
McCormick and Joan S. Hooper, and both of them, either of whom may act without
the joinder of the other, as his true and lawful attorneys-in-fact and agents,
with full power of substitution and resubstitution, for him and in his name,
place and stead, in any and all capacities, to sign any and all amendments to
this Annual Report on Form 10-K, and to file the same, with all exhibits thereto
and all other documents in connection therewith, with the Commission, granting
unto said attorneys-in-fact and agents full power and authority to perform each
and every act and thing appropriate or necessary to be done, as fully and for
all intents and purposes as he might or could do in person, hereby ratifying and
confirming all that said attorneys-in-fact and agents or their substitute or
substitutes may lawfully do or cause to be done by virtue hereof. Pursuant to
the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated.

59

CERTIFICATIONS UNDER SECTION 302 OF SARBANES/OXLEY ACT

I, David H. McCormick, certify that:

1. I have reviewed this annual report on Form 10-K 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 annual report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual 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 annual 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
annual report (the "Evaluation Date"); and

c) presented in this annual 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
annual 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: March 14, 2003 /s/ DAVID H. MCCORMICK
--------------------------------------
David H. McCormick
President and Chief Executive Officer

60

CERTIFICATIONS UNDER SECTION 302 OF SARBANES/OXLEY ACT

I, Joan S. Hooper, certify that:

1. I have reviewed this annual report on Form 10-K 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 annual report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual 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 annual 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
annual report (the "Evaluation Date"); and

c) presented in this annual 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
annual 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: March 14, 2003 /s/ JOAN S. HOOPER
--------------------------------------
Joan S. Hooper
Executive Vice President, Chief
Financial Officer,
Secretary and Treasurer

61

EXHIBIT INDEX

62

REPORT OF INDEPENDENT ACCOUNTANTS ON
FINANCIAL STATEMENT SCHEDULE

To the Board of Directors
of FreeMarkets, Inc. and Subsidiaries:

Our audits of the consolidated financial statements referred to in our
report dated January 24, 2003, except for Note 16, as to which the date is
February 28, 2003, appearing in this Form 10-K also included an audit of the
financial statement schedule listed in Item 15(a)(2) of this Form 10-K. In our
opinion, this financial statement schedule presents fairly, in all material
respects, the information set forth therein when read in conjunction with the
related consolidated financial statements.

/s/ PricewaterhouseCoopers LLP

Pittsburgh, Pennsylvania
January 24, 2003, except for Note 16,
as to which the date is March 7, 2003

SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS