UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

For the quarterly period ended June 30, 2004

OR

For the transition period from ____________ to ____________ .

Commission file number: 0-26811

NexPrise, Inc.

5950 La Place Court, Suite 200
Carlsbad, CA 92008
760-804-1333
(Address, including zip code, and telephone
number, including area code, of Registrant’s principal
executive offices)

     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 o

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

     On June 30, 2004, 3,237,718 shares of the registrant’s common stock, $.0002 par value per share, were issued and outstanding.

NEXPRISE, INC.
FORM 10-Q

TABLE OF CONTENTS

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NEXPRISE, INC

CONSOLIDATED BALANCE SHEETS
(in thousands, except per share values)

(1)

Derived from December 31, 2003 audited consolidated financial statements. See accompanying notes to consolidated financial statements.

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NEXPRISE, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(Unaudited)

See accompanying notes to consolidated financial statements

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NEXPRISE, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

See accompanying notes to consolidated financial statements

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NEXPRISE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Unaudited

Note 1.

Description of Business

     NexPrise, Inc. (the “Company” or “NexPrise” or “we”), formerly known as Ventro Corporation and Chemdex Corporation, is a seller of business process automation and management applications and collaborative solutions for program management and quote management. Our revenue primarily consists of subscriptions of bundled license, post contract support (PCS) and, in most cases, hosting services.

     As of June 30, 2004, the Company had working capital of approximately $1.2 million and stockholders’ deficit of approximately $10.2 million. During the three months ended June 30, 2004, the Company used cash and cash equivalents in operating activities of approximately $1.1 million, a decrease of approximately $42,000 from the $1.2 million used in the three months ended March 31, 2004. Management believes it has sufficient cash, cash equivalents and short term investments to support the Company’s planned activities through at least 2004. Management is committed to the successful execution of our operating plan and will take further action as necessary to align our operations and reduce expenses.

Note 2.

Summary of Significant Accounting Policies

Basis of Presentation

     The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. Intercompany accounts and transactions have been eliminated. While the quarterly financial information is unaudited, the financial statements included in this Form 10-Q reflect all adjustments (consisting of normal recurring adjustments) that the Company considers necessary for a fair presentation of the results of operations for the interim periods covered and of the financial condition of the Company at the date of the interim balance sheet. The results for the interim periods are not necessarily indicative of the results for the entire year. The consolidated balance sheet as of December 31, 2003 has been derived from the audited consolidated balance sheet as of that date. The information included in this report should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.

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 amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

Revenue Recognition

     For all arrangements, we determine whether evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable and collection is probable. If any of these criteria are not met, revenue recognition is deferred until such time as all of the criteria are met. Our revenue recognition policy is in accordance with Statement of Position (“SOP”) No. 97-2, Software Revenue Recognition, as amended, SEC Staff Accounting Bulletin 104 and EITF 00-21, Revenue Arrangements with Multiple Deliverables.

     Term license revenue includes bundled term licenses, post contract support and, in most cases, hosting services. The Company recognizes such revenue using the “subscription” method, whereby the initial and renewal amounts are recognized ratably over the period of the license during which the services are expected to be provided. In instances where maintenance is bundled with licenses of software products, such maintenance terms are typically one year.

     Perpetual license revenue is recognized using the residual method described in SOP No. 98-9 for arrangements in which licenses are sold with multiple elements. We allocate revenues on these licenses based upon the fair value of each undelivered element (for example, undelivered maintenance and support, training and consulting). The determination of fair value is based upon vendor specific objective evidence (“VSOE”). VSOE of the fair value of maintenance for license agreements with and without stated renewal rates is based on the Company’s price list. VSOE of the fair value of maintenance for license agreements that do not include stated renewal rates is determined by reference to the price paid by the Company’s customers when maintenance is sold separately. Past history has shown that the rate the Company charges for maintenance on license agreements with a stated renewal rate is similar to the

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rate the Company charges for maintenance on license agreements without a stated renewal rate. Revenue for training or consulting is based upon separate sales of these services. When software services are considered essential or the arrangement involves significant customization or modification of the software, both the net license and service revenues under the arrangement are recognized under the percentage of completion method of contract accounting, based on input measures of hours, or completed contract method. Assuming all other revenue recognition criteria are met, the difference between the total arrangement fee and the amount deferred for each undelivered element is recognized as license revenue.

     NexPrise did not establish VSOE for maintenance prior to March 31, 2003, and therefore recognized the revenue from license agreements entered into prior to March 31, 2003 ratably over the maintenance period. NexPrise established VSOE on maintenance in the three months ended June 30, 2003.

     Revenue for training or consulting services is recognized based upon contract completion or on a time and materials basis.

Net Income (Loss) Per Share

     Net income (loss) per share is presented in accordance with the requirements of Statement of Financial Accounting Standards (“SFAS”) No. 128, Earnings Per Share, which requires dual presentation of basic earnings per share (“EPS”) and diluted EPS.

     Basic net income (loss) per share is computed using the weighted average number of common shares outstanding during the period. Diluted net income per share is computed using the weighted average number of common shares and potentially dilutive shares outstanding during the period.

Stock-Based Compensation

     In December 2002, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure—an amendment of FASB Statement No. 123. SFAS 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require prominent disclosure in both annual and interim financial statements about the method of accounting for stock-based compensation and the effect of the method used on reported results. The transition guidance and disclosure provisions of SFAS 148 are effective for the Company’s financials statements issued for 2003.

     The Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, in accounting for its employee stock options. Accordingly, no compensation expense is recognized in the Company’s financial statements in connection with employee stock awards where the exercise price of the award is equal to the fair market value of the stock on the date of grant. When stock options are granted with an exercise price that is lower than the fair market value of the stock on the date of grant, the difference is recorded as deferred compensation and amortized to expense on a straight-line basis over the vesting term of the stock options.

     Pro forma information regarding net loss and net loss per share is required by FAS 123. This information is required to be determined as if the Company had accounted for its employee stock options (including shares issued under the Employee Stock Purchase Plan, collectively called “stock-based awards”), under the fair value method of FAS 123. Stock-based awards have been valued using the Black-Scholes option-pricing model. Among other things, the Black-Scholes model considers the expected volatility of the Company’s stock price, determined in accordance with FAS 123, in arriving at an option valuation.

     The fair value of the stock-based compensation was estimated at the date of grant using the Black-Scholes option-pricing model using the assumptions below.

     The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected volatility of the stock price. Because the Company’s stock-based awards have characteristics significantly

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different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimates, in the opinion of management, the existing models do not necessarily provide a reliable single measure of the fair value of its stock-based awards.

     For purposes of pro forma disclosures, the estimated fair value of the stock-based awards is amortized to expense over the awards’ vesting periods. The pro forma stock-based employee compensation expense has no impact on the Company’s cash flow. In the future, the Company may elect, or be required, to use a different valuation model, which could result in a significantly different impact on pro forma net income (loss). For purposes of this reconciliation, the Company adds back to previously reported net income all stock-based employee compensation expense that relates to acquisitions, then deducts the pro forma stock-based employee compensation expense determined under the fair value method for all awards. The Company’s pro forma information is as follows (in thousands, except per share amounts):

     On February 17, 2004, the Compensation Committee approved an increase of 500,000 shares under the 1998 Stock Plan and 8,825 shares under the 1999 Directors Stock Plan.

Concentration of Credit Risk and Significant Customers

     The Company’s customer base consists of businesses located primarily in North America. The Company maintains allowances for potential credit losses and historically, such losses have been within management’s expectations. Revenue and accounts receivable by customers comprising more than 10% of total amounts are as follows:

Long Lived Assets

     The Company reviews property, plant and equipment, goodwill and purchased intangible assets for impairment whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. Our asset impairment review assesses the

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fair value of the assets based on the future cash flows the assets are expected to generate. An impairment loss is recognized when estimated undiscounted future cash flows expected to result from the use of the asset, plus net proceeds expected from disposition of the asset (if any) are less than the carrying value of the asset. This approach uses our estimates of future market growth, forecasted revenue and costs, expected periods the assets will be utilized and appropriate discount rates. When an impairment is identified, the carrying amount of the asset is reduced to its estimated fair value. This impairment analysis is required to be performed at least annually for goodwill and purchased intangibles with indefinite useful lives. Also, potential impairment of long-lived assets other than goodwill and purchased intangible assets with indefinite useful lives is evaluated using the guidance provided by SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.

Note 3. Comprehensive Loss

     SFAS No. 130, Reporting Comprehensive Income, establishes standards of reporting and display of comprehensive income and its components of net loss and “Other Comprehensive Income.” Other Comprehensive Income refers to revenues, expenses, gains and losses that are not included in net income (loss) but rather are recorded directly in stockholders’ deficit. For all periods presented there are no reconciling items for comprehensive loss. Net loss as presented on the Consolidated Statements of Operations is the same as total comprehensive loss.

Note 4. Goodwill and Purchased Intangibles

     SFAS 142, Goodwill and Other Intangible Assets, requires that we evaluate on an annual basis (or whenever events occur which may indicate possible impairment) whether any portion of our recorded intangible assets is impaired. This analysis requires management to make a series of critical assumptions to (1) evaluate whether any impairment exists, and (2) measure the amount of impairment.

     In accordance with our policy for assessing the carrying value of our long lived assets, in each quarter of 2003 we compared the carrying value of the intangible assets with the undiscounted cash flows expected to be generated by those assets over their remaining estimated useful lives. No indicators of impairment were found in the first, second or third quarters of 2003. In the fourth quarter of 2003 a reduction in our revenue forecast and a reduction in the estimated useful lives of the intangible assets due to our fourth quarter decision to adopt a plan to transition toward an indirect channel solution led us to conclude there were indicators the intangible assets were impaired. The resulting analysis of discounted cash flows led to an impairment charge of approximately $6.4 million, leaving approximately $139,000 of intangible assets to be amortized evenly over 2004. Of that value, approximately $137,000 is purchased technology related to the acquisitions of NexPrise and InfoPrise and approximately $2,000 is for a non-compete agreement signed at the time of the NexPrise acquisition. During 2004, we will continue to evaluate these intangible assets for impairment as events and circumstances warrant. If an impairment is determined, further write-offs may be required.

     Subsequent to the adoption of SFAS 142, identifiable intangible assets with definite lives will continue to be amortized over their useful lives and will be reviewed for impairment in accordance with SFAS 144 when impairment indicators exist. These assets are shown as intangible assets on the face of the balance sheet and are as follows (in thousands):

     Prior to the writedown in the fourth quarter of 2003, NexPrise purchased technology was being amortized based on forecast revenue over 5 years. InfoPrise purchased technology was being amortized based on forecast revenue over 3 years. The NexPrise trade name and non-compete intangible assets were being amortized using a straight line method over 2 and 3 year periods, respectively. All remaining NexPrise and InfoPrise intangible assets will be fully amortized using a straight line method over their remaining useful lives, which extend through the end of 2004.

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Note 5. Balance Sheet Details

Other Current Assets

     Other current assets of $240,000 and $362,000 as of June 30, 2004 and December 31, 2003, respectively, are comprised primarily of prepaid royalties, current deposits and other receivables.

Other Long-term Assets

     Other long-term assets are comprised of the following (in thousands):

Note 6. Convertible Notes

     In February 2002 NexPrise issued unsecured, convertible promissory notes due in 2007 with a face value of $3,040,000, a common stock conversion price of $18.75 and interest rate of 6% in connection with the acquisition of InfoPrise. As of June 30, 2004, no amount of the notes had been converted into NexPrise common stock. With respect to the InfoPrise convertible promissory note, approximately $73,000, which represents 40% of annual interest, is payable annually on each anniversary date of the issuance of the promissory note, with the balance of interest owed due at maturity. The interest balance accrued in accrued expenses at June 30, 2004 is approximately $292,000. In April 2000, NexPrise issued $250 million of convertible subordinated notes due in 2007, bearing annual interest at 6% and convertible at the option of the holder into the Company’s common stock at a price of $1,361.70 per share. The Company subsequently repurchased $241.2 million of these notes during 2001. Approximately $8.8 million of the convertible subordinated notes remained outstanding as of June 30, 2004 and December 31, 2003.

Note 7. Contingencies

     Starting in March 2001, several lawsuits were filed in United States District Court for the Northern District of California against the Company and certain of its officers and directors on behalf of putative classes of persons who purchased the Company’s securities during time periods from December 1999 through December 6, 2000. One of the lawsuits also names as a defendant the underwriters for the Company’s offering of convertible notes. The lawsuits generally allege that the Company and certain individuals violated the federal securities laws by making false and misleading statements during 2000, including in the Company’s registration statement for its convertible notes offering. These lawsuits were consolidated as In re Ventro Corp. Sec. Litig., Master File No. Civ. 01-1287 SBA, and a consolidated complaint was filed. Following several motions to dismiss and the filing of amended complaints, the Court set a trial date for January 20, 2005 with respect to the issues remaining in the case, and discovery commenced. The parties have tentatively reached an agreement in principle to settle the securities action together with the settlement of the related derivative action described below. The Company’s portion of the settlement would be funded by insurance. There can be no assurance that the settlement will be finalized, and if the settlement is not finalized, the Company intends to defend the case vigorously.

     In August 2001, Chadwell v. Byers, Case No. CV800814, a putative stockholder derivative suit, was filed in California Superior Court, Santa Clara County against certain of the Company’s present and former officers and directors, alleging breaches of fiduciary duty and insider trading. The Company is named solely as a nominal defendant against which no recovery is sought. After a demurrer was sustained with leave to amend, the parties stipulated to a stay of proceedings pending resolution of the In re Ventro Corp. Sec. Litig. action. As described above, the parties have reached an agreement in principle to settle this litigation together with the settlement of the federal securities action.

     In March 2001, Kassin v. Ventro Corp. et al., Index No. 01-CV-3450 (SAS), a stockholder class action complaint, was filed in the United States District Court for the Southern District of New York against the Company, several of its officers and directors, and the

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underwriters of its initial public offering. The class action has been consolidated for pre-trial purposes with more than one thousand other actions, filed against more than 300 other issuers of securities, affiliated individuals and dozens of underwriters of the securities offerings in In Re Initial Public Offering Securities Litigation, 21 MC 92 (SAS) (“IPO Allocation Litigation”). The plaintiffs allege that the prospectus for the initial public offering of the Company’s common stock, incorporated in the Registration Statement on Form S-1 filed with the Securities and Exchange Commission, was materially false and misleading because it failed to disclose, among other things, that the underwriters had made secret arrangements for aftermarket purchases of the securities and made arrangements for excessive and improper underwriters’ compensation in the form of increased brokerage commissions. Plaintiffs are claiming damages of an unspecified amount based on the subsequent decline in the market price of the Company’s shares below their original offering price. In recent months in the IPO Allocation Litigation, counsel for the plaintiffs, liaison counsel for the issuer defendants and counsel for insurers of the issuer defendants have taken part in continuing discussions mediated by a former federal district court judge to explore a possible settlement of the claims against all of the issuer defendants, including the Company. In June 2003, a memorandum of understanding was entered into by and among the plaintiffs, liaison counsel for the issuer defendants and counsel for the insurers which would result in dismissal of the action against the issuers, including the Company, on terms that would not require any current payment by the Company and are believed by the Company’s board of directors to carry only a remote risk that any future payment by the Company would be required. In addition, the plaintiffs would release the Company and its officers and directors from the claims that have been asserted against them in the IPO Allocation Litigation as a part of the proposed settlement. On June 30, 2003, the Company’s board of directors approved the memorandum of understanding and authorized the Company to enter into the proposed settlement. On June 14, 2004, the proposed settlement was submitted to the Court for its required approval, and the Court has taken the motion for preliminary approval of the proposed settlement under submission. The IPO Allocation Litigation in general, and the litigation against the Company in particular, are in an early phase, and no date has yet been set by the court for completion of pre-trial discovery or trial.

     Although we believe that we have meritorious defenses to the actions and intend to defend the suits vigorously, we cannot predict with certainty the outcome of these lawsuits. Our defense against such lawsuits could be costly and will require a significant commitment of time and resources by our senior management. Although the Company has insurance to cover these claims, the recovery of all future costs is not assured.

     The Company is a party to various claims in the ordinary course of business. Although the results of litigation and claims cannot be predicted with certainty, the Company believes the final outcome of such matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.

Indemnification

     The Company sells software licenses and services to its customers under contracts which the Company refers to as Software License and Service Agreements (each an “SLSA”). Each SLSA contains the relevant terms of the contractual arrangement with the customer, and generally includes certain provisions for indemnifying the customer against losses, expenses, and liabilities from damages that may be incurred by or awarded against the customer in the event the Company’s software or services are found to infringe upon a patent, copyright, trade secret, trademark, or other proprietary right of a third party. The SLSA generally limits the scope of remedies for such indemnification obligations in a variety of industry-standard respects, including but not limited to certain product usage limitations and geography-based scope limitations and a right to replace an infringing product or modify it to make it non-infringing. If the Company cannot address the infringement by replacing the product or services, or modifying the product or services, the Company is allowed to cancel the license or services and return the fees paid by the customer. The Company requires its employees to sign a proprietary information and inventions assignment agreement, which assigns the rights in its employees’ development work to the Company.

     To date, the Company has not had to reimburse any of its customers for any losses related to these indemnification provisions and no material claims are outstanding as of June 30, 2004. For several reasons, including the lack of prior indemnification claims and the lack of a monetary liability limit for certain infringement cases under the SLSA, the Company cannot determine the maximum amount of potential future payments, if any, related to such indemnification provisions. There can be no assurance that potential future payments will not have a material adverse effect on the Company’s business, results of operations or financial condition.

Government Regulations

     In addition to regulations applicable to businesses generally, the Company is or may be subject to direct regulation by governmental agencies which includes numerous laws and regulations generally applicable to the chemical, pharmaceutical, controlled substances, human and biological reagents, medical and in vitro devices, nuclear chemical businesses and environmental spills, as well as U.S. import and export controls and import controls of other countries. While the shutdown of Chemdex, Promedix and

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SpecialtyMD may limit future regulatory and product liability risks, until all statutes of limitation have expired, certain legal risks will remain.

     The Company relied on its suppliers to comply with applicable local, state and federal laws regarding the labeling and the dissemination of information on any products sold that may be hazardous or present a health threat to the user. If these suppliers have failed, or we have failed, to maintain the requisite records irrespective of the actions of the suppliers, or if either of us had failed to adequately comply with labeling and information dispensing requirements of local, state or federal laws, then the Company may be held legally responsible, since Company held title to these products, and could be subject to governmental penalties or fines, as well as private lawsuits to enforce these laws.

     Finally, the Company has relied upon its suppliers to obtain appropriate approvals for products regulated by the FDA and to comply with the requirements relating to those approvals and products. The failure of suppliers to obtain or comply with those approvals, or the failure of the product advertising or labeling to be consistent with the FDA approval for the products, or other failures by the products themselves, or our failure to keep regulatory records required by the FDA, such as complaint files, could result in costly product recalls, significant fines and judgments, civil and criminal liabilities and negative publicity.

     In February 2001, the Company received a subpoena from the U.S. Department of Justice, Drug Enforcement Administration, for certain billing, invoice, and shipping records concerning sales to an unaffiliated purchaser. Other than the foregoing, the Company is unaware of any current investigations, inquiries, citations, fines or allegations of violations or non-compliance relating to regulatory requirements pending by government agencies or by third parties against us. It is possible, however, that there may be such investigations or allegations that the Company is not aware of or future investigations or allegations. The risk that any noncompliance may be discovered in the future is currently unknown. Although any potential impact on the Company for noncompliance cannot currently be established, it could result in significant civil or criminal penalties, including monetary fines and injunctions, for noncompliance and negative publicity, and seriously harm our business, revenues, results of operations and financial condition.

Note 8. Accrued Expenses

     Accrued expenses were comprised of the following as of June 30, 2004 and December 31, 2003 (in thousands):

Note 9. Deferred Stock-Based Compensation

     In connection with the acquisition of InfoPrise completed in February 2002, the Company assumed the outstanding options granted under the InfoPrise stock option plans. The Company recorded deferred compensation of $132,293 for the difference between the exercise price of the unvested options assumed and the fair value of the common stock underlying those options as of the date the acquisition was consummated. That charge is being amortized over the remaining vesting period of the options. Additionally, the Company recorded deferred compensation of $184,178 with respect to the issuance of restricted common stock. That charge is being amortized over the remaining vesting period of the stock.

     The Company recognized $100,000 and $169,000 in stock compensation expense for the six months ended June 30, 2004 and 2003, respectively.

Note 10. Settlement, Restructuring and Discontinued Operations

     During the year ended December 31, 2002, the Company took actions to improve efficiencies and reduce operating costs, including employee and contractor terminations, consolidation of facilities, and settlements of various disputes and termination of leases. The net of these charges was reported as a component of loss from continuing operations.

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     The Company paid approximately $12,000 in severance payments during the quarter ended March 31, 2003. In the quarter ending June 30, 2003, the Company reversed an accrual related to the Company’s cancellation of a contract as part of a restructuring in 2001. The reversal was made in accordance with Company policy, as two years had passed since the related activity ceased and no actual charges had been, were then expected to be, or have been paid. At June 30, 2004, and 2003, the Company had no remaining restructuring accruals and reserves.

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

     The following Management’s Discussion and Analysis of Results of Operations and Financial Condition contains forward-looking statements. In some cases, readers can identify forward-looking statements by terminology such as “may,” “will,” “should,” “could,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or “continue.” These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from those stated herein. Although management of NexPrise believes that the expectations reflected in the forward-looking statements are reasonable, the Company cannot guarantee future results, performance, or achievements. For further information, refer to Management’s Discussion and Analysis and the Risk Factors section of NexPrise’s Annual Report on Form 10-K and the section entitled “Risk Factors” in this Form 10-Q.

Overview

     We are a seller of business process applications and collaborative solutions for program management and quote management. Our revenue primarily consists of subscriptions of bundled licenses, post contract support and, in most cases, hosting services and also includes perpetual licenses.

     On February 4, 2002, we acquired privately-held InfoPrise, a provider of data management solutions located in Carlsbad, California. As consideration for the acquisition, we issued to InfoPrise’s stockholders an aggregate of 139,790 shares of NexPrise common stock together with unsecured 6% promissory notes convertible into the Company’s common stock, due in 2007, with a face value of $3,040,000 and a common stock conversion price of $18.75 per share. We also assumed InfoPrise’s outstanding stock options, which may result in the issuance of up to approximately 64,000 shares of common stock if all of the assumed options are exercised. As of June 30, 2004, 2,096 of these options had been exercised. All operating results presented for periods following the above date are derived from the combined operations of NexPrise and InfoPrise. We expect to incur operating losses on a quarterly basis for at least the next 12 months as we continue to develop and enhance our technology and service offerings and build our customer base.

Critical Accounting Policies

     Use of Estimates. Management’s discussion and analysis of its financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

     Management believes the following critical accounting policies concerning revenue recognition, long lived assets and legal issues, affect its more significant estimates and assumptions used in the preparation of its consolidated financial statements

     Revenue Recognition. For all arrangements, we determine whether evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable and collection is probable. If any of these criteria are not met, revenue recognition is deferred until such time as all of the criteria are met. Our revenue recognition policy is in accordance with Statement of Position (“SOP”) No. 97-2, Software Revenue Recognition, as amended, Staff Accounting Bulletin 104 and EITF 00-21, Revenue Arrangements with Multiple Deliverables.

     Term license revenue includes bundled term licenses, post contract support and, in most cases, hosting services. The Company recognizes such revenue using the “subscription” method, whereby the initial and renewal amounts are recognized ratably over the

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period of the license during which the services are expected to be provided. In instances where maintenance is bundled with licenses of software products, such maintenance terms are typically one year.

     Perpetual license revenue is recognized using the residual method described in SOP No. 98-9 for arrangements in which licenses are sold with multiple elements. We allocate revenues on these licenses based upon the fair value of each undelivered element (for example, undelivered maintenance and support, training and consulting). The determination of fair value is based upon vendor specific objective evidence (“VSOE”). VSOE of the fair value of maintenance for license agreements with and without stated renewal rates is based on the Company’s price list. VSOE of the fair value of maintenance for license agreements that do not include stated renewal rates is determined by reference to the price paid by the Company’s customers when maintenance is sold separately. Past history has shown that the rate the Company charges for maintenance on license agreements with a stated renewal rate is similar to the rate the Company charges for maintenance on license agreements without a stated renewal rate. Revenue for training or consulting is based upon separate sales of these services. When software services are considered essential or the arrangement involves significant customization or modification of the software, both the net license and service revenues under the arrangement are recognized under the percentage of completion method of contract accounting, based on input measures of hours, or completed contract method. Assuming all other revenue recognition criteria are met, the difference between the total arrangement fee and the amount deferred for each undelivered element is recognized as license revenue.

     NexPrise did not establish VSOE for maintenance prior to March 31, 2003, and therefore recognized the revenue from license agreements entered into prior to March 31, 2003 ratably over the maintenance period. NexPrise established VSOE in the three months ended June 30, 2003. The Company must maintain VSOE on maintenance for perpetual licenses or risks an end to recognition of perpetual license revenue using the residual method and potentially revision to previously recognized perpetual licenses.

     Revenue for training or consulting services is recognized based upon contract completion or on a time and materials basis.

     Long Lived Assets. The Company reviews the carrying value of property, plant and equipment and purchased intangible assets for impairment whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. Our asset impairment review assesses the fair value of the assets based on the future cash flows the assets are expected to generate. An impairment loss is recognized when estimated undiscounted future cash flows expected to result from the use of the asset, plus net proceeds expected from disposition of the asset (if any) are less than the carrying value of the asset. This approach uses our estimates of future market growth, forecasted revenue and costs, expected periods the assets will be utilized and appropriate discount rates. When an impairment is identified, the carrying amount of the asset is reduced to its estimated fair value.

     No indicators of impairment were found in the first, second or third quarters of 2003. In the fourth quarter of 2003 a reduction in our revenue forecast and a reduction in the estimated useful lives of the intangible assets due to our fourth quarter decision to adopt a plan to transition toward an indirect channel solution led us to conclude there were indicators the intangible assets were impaired. The resulting analysis of discounted cash flows led to an impairment charge of approximately $6.4 million, leaving approximately $139,000 of intangible assets to be amortized evenly over their revised remaining estimated useful lives, which is through the end of 2004.

     During 2004 we will continue to evaluate our intangible assets for impairment as events and circumstances warrant. Among other circumstances, a material deterioration in the future cash flows expected from these assets due to lower than planned revenue or a decline in the Company’s market capitalization could be indicators of impairment and lead to write-offs.

     Legal. The Company is involved in certain claims and litigation related to its operations, including ordinary, routine litigation incidental to its business. Management reviews and determines which liabilities, if any, arising from these claims and litigation could have a material adverse effect on the Company’s consolidated financial position, liquidity or results of operations. In reviewing these claims and litigation, management assesses the likelihood of any adverse judgments or outcomes to these matters as well as potential ranges of probable losses. A determination of the amount of accruals required, if any, for these contingencies is made after analysis of each matter, which includes discussion with counsel retained in such matter. The required accruals may change in the future due to new developments in a matter or changes in strategies to resolve that matter, including changes in litigation defense and settlement strategies. The Company had no accruals for legal contingencies at June 30, 2004.

Results of Operations

     Net Revenues. NexPrise’s revenues were approximately $672,000 and $1.3 million for the three and six months ended June 30, 2004, a decrease of 33% from the three months ended June 30, 2003 and 23% from the six months ended June 30, 2003. The revenue is primarily made up of revenue being recognized ratably over the contract term that consists of bundled subscriptions, with maintenance, perpetual licenses, with maintenance, sold prior to the establishment of VSOE for maintenance and maintenance on

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perpetual licenses sold after the establishment of VSOE on maintenance. Other components of revenue include license revenue recognized upon delivery and consulting and training. The table below shows the relative percentages of each type of revenue for the three and six months ended June 30, 2004 and 2004.

     Cost of Product Licenses and Services. The cost of product licenses and services was $242,000 and $554,000 for the three and six months ended June 30, 2004, a decrease of 21% and 5% from the three and six months ended June 30, 2003. These costs consist primarily of outsourced hosting and co-location services for our customers, personnel and other expenses associated with providing maintenance and technical support services and royalties payable to third parties whose software is incorporated in the NexPrise solution. The decrease in 2004 was primarily due to lower managed hosting expenses achieved as a result of migrating part of the hosting infrastructure to a collocation facility.

     Cost of Amortization of Purchased Technology. Amortization of the developed technology intangible assets acquired in the purchases of NexPrise in August 2001 and InfoPrise in February 2002 was $34,000 and $68,000 for the three and six months ended June 30, 2004, a 93% decrease from the three and six months ended June 30, 2003. This decrease is a result of the write-down in the fourth quarter of 2003. These assets will be fully amortized in 2004.

     Research and Development. Research and development (“R&D”) expenses consist primarily of personnel and other expenses associated with developing, updating, and enhancing software. R&D expenses were approximately $571,000 and $1.2 million for the three and six months ended June 30, 2004, an increase of 3% from the three months ended June 30, 2003 and a decrease of 12% from the six months ended June 30, 2003. The increase for the three months ended June 30, 2004 is due to a $191,000 reversal of an estimated liability originally accrued in 2001 that decreased R&D expenses for the three months ended June 30, 2003. The reversal was made on the basis that two years had passed since the estimated liability had been accrued and no actual charges related to that liability had been, were then expected to be, or have since been paid. The decrease for the six months ended June 30, 2004 reflects reduced depreciation and payroll expenses. To date, all software development costs have been expensed in the period incurred. We believe that continued investments in research and development are required to remain competitive.

     Sales and Marketing. Sales and marketing expenses consist primarily of payroll and related expenses for personnel engaged in enterprise sales activities and enterprise account management, as well as travel and promotional expenses. Sales and marketing expenses were approximately $407,000 and $1.0 million for the three and six months ended June 30, 2004, a decrease of 57% and 48% from the three and six months ended June 30, 2003. The decreases were driven by reductions in workforce performed throughout 2003 and in the first quarter of 2004, reduced spending on marketing programs and lower amortization of intangible assets.

     General and Administrative. General and administrative expenses consist primarily of salaries, fees for professional services and facilities expenses. General and administrative expenses were approximately $636,000 and $1.2 million for the three and six months ended June 30, 2004, a decrease of 31% and 27% from the three and six months ended June 30, 2003. The decreases were driven by reductions in infrastructure costs, including depreciation and insurance expenses.

     Restructuring & Settlement. In the three months ended June 30, 2003, the Company reversed a restructuring and settlement accrual related to the Company’s cancellation of a contract as part of a restructuring in 2001. The reversal was made in accordance with Company policy, as two years had passed since the related activity ceased and no actual charges had been, were then expected to be, or have since been paid. The reversal resulted in a credit of $493,000 being reported on the restructuring line of the statement of operations.

     Interest Expense. Interest expense was $189,000 in both the three and six months ended June 30, 2004, and in the comparable periods in 2003. Interest expense consists primarily of interest related to convertible subordinated notes issued in April 2000, the convertible promissory note issued in association with the purchase of InfoPrise in February 2002 and, to a lesser extent, financed equipment and other financing arrangements. With respect to the subordinated notes, approximately $264,000 is payable semi-annually in arrears on April 1 and October 1 of each year for interest on the notes that remain outstanding at June 30, 2004. In addition, the remaining deferred offering costs of approximately $128,000 related to the subordinated notes are being amortized as interest expense ratably over the term of the subordinated notes. With respect to the InfoPrise convertible promissory note,

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approximately $73,000, which represents 40% of the annual interest, is payable annually on each anniversary of the issuance of the promissory note, with the balance of interest owed due at maturity.

     Interest Income and Other, Net. Interest income and other, net, was $9,000 and $49,000 for the three and six months ended June 30, 2004, a decrease of $119,000 for the three months ended June 30, 2003 and of $112,000 from the six months ended June 30, 2003. Interest income and other, net, has been derived primarily from earnings on investments in cash equivalents and short-term investments. Also included in the six months ended June 30, 2004 are fees of approximately $28,000 charged for late rental payments on subleased office space. Included in the six months ended June 30, 2003 is a gain from reversal of estimated taxes associated with the gain from retirement of bonds recognized in 2001. All tax returns have been filed and no liability was incurred.

     Investment Losses. Investment losses for the three and six months ended June 30, 2003 were $113,000. The loss is a write-down for impairment deemed to be other than temporary of an investment accounted for using the cost method. The book value of the investment was approximately $500,000 as of June 30, 2003. The investment was sold in the third quarter of 2003.

     Gain from discontinued operations. In the quarter ended June 30, 2003, the Company reversed an accrual of $334,000 related to an estimated liability accrued upon the Company’s cancellation of a contract that had been part of operations discontinued in 2000 and which ceased functioning in 2001. The reversal was made in accordance with Company policy, as two years had passed since the related activities ceased and no actual charges had been, were then expected to be or have since been paid.

     Net Loss. As a result of the changes described above, the net loss was approximately $1.4 million and $3.0 million for the three and six months ended June 30, 2004, a decrease of 11% and 29% from the net losses reported for the three and six months ended June 30, 2003.

Liquidity and Capital Resources

     As of June 30, 2004 NexPrise had approximately $3.6 million of cash, cash equivalents and short-term investments and working capital was approximately $1.2 million.

     Net cash used in operating activities was approximately $2.3 million for the six months ended June 30, 2004 compared to $1.9 million of net cash used in operating activities for the six months ended June 30, 2003. Net cash used in operating activities for the six months ended June 30, 2004 consists primarily of the net loss for the period less non-cash items.

     Net cash provided by investing activities totaled $3.5 million for the six months ended June 30, 2004, compared to net cash used in investing activities of $31,000 for the six months ended June 30, 2003. Net cash provided during the six months ended June 30, 2004, related primarily to net sales and maturities of approximately $3.5 million of short-term investments, partially offset by purchases of approximately $50,000 in property and equipment. Such purchases accounted for all of the net cash used in investing activities during the six months ended June 30, 2003.

     Management believes the Company has adequate cash to sustain operations at least through 2004 and is managing its business to achieve positive cash flow utilizing existing assets. During 2003 the Company continued to reduce ongoing operating expenses by reducing purchases of other services and making workforce reductions. In January 2004, the Company eliminated several positions, primarily in the sales and marketing functions, to reduce operating expenses. At the same time, our product development team is focusing on enhancing our solutions so they can be more easily configured by customers and indirect channel partners, will require less involvement by our technical personnel and can be delivered efficiently via the Internet. It will take several quarters before the business flowing through this indirect channel has a significant impact on operating results, but the reduced variable cost per incremental revenue dollar is expected to significantly improve our operating margin and allow our business to scale more readily. We are hopeful that we can achieve cash flow break-even in 2005 using this indirect channel, our continuing direct sales efforts and the aforementioned reduction in expenses.

     Management believes that the Company’s restructuring activities have reduced ongoing operating expenses such that the quarterly use of cash in 2004 will be between $500,000 and $1.2 million and the Company will have sufficient working capital to support planned activities at least through 2004. Management is committed to the successful execution of our operating plan and will take further action as necessary to align our operations and reduce expenses.

     Although we expect our existing cash, cash equivalent and investment balances together with our anticipated cash flows from operations to be sufficient to meet our working capital and operating resource expenditure requirements for at least through 2004 and beyond, higher than anticipated expenses or lower than anticipated receipts may result in lower cash, cash equivalents and investments balances than presently anticipated and we may find it necessary to obtain additional equity or debt financing. In the event additional financing is required, we may not be able to raise it on acceptable terms or at all.

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Risk Factors

     This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Securities Litigation Reform Act of 1995 that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth in the following cautionary statements and elsewhere in this Quarterly Report on Form 10-Q. If any of the following risks were to occur, our business, financial condition or results or operations would likely suffer. In addition to other information in this Form 10-Q, the following risk factors should be carefully considered in evaluating NexPrise and its business because such factors currently may have significant impact on NexPrise’s business, operating results and financial condition.

     An investment in our securities involves significant risks, including those described below. These risks relate to our ability to generate revenues and gain operating efficiencies, our history of losses, significant changes, our ability to hire and retain key personnel, our reliance on the hosted environment and technology provided by others, the possible delisting of our common stock, the need to respond to rapid technological change and legal claims against us.

     Our actual results may differ materially from those expressed in any forward-looking statement as a result of certain factors, including but not limited to those set forth below and included in other portions of this document.

     The Company Has a History of Losses and Expects to Continue to Incur Significant Operating Losses and Negative Cash Flow; We May Never Achieve or Maintain Profitability

     We have incurred substantial net losses in the past and we expect to incur net losses in future periods. We incurred a net loss of approximately $1.4 million during the three months ended June 30, 2004. As of June 30, 2004 we had an accumulated deficit of approximately $642 million. We will need to generate significant increases in revenues to achieve and maintain profitability, and we may not be able to do so. If our revenues grow more slowly than we anticipate or if our operating expenses cannot be reduced in the event of lower than expected revenues, we may find it necessary to obtain additional equity or debt financing or, in the alternative, significantly curtail our operations. Such financing may not be available on acceptable terms or at all. Even if we achieve profitability in the future on a quarterly or annual basis, we may not be able to sustain or increase profitability. Failure to achieve profitability or achieve and sustain the level of profitability expected by investors and securities analysts may adversely affect the market price of our common stock.

     Our Common Stock is not Listed on an Exchange or the Nasdaq System, and Trading is Restricted by the Additional Regulations on the Sale of Penny Stocks

     Our common stock is neither listed on any exchange nor quoted on Nasdaq but is reported on the OTC Bulletin Board. Accordingly, our shares are subject to the regulations regarding trading in “penny stocks,” which are those securities trading for less than $5.00 per share. The following is a list of the primary restrictions on the sale of penny stocks:

	•		Prior to the sale of penny stock by a broker-dealer to a new purchaser, the broker-dealer must determine whether the purchaser is suitable to invest in penny stocks. To make that determination, a broker-dealer must obtain, from a prospective investor, information regarding the purchaser’s financial condition and investment experience and objectives. Subsequently, the broker-dealer must deliver to the purchaser a written statement setting forth the basis of the suitability finding.
	•		A broker-dealer must obtain from the purchaser a written agreement to purchase the securities. This agreement must be obtained for every purchase until the purchaser becomes an “established customer.”
	•		The Securities Exchange Act of 1934 requires that prior to effecting any transaction in any penny stock, a broker-dealer must provide the purchaser with a “risk disclosure document” that contains, among other things, a description of the penny stock market and how it functions and the risks associated with such investment. These disclosure rules are applicable to both purchases and sales by investors.
	•		A dealer that sells penny stock must send to the purchaser, within ten days after the end of each calendar month, a written account statement including prescribed information relating to the security.

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     As a result of the foregoing, an investor’s ability to convert shares of our common stock into cash or to sell to a third party may be very limited. We can provide no assurance that our current market-makers will continue to make a market in our securities, or that any market for our securities will continue.

     We Have a Limited Operating History and an Evolving Technology and Service Offering, Which Makes it Difficult to Evaluate Our Future Prospects

     Our success is based on integrating and developing a viable technology and services offering and securing new customers. Our business model is not fully developed, not proven and depends upon our ability, among other things, to:

	•		develop and market technology and services solutions that achieve broad market acceptance by our customers;
	•		acquire and deploy a sufficient number of customers to achieve profitability;
	•		extend our technology to support a large range of customers with a variety of needs;
	•		acquire or license third party technologies that we require to deliver our technology and services;
	•		overcome publicity related to our public announcements of restructurings, litigation and the shutdown of our former marketplaces;
	•		overcome customer bias toward choosing larger, well capitalized vendors to provide their enterprises software solutions; and
	•		acquire customers operating in industries where we have limited experience and provide them quality technology and services.

     We may not successfully address these risks. If we do successfully address these risks, additional risks related to factors that are outside our control may prevent us from realizing sufficient revenues or profit margins to reach or sustain profitability. For example, collaborative business process solutions may experience problems with users as a result of security and privacy concerns or general reticence about technology.

     We Are Dependent on a Small Number of Customers in a Limited Number of Industries

     To date, we have derived a significant portion of our revenues from a small number of customers in two industries. Many of our customers do not have contracts that extend beyond one year. Critical to the success of the Company’s business plan will be the acquisition of new customers in other industries, increasing the number of users in our current customers and renewing current contracts. There can be no assurance that we will be successful in developing profitable relationships with new customers in new industries or that we will retain existing customers.

     Our Business Involves a Lengthy and Unpredictable Sales Cycle

     The sales cycle for the target customers for the software and services we offer tends to be lengthy and may be somewhat longer than those of our more established competitors. The unpredictability of the length of our sales cycle could make it difficult to forecast revenue and plan expenditures. Additionally, any delays in deployment of our software related to our inexperience with a type of business or the size or complexity of the account would delay our ability to recognize revenue from that account. Such delays could adversely affect our financial results.

     Legislative Actions, Higher Insurance Costs and Potential New Accounting Pronouncements May Cause our General and Administrative Expenses to Increase and Impact our Future Financial Position and Results of Operations

     In order to comply with the newly adopted Sarbanes-Oxley Act of 2002 and proposed accounting changes and to implement other corporate governance practices that are now expected of publicly-traded companies, we may be required to hire additional personnel and will utilize additional outside legal, accounting and advisory services, all of which would cause our general and administrative costs to increase beyond what we currently have planned. Insurers may also increase premiums for liability coverage as a result of the high claims rates incurred in past years, and so our premiums for our various insurance policies, including our directors’ and officers’ insurance policies, may increase. Proposed changes to accounting rules, including proposals to account for employee stock options as a compensation expense, could, if mandated, materially increase the expenses we report under generally accepted accounting principles and adversely affect our operating results.

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     Security Risks and Concerns May Decrease the Demand for Our Services, and Security Breaches May Disrupt Our Services or Make Them Inaccessible to Our Customers

     Our services include the storage and transmission of business-critical, proprietary information. If the security measures we or our third party data centers have implemented are breached, our customers could lose this information, or a party who circumvents these security measures could misappropriate business-critical proprietary information or cause interruptions in our services or operations. As a result, we could be exposed to litigation and possible liability to our customers. In addition, computer “hackers” could introduce computer viruses into our systems or those of our customers, which could disrupt our services or make them inaccessible to customers. We may be required to expend significant capital and other resources to protect against the threat of security breaches or to alleviate problems caused by breaches. Our security measures and those that our third-party data centers provide may be inadequate to prevent security breaches, and our business and reputation will suffer if these breaches occur.

     We May Not Be Able to Sustain VSOE and May Not be Able to Use the Residual Method

     We established VSOE for maintenance in the second quarter of 2003 and began recognizing perpetual license revenue upon delivery of the license. If we are unable to continuously meet the criteria required to maintain VSOE on maintenance, we may not be able to continue to recognize perpetual license revenue using the residual method.

     Our Products May Contain Defects That Could Harm Our Reputation, Be Costly to Correct, Delay Revenue and Expose Us to Litigation

     Despite testing by us, our partners and our customers, errors may be found in our products after commencement of commercial delivery. Errors have arisen in our software products from time to time, and they could arise again in the future. If errors are discovered, we may not be able to successfully correct them in a timely manner or at all. Errors and failures in our products could result in loss of or delay in market acceptance of our products and damage to our reputation and our ability to convince commercial users of the benefits of our products. In addition, we may need to make significant expenditures of capital resources in order to eliminate errors and failures. Since our products are used by customers for mission-critical applications, errors, defects or other performance problems could also result in financial or other damages to our customers, which could assert warranty and other claims for substantial damages against us. Although our license agreements with our customers typically contain provisions designed to limit our exposure to potential product liability claims, it is possible that such provisions may not be effective or enforceable under the laws of certain jurisdictions. In addition, our insurance policies may not adequately limit our exposure with respect to such claims. A product liability claim, even if unsuccessful, would be costly and time-consuming to defend and could harm our business.

Our Operating Results Fluctuate Significantly from Quarter-to-Quarter

     Important factors that could cause our quarterly results to fluctuate materially include:

	•		our lengthy sales cycle and the resulting unpredictability of the timing of obtaining new customers;
	•		the timing of deploying services for new customers;
	•		whether our customers purchase perpetual licenses or subscriptions;
	•		the timing and magnitude of operating expenses and capital expenditures;
	•		costs associated with the various third-party technologies we incorporate into our products;
	•		utilization of third party data center services and technology infrastructure;
	•		changes in our pricing policies or those of our competitors; and
	•		the amount of credits that we may be required to issue to our current customers if we fail to deliver our services pursuant to contractual arrangements.

     Due to these and other factors, quarter-to-quarter comparisons of our operating results may not be meaningful. You should not rely on our results for any one quarter as an indication of our future performance. In future quarters, our operating results may fall below the expectations of public market analysts or investors. If this occurs, the market price of our common stock would likely decline.

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     Our current and future levels of operating expenses and capital expenditures are based largely on our operating plans and estimates of future billings and revenues. These expenditure levels are, to a large extent, fixed in the short term. We may not be able to adjust spending in a timely manner to compensate for any unexpected revenue shortfall, and any significant shortfall in revenue relative to planned expenditures could negatively impact our business and results of operations.

     Our Operating Results Are Highly Dependent on License and Service Revenues from Our Software Suite, and Our Business Could Be Materially Harmed by Factors That Adversely Affect the Pricing and Demand for This Software Suite

     Substantially all of our revenues to date have been derived from the sale of licenses and services associated with the ipTeam™ and nProcess solutions. Our future operating results will depend on continued demand for ipTeam and the nProcess Platform. ipTeam was commercially launched in 1998 and nProcess was launched in June 2002. If our competitors release new products that are superior to ipTeam or nProcess Platform in performance or price, or if we fail to enhance ipTeam and nProcess Platform in a timely manner, demand for our products may decline, and we may have to reduce the pricing of our products. A decline in demand or pricing as a result of these or other factors would significantly reduce the revenues we can expect in the future.

     In the past, many software companies have experienced delays in the commencement of commercial release of their products. To date, such delays have not had a material impact on NexPrise’s revenues. In the future, we may fail to introduce or deliver new products on a timely basis. If new releases or products are delayed or do not achieve market acceptance, we could experience customer dissatisfaction or a delay or loss of revenues. In addition, customers may delay purchases of our products in anticipation of future releases. If customers defer material orders in anticipation of new releases or new product introductions, our revenues may decline.

     Moreover, as we release enhanced versions of our products, we may not be successful in upgrading our customers who purchased previous versions of the product to the current version. We also may not be successful in selling add-on modules for our products to existing customers. Any failure to continue to upgrade existing customers’ products or sell new modules, if and when they are introduced, could negatively impact customer satisfaction and our revenues.

     As with most software companies, developing and selling a product that does not require significant customization in product features or sales process for any particular customer or set of customers is critical to our success. If we are unable to resist customer requests to individualize our product or unable to develop a repeatable sales process our revenues will suffer and our costs will increase.

     We Operate in a Highly Competitive Market and Our Inability to Compete Successfully Against New Entrants and Established Companies Could Adversely Affect Our Market Share

     Our target market is rapidly evolving and is highly competitive. It may be characterized by an increasing number of market entrants, as many companies may find a technological path around existing barriers to entry.

     We already have competition from a diverse group of companies, including companies such as MatrixOne and PTC. In addition, providers of various software products such as Oracle, IBM, PeopleSoft and SAP may expand their product offerings to be competitive with us in the future.

     Our current and potential competitors may develop superior platforms that achieve greater market acceptance than our solution. Many of our existing and potential competitors have longer operating histories, greater name recognition, larger customer bases and significantly greater financial, technical and marketing resources than we do. Such competitors can undertake more extensive marketing campaigns for their brands, products and services, adopt more aggressive pricing policies and make more attractive offers to customers, potential employees, distribution partners, commerce companies and third-party suppliers.

     In addition, substantially all of our prospective customers have established and long-standing relationships with some of our current or potential competitors. Accordingly, we cannot be certain that we will be able to expand NexPrise’s customer and user base, or retain its current customers. We may not be able to compete successfully against our current or future competitors, which could have a material adverse effect on our business, results of operations and financial condition.

     We Are Dependent Upon Outsourcing Providers for Provision of the Hosted Environment for our Customers; Connection and Performance Issues Have Occurred and May Recur

     We rely on third-party providers for our data center services, principal Internet connections and data hosting. This hosted environment is critical to the provision of our software to many of our customers and if the environment does not work well, is cut-off or fails, our customers would be unable to use our solution. We have experienced and may continue to experience interruptions and

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delays in service and availability for such services. We have signed an agreement with a new vendor to provide the hosted environment, but there can be no assurance that the new provider will provide service to the full satisfaction of our customers. Furthermore, we rely on these third party providers to respond promptly to requests we make for changes to our hardware, networking and telecommunications configuration in order to deliver our products and services to our customers. Any failures, security breaches, interruptions, or delays experienced or caused by these third party providers could negatively impact our relationship with users and adversely affect our brand and our business and could expose us to liabilities to third parties.

     Our operations could be significantly hindered by the occurrence of a natural disaster or other catastrophic event at our company or any third party provider. Our operations and theirs are susceptible to outages due to fire, floods, power loss, telecommunications failures, break-ins and similar events. In addition, the majority of our network infrastructure is located in California, an area susceptible to earthquakes. In the recent past, the western United States (and California, in particular) has experienced repeated episodes of diminished electrical power supply. As a result of these episodes, certain of our and their operations or facilities may be subject to “rolling blackouts” or other unscheduled interruptions of electrical power. The prospect of such unscheduled interruptions may continue for the foreseeable future, and we are unable to predict their occurrence, duration or cessation. We do not have, and our third party providers may not have, multiple site capacity for all of our services in the event of any such occurrence. Despite implementation of network security measures, the servers are vulnerable to computer viruses, physical and electronic break-ins, and similar disruptions from unauthorized tampering with our computer systems. In addition, systems are vulnerable to coordinated attempts to overload them with data, which could result in denial or reduction of service to some or all of our users for a period of time. Furthermore, the failure by the third party providers to provide our required data communications capacity could result in interruptions in our service. Interruptions in our service will reduce our revenues and profits, and our future revenues and profits will be harmed if our users believe that our system is unreliable or insecure. We have experienced system failures from time to time. If we experience frequent or persistent system failures, our reputation and brand could be permanently harmed. We do not carry sufficient business interruption insurance to compensate us for losses that may occur as a result of any of these events. Any such event could have a material adverse effect on our business, operating results, and financial condition.

     Our Financial Performance and Workforce Reductions May Adversely Affect the Morale and Performance of Our Personnel and Our Ability to Hire New Personnel

     In connection with the evolution of our business model and in order to reduce our cash expenses, we have adopted a number of changes in personnel, including significant workforce reductions and transfers of several employees. The changes in personnel may adversely affect morale and the Company’s ability to attract and retain key personnel. In addition, recent trading levels of our common stock have decreased the value of the stock options granted to employees pursuant to our stock option plan. As a result of these factors, our remaining personnel may seek employment with larger, more established companies or companies they perceive to have better prospects.

     Our Business Will Suffer If We Do Not Enhance Our Product or Introduce New Features to Meet Changing Customer Requirements

     The market for software and services is characterized by rapid technological change, frequent new hardware, software and networking product introductions and Internet-related technology enhancements, uncertain product life cycles, changes in customer demands and evolving industry standards. If we do not develop technology that can respond to these changes we will find it very difficult to attract new customers. In particular, we are designing our technology to support a variety of hardware, software and networking products that we believe to be proven and among the most widely used. We can make no assurances, however, that future customers will continue to use these products. Even if they do, as new versions of these products are released, we will need to adapt our technology to keep pace with changes made to hardware and software configurations and network infrastructures.

     If we do not develop, license or acquire new technology, or deliver enhancements to existing products on a timely and cost-effective basis, we may be unable to meet the growing demands of potential customers. In addition, as we introduce new services or technologies into existing customer architectures, we may experience performance problems associated with incompatibility among different versions of hardware, software and networking products. To the extent that such problems occur, we may face adverse publicity, delay in market acceptance of our services or customer claims against us, any of which could harm our business.

     We Are Dependent on Intellectual Property and on Products Licensed or Purchased from Third Parties and are Exposed to Legal Liability for Infringement

     Our success and ability to compete depends on our ability to develop and maintain the proprietary aspects of our technology. We rely on a combination of copyright, trademark and trade secret laws and contractual restrictions to establish and protect the proprietary aspects of our technology. We seek to protect the source code for our software, documentation and other written materials under trade

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secret copyright laws. Finally, we seek to avoid disclosure of our intellectual property by requiring employees and consultants with access to our proprietary information to execute confidentiality agreements with us and by restricting access to our source code.

     Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. Litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets, and to determine the validity and scope of the proprietary rights of others. Any resulting litigation could result in substantial costs and diversion of resources and could have a material adverse effect on our business operating results.

     Our business has involved the licensing of our technology to our customers. Pursuant to our existing licenses, we have made certain representations and warranties and agreed to indemnify our licensees against claims of infringement by third parties. Thus, we may be exposed to a significant risk of liability for intellectual property infringement claims by others. Our success and ability to compete also depend on our ability to operate without infringing upon the proprietary rights of others. In the event of a successful claim of infringement against us and our failure or inability to license the infringed technology, our business and operating results would be significantly harmed.

     As part of our normal operations, we purchase or license software products from third party commercial vendors. These products may not continue to be available on commercially reasonable terms, or at all. The loss of these products could result in delays in the sale of our services until equivalent technology, if available, is identified, procured and integrated, and these delays could result in lost revenues. Some of the key components of our services are available only from sole or limited sources. Further, to the extent that the vendors from whom we purchase these products increase their prices, our gross margins could be negatively affected.

     Non-Compliance with Government Regulations May Subject Us to Liability

     In addition to regulations applicable to businesses generally, in connection with our former business of servicing business-to-business marketplaces, we were subject to direct regulation by governmental agencies which includes numerous laws and regulations generally applicable to the chemical, pharmaceutical, controlled substances, human and biological reagents, medical and invitro devices, nuclear chemical businesses and environmental spills, as well as U.S. import and export controls and import controls of other countries. While the shutdown of Chemdex, Promedix and SpecialtyMD may limit future regulatory and product liability risks, until all statutes of limitation have expired, certain legal risks will remain.

     We relied on our suppliers to comply with applicable local, state and federal laws regarding the labeling and the dissemination of information on any products sold that may be hazardous or present a health threat to the user. If these suppliers have failed, or we have failed to maintain the requisite records irrespective of the actions of the suppliers, or if either of us have failed to adequately comply with labeling and information dispensing requirements of local, state or federal laws, then we may be held legally responsible, since we held title to these products, and could be subject to governmental penalties or fines, as well as private lawsuits to enforce these laws. We have also relied upon our suppliers to obtain appropriate approvals for products regulated by the Food and Drug Administration (“FDA”) and to comply with the requirements relating to those approvals and products. The failure of suppliers to obtain or comply with those approvals, or the failure of the product advertising or labeling to be consistent with the FDA approval for the products, or other failures by the products themselves, or our failure to keep regulatory records required by the FDA, such as complaint files, could result in costly product recalls, significant fines and judgments, civil and criminal liabilities and negative publicity. In addition, we may discover that we inadvertently sold other regulated products without a requisite license or permit or failed to fully comply with other local, state or federal laws governing these sales.

     We are unaware of any current investigations, inquiries, citations, fines or allegations of violations or noncompliance relating to regulatory requirements pending by government agencies or by third parties against us, other than a subpoena we received in February, 2001 from the U.S. Department of Justice, Drug Enforcement Administration, for certain billing, invoice, and shipping records concerning sales to an unaffiliated purchaser, which we complied with. It is also possible that there may be investigations or allegations that we are not aware of or future investigations or allegations. The risk that any noncompliance may be discovered in the future is currently unknown. Although any potential impact on us for noncompliance cannot currently be established, it could result in significant civil or criminal penalties, including monetary fines and injunctions, for noncompliance and negative publicity, and seriously harm our business, revenues, results of operations and financial condition.

     Government Contracts and Compliance With Government Regulations May Subject Us to Increased Administrative Burdens and Risks That May Increase the Cost of Doing Business

     As a result of increased contracting with Federal, state and local agencies and their primary contractors, we may become subject to additional laws and regulations not currently applicable to us thereby increasing our administrative burdens. Furthermore, we must comply with any new regulations in both Europe and the United States, as well as any other regulations adopted by other countries

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where we may do business. Compliance with any newly adopted laws may prove difficult and may harm our business, operating results and financial condition.

     Government entities may also terminate their contracts with us earlier than we expect which could result in revenue shortfalls. Government entities may also investigate and audit our contracts and, if any improprieties are found, we may be required to refund revenues we have received and forego anticipated revenues and may be subject to penalties. In addition, if we fail to establish and maintain important relationships with government entities and agencies, our ability to successfully bid for future contracts may be adversely affected.

     We Face Risks Associated With Stockholder and Bondholder Litigation

     Several class action lawsuits have been filed and served upon us alleging that we and certain individuals made false and misleading statements concerning our business model and earnings for fiscal 2000 and concerning our initial public offering. Although we believe that we have meritorious defenses to the actions, intend to defend the suits vigorously and tentative settlements have been reached, we cannot predict with certainty the outcome of these lawsuits. Our defense against such lawsuits has been costly, may require additional expenditures and will require a significant commitment of time and resources by our senior management.

     General Economic and Political Conditions May Impact Our Results

     Our revenue growth and future profitability depend on the overall demand for software and related services. This demand can be adversely affected by unfavorable economic conditions, as customers reduce or defer spending on information technology improvements. We may be especially prone to this as a result of the relatively small installed base and operating history of our products. A softening demand for software caused by a prolonged slowdown of the economy would result in decreased revenue or lower revenue growth rates and would adversely affect our operating results.

     Recent political events, including the U.S. military action in the Middle East, have put further pressure on economic conditions. The potential turmoil that may result from such events contribute to the uncertainty of the economic climate, further reducing predictability and our ability to develop and implement long-term strategic plans. The impact of these or future similar events may have a material adverse impact on our operating results and financial position.

     Our Common Stock Price is Especially Volatile, Which Could Result in Substantial Losses to Investors

     The stock market and specifically the stock prices of technology related companies have been very volatile. This broad market volatility and industry volatility may reduce the price of our common stock, because our business is Internet-based without regard to our operating performance. On a post reverse split basis, our stock reached a high of $7.25 and a low of $1.34 during fiscal 2002. Our stock reached a high of $4.20 and a low of $1.15 during fiscal 2003. On June 30, 2004 the last quoted price on the OTC Bulletin Board was $1.21.

Item 3. Qualitative and Quantitative Disclosure about Market Risk

     The following discussion about the Company’s market risk disclosures involves forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements. We are exposed to market risk related primarily to changes in interest rates. However, we do not hold derivative financial instruments for speculative or trading purposes.

Interest Rate Sensitivity

     We are also exposed to interest rate risk related to our investment portfolios. We have performed a sensitivity analysis as of June 30, 2004, using a modeling technique that measures the change in the fair values arising from a hypothetical 10% adverse movement in the levels of interest rates across the entire yield curve with all other variables constant. The discount rates used were based on the market interest rates in effect at June 30, 2004. The sensitivity analysis at June 30, 2004 indicated that a potential loss in the fair values of our interest rate sensitive investment instruments was not material.

     Our convertible and promissory notes are not exposed to interest rate risk as our interest rate is fixed at 6%.

Foreign Currency Risk

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     Our sales to-date have primarily been made to U.S. customers and, as a result, we have not had any exposure to factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. If our sales outside of the U.S. increase and are made in U.S. dollars, a strengthening of the U.S. dollar could make our products less competitive in foreign markets.

Item 4. Controls and Procedures

     (a) Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this quarterly report on Form 10-Q.

     (b) There has been no change in our internal control over financial reporting during the quarter ended June 30, 2004 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

     Starting in March 2001, several lawsuits were filed in United States District Court for the Northern District of California against the Company and certain of its officers and directors on behalf of putative classes of persons who purchased the Company’s securities during time periods from December 1999 through December 6, 2000. One of the lawsuits also names as a defendant the underwriters for the Company’s offering of convertible notes. The lawsuits generally allege that the Company and certain individuals violated the federal securities laws by making false and misleading statements during 2000, including in the Company’s registration statement for its convertible notes offering. These lawsuits were consolidated as In re Ventro Corp. Sec. Litig., Master File No. Civ. 01-1287 SBA, and a consolidated complaint was filed. Following several motions to dismiss and the filing of amended complaints, the Court set a trial date for January 20, 2005 with respect to the issues remaining in the case, and discovery commenced. The parties have tentatively reached an agreement in principle to settle the securities action together with the settlement of the related derivative action described below. The Company’s portion of the settlement would be funded by insurance. There can be no assurance that the settlement will be finalized, and if the settlement is not finalized, the Company intends to defend the case vigorously.

     In August 2001, Chadwell v. Byers, Case No. CV800814, a putative stockholder derivative suit, was filed in California Superior Court, Santa Clara County against certain of the Company’s present and former officers and directors, alleging breaches of fiduciary duty and insider trading. The Company is named solely as a nominal defendant against which no recovery is sought. After a demurrer was sustained with leave to amend, the parties stipulated to a stay of proceedings pending resolution of the In re Ventro Corp. Sec. Litig. action. As described above, the parties have reached an agreement in principle to settle this litigation together with the settlement of the federal securities action.

     In March 2001, Kassin v. Ventro Corp. et al., Index No. 01-CV-3450 (SAS), a stockholder class action complaint, was filed in the United States District Court for the Southern District of New York against the Company, several of its officers and directors, and the underwriters of its initial public offering. The class action has been consolidated for pre-trial purposes with more than one thousand other actions, filed against more than 300 other issuers of securities, affiliated individuals and dozens of underwriters of the securities offerings in In Re Initial Public Offering Securities Litigation, 21 MC 92 (SAS) (“IPO Allocation Litigation”). The plaintiffs allege that the prospectus for the initial public offering of the Company’s common stock, incorporated in the Registration Statement on Form S-1 filed with the Securities and Exchange Commission, was materially false and misleading because it failed to disclose, among other things, that the underwriters had made secret arrangements for aftermarket purchases of the securities and made arrangements for excessive and improper underwriters’ compensation in the form of increased brokerage commissions. Plaintiffs are claiming damages of an unspecified amount based on the subsequent decline in the market price of the Company’s shares below their original offering price. In recent months in the IPO Allocation Litigation, counsel for the plaintiffs, liaison counsel for the issuer defendants and counsel for insurers of the issuer defendants have taken part in continuing discussions mediated by a former federal district court judge to explore a possible settlement of the claims against all of the issuer defendants, including the Company. In June 2003, a memorandum of understanding was entered into by and among the plaintiffs, liaison counsel for the issuer defendants and counsel for the insurers which would result in dismissal of the action against the issuers, including the Company, on terms that would not require any current payment by the Company and are believed by the Company’s board of directors to carry only a remote risk that any future payment by the Company would be required. In addition, the plaintiffs would release the Company and its officers and directors from the claims that have been asserted against them in the IPO Allocation Litigation as a part of the proposed settlement. On June 30, 2003, the Company’s board of directors approved the memorandum of understanding and authorized the Company to enter into the

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proposed settlement. On June 14, 2004, the proposed settlement was submitted to the Court for its required approval, and the Court has taken the motion for preliminary approval of the proposed settlement under submission. The IPO Allocation Litigation in general, and the litigation against the Company in particular, are in an early phase, and no date has yet been set by the court for completion of pre-trial discovery or trial.

     The Company is a party to various claims in the ordinary course of business. Although the results of litigation and claims cannot be predicted with certainty, the Company believes the final outcome of such matters will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.

Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities

     None

Item 3. Defaults upon Senior Securities

     None

Item 4. Submission of Matters to a Vote of Securities Holders

The Company held its annual meeting of stockholders in Palo Alto, California on April 22, 2004. Of the 3,238,443 shares outstanding as of March 10, 2004, the record date, 2,180,307 shares were present or represented by proxy at the meeting. At the meeting the following actions were voted upon:

          1) To elect the following five (5) directors to serve until the next Annual Meeting of Shareholders and until their successors are duly elected and qualified:

          2) To approve the appointment of Ernst & Young LLP as the independent auditors of NexPrise for fiscal year 2004:

          3) To approve the amendment to the certificate of incorporation effecting a reduction of authorized common shares:

Item 5. Other Information

     None

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Item 6. Exhibits and Reports on Form 8-K

     (a) Exhibits. The following is a list of exhibits filed as part of this Report on Form 10-Q. Where indicated by footnote, exhibits that were previously filed are incorporated by reference.

     (b) Reports on Form 8-K:

A Report on Form 8-K was furnished on April 23, 2004 (Item 12). The report contained information announcing NexPrise, Inc. earnings release issued on April 21, 2004.

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SIGNATURE

     Pursuant to the requirements 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 on July 30, 2004.

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EXHIBIT INDEX