FREEMARKETS INC - 10-Q Quarterly Report

Back to GetFilings.com

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

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

FORM 10-Q

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

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002

OR

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

FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NUMBER 000-27913

FREEMARKETS, INC.
(Exact Name of Registrant as Specified in its Charter)

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

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

(412) 434-0500
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)

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 [ ] No [X]

The number of shares of the registrant's common stock outstanding as of the
close of business on October 31, 2002 was 42,119,029.

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

FREEMARKETS, INC.

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002

INDEX

2

PART I -- FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

FREEMARKETS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

($ IN THOUSANDS)

The accompanying notes are an integral part of the condensed consolidated
financial statements.
3

FREEMARKETS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED; IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

The accompanying notes are an integral part of the condensed consolidated
financial statements.
4

FREEMARKETS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED; $ IN THOUSANDS)

The accompanying notes are an integral part of the condensed consolidated
financial statements.
5

FREEMARKETS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED; IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

NOTE 1. BASIS OF PRESENTATION

The unaudited condensed consolidated financial statements have been
prepared by FreeMarkets, Inc. and Subsidiaries (the "Company") and reflect all
adjustments (all of which are normal and recurring in nature) that, in the
opinion of management, are necessary for a fair presentation of the interim
periods presented. The results of operations for the interim periods presented
are not necessarily indicative of the results to be expected for any subsequent
quarter or for the entire year ending December 31, 2002. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted in accordance with the rules and regulations of the Securities and
Exchange Commission (the "SEC"). The unaudited condensed consolidated financial
statements and notes included herein should be read in conjunction with the
Company's audited consolidated financial statements and notes for the year ended
December 31, 2001, included in the Company's Annual Report on Form 10-K filed
with the SEC in March 2002. Certain prior year amounts have been reclassified to
conform with the current presentation.

NOTE 2. REVENUES AND FEES

Revenues exclude fees earned under a service contract with Visteon
Corporation ("Visteon"). Below is a reconciliation of revenues under generally
accepted accounting principles with revenues plus the fees the Company earned
under its service contract with Visteon:

NOTE 3. EARNINGS PER SHARE

The computation of earnings per share is as follows:

6

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

NOTE 4. COMPREHENSIVE INCOME OR LOSS

Other comprehensive income or loss includes the net effect of foreign
currency translation adjustments and unrealized gains or losses on marketable
investments. Including net loss from the condensed consolidated statements of
operations, comprehensive loss was $3.3 million, $8.1 million, $15.3 million and
$292.1 million for the three and nine months ended September 30, 2002 and
September 30, 2001, respectively.

NOTE 5. INVESTMENT WRITE-DOWN

During the third quarter of 2002, the Company recorded a $371,000 loss on
its investment in Adexa, Inc. ("Adexa"). The loss was based on a valuation
determined by financing completed by Adexa in July 2002. Also, during the first
quarter of 2002, the Company recorded a $4.7 million loss on its investment in
Adexa based on its review of Adexa's financial results and general market
conditions. The Company concluded after each of these reviews that there was an
other-than-temporary decline in the value of its investment in Adexa. As of
September 30, 2002, the remaining carrying value of the original $6.0 million
investment in Adexa was $889,000.

NOTE 6. RESTRUCTURING CHARGES, GOODWILL IMPAIRMENT AND TERMINATED
MERGER-RELATED COSTS

During the second quarter of 2001 ("Q2 2001"), the Company recorded $6.4
million of restructuring charges, $204.3 million of goodwill impairment and $3.4
million of terminated merger-related costs.

In April 2001, the Company closed its Austin, Texas office, formerly the
headquarters of its iMark subsidiary, and centralized the Company's asset
recovery operations at its corporate headquarters in Pittsburgh, Pennsylvania.
As a result of the closing of the Austin office, the Company recorded a $3.1
million restructuring charge covering the severance costs, lease termination
costs and non-cash write-off of assets related to the Austin office. In June
2001, the Company closed two foreign offices and terminated certain employees in
those and other offices. As a result, the Company recorded a $3.3 million
restructuring charge covering severance and lease termination costs.

The restructuring reserve activity for the period ended September 30, 2002
was:

The Company recorded initial restructuring charges in Q2 2001 based on
assumptions and related estimates that it deemed appropriate for the economic
environment that existed at the time these estimates were made. In the third
quarter of 2002, the Company re-evaluated its office space in one of the
Company's foreign offices and reviewed its accrual for employee severance and
terminations benefit costs. As a result of the review, the Company reversed
$278,000 through results of operations in Q3 2002.

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

7

In addition, in February 2001, the Company signed a definitive agreement to
acquire Adexa. However, in June 2001, FreeMarkets and Adexa mutually agreed to
terminate their proposed merger without payment of any termination fees due to
the challenging economic and market conditions. The Company had incurred merger-
related costs of approximately $3.4 million related to financial advisor and
other professional fees, which were all expensed in Q2 2001.

NOTE 7. STOCK COMPENSATION AND WARRANT COSTS

Stock compensation and warrant costs include charges resulting from stock
options and warrants granted at exercise prices less than fair value. The
following table shows the amounts of stock compensation and warrant costs by
category had these amounts been separately stated on the condensed consolidated
statements of operations:

NOTE 8. SEGMENT REPORTING

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

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

NOTE 9. RECENTLY ADOPTED ACCOUNTING STANDARDS

The Company adopted the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets", on January
1, 2002, and no longer records goodwill amortization. In connection with
adopting this standard, the Company completed step one of the test for
impairment, which indicated that the carrying value of Surplus Record exceeded
the estimated fair value, as determined utilizing various valuation techniques
including discounted cash flow and comparative market analysis. Thereafter,
given the indication of a potential impairment, the Company completed step two
of the test. Based on that analysis, a transitional impairment loss of $5.3
million was recognized as the cumulative effect of an accounting change.

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

In August 2001, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets."
SFAS No. 144 supercedes SFAS No. 121, but retains the fundamental provisions of
SFAS No. 121 for (i) recognition/measurement of impairment of long-lived assets
to be held and (ii) measurement of long-lived assets to be disposed of by sale.
SFAS No. 144 also supercedes the accounting and reporting provisions of APB
Opinion No. 30, "Reporting the Results of Operations -- Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions," for segments of a business to be disposed
of, but retains the APB Opinion No. 30 requirement to report discontinued
operations separately from continuing operations and extends that reporting to a
component of an entity that either has been disposed of or is classified as held
for sale. SFAS No. 144 was effective for fiscal years beginning after December
15, 2001. The adoption of this standard did not have an impact on the Company's
financial statements.

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

NOTE 10. SECURITIES CLASS ACTION COMPLAINTS

Since April 27, 2001, eleven securities fraud class action complaints have
been filed against the Company and two executive officers in federal court in
Pittsburgh, Pennsylvania. The complaints, all of which assert the same claims,
stem from the Company's announcement on April 23, 2001 that, as a result of
discussions with the staff of the SEC, the Company was considering amending its
2000 financial statements for the purpose of reclassifying fees earned by the
Company under a service contract with Visteon. All of the cases have been
consolidated into a single proceeding. On October 30, 2001, the Company filed a
motion seeking to dismiss all of the cases in their entirety. That motion is
still pending before the Court. In addition, on September 24, 2001, an
individual claiming to be a FreeMarkets shareholder filed a shareholder's
derivative action, nominally on behalf of FreeMarkets, against all of the
Company's directors and certain of its executive officers. FreeMarkets is also
named as a nominal defendant. The suit is based on the same facts alleged in the
foregoing securities fraud class actions and has been stayed pending a ruling on
the Company's motion to dismiss those class actions. The Company and the
individual defendants believe that the plaintiffs' allegations are completely
without merit and they intend to defend these claims vigorously.

Since July 31, 2001, several securities fraud class action complaints have
been filed in the United States District Court for the Southern District of New
York alleging violations of the securities laws in connection with

9

the Company's December 1999 initial public offering ("IPO"). The complaints
allege that underwriters in the IPO received excessive commissions and entered
into unlawful agreements with certain of their clients pursuant to which those
clients purchased the Company's stock in the after-market for the purpose of
artificially inflating the price of the Company's shares. In four of the
complaints, the Company and certain of its officers are named as defendants,
together with the underwriters that are the subject of the plaintiffs'
allegations. Each of these cases has been consolidated for pretrial purposes
into an earlier lawsuit against the underwriters of the Company's IPO. In
addition, the cases have been consolidated for pretrial purposes with
approximately 1,000 other lawsuits filed against other issuers, their officers,
and underwriters of their initial public offerings. On April 19, 2002, a
consolidated amended class action complaint (the "Consolidated Complaint") was
filed. The Consolidated Complaint alleges claims against the Company and seven
of its officers and/or directors, and seven investment banking firms who either
served as underwriters or are successors in interest to underwriters of the
Company's initial public offering. The defendants have filed a motion to dismiss
the Consolidated Complaint, which is sub judice. By stipulation and order dated
October 9, 2002, the individual defendants have been dismissed without prejudice
from the Consolidated Complaint. The Company believes that the claims asserted
against it are without merit, and it intends to defend these claims vigorously.

10

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following discussion and analysis of our financial condition and
results of operations should be read in conjunction with our condensed
consolidated financial statements and related notes contained in this Quarterly
Report on Form 10-Q ("Form 10-Q").

Our financial condition and results of operations are determined based on
the application of our accounting policies. These policies can be subject to
judgments and estimations, and different amounts could be reported using
different assumptions and estimates. We use our best estimates and judgments in
determining the appropriate amount to reflect in the financial statements, using
historical experience and all available information. Reference should be made to
the "Revenue Recognition" section of the Management's Discussion and Analysis
for a discussion regarding critical accounting policies and judgments associated
with revenue recognition.

Certain statements contained in this Form 10-Q constitute "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. These statements involve known and unknown risks, uncertainties and
other factors that may cause our actual results, levels of activity, performance
or achievements to be materially different than any expressed or implied by
these forward-looking statements. In some cases, you can identify
forward-looking statements by terminology such as "may," "will," "should,"
"expects," "plans," "anticipates," "believes," "estimates," "predicts,"
"potential," "continue," or the negative of these terms or other comparable
terminology. Furthermore, in addition to the risks described in this Form 10-Q,
we are subject to specific risks and uncertainties related to our business
model, strategies, markets and legal and regulatory environment. For a detailed
discussion of some of these risks, please see the risk factors included in our
Annual Report on Form 10-K for the year ended December 31, 2001, as filed with
the SEC in March 2002.

OVERVIEW

FreeMarkets is a global provider of enterprise sourcing software and
services. Our solutions combine proprietary software, sourcing services, global
commodity expertise and operations support to help companies achieve and sustain
improved financial performance. Our solutions support the entire sourcing
process, from spend visibility and supply base rationalization to competitive
negotiations and savings implementation.

Our portfolio of sourcing solutions includes our FullSource(TM) offering
and our QS(TM) software application. Our FullSource offering enables our
customers to access our web-based technology, market operations, supply market
information, commodity expertise and sourcing services. Through FullSource, we
create business-to-business online auctions -- which we call markets -- and help
our customers identify and screen global suppliers and assemble a request for
quotation that provides detailed, clear and consistent information for suppliers
to use as a basis for their competitive bids. Our QS software gives customers
access to our web-enabled technology in order to create and run online markets
on their own. We offer optional, add-on services designed to enhance the use of
QS, and provide our customers with additional capabilities that they may need to
create effective online markets and achieve their strategic sourcing objectives.
In addition, in the third quarter, we introduced our spend visibility integrated
offering that combines software and services to help companies design, execute
and measure the effectiveness of spend management strategies.

Since 1995, our FullSource online markets have enabled customers to
purchase over $45 billion worth of goods and services. Based upon the difference
between the prices that our customers have historically paid for goods and
services and the lowest prices identified in our markets, we estimate that we
have helped our customers access more than $9 billion in potential savings.

DETERMINATION OF FULLSOURCE MARKET VOLUME AND ACHIEVABLE SAVINGS

Revenues from our FullSource offering represent a substantial majority of
our total revenues. Therefore, we believe that one indicator of our market
acceptance is the dollar volume of materials, commodities and services for which
we create markets on behalf of our customers as part of our FullSource offering.
We measure this market volume by multiplying the lowest bid price per unit in
each market by the estimated number of units that our customer expects to
purchase. When our customers specify multi-year purchases in a request for
quotation, we calculate volume for the estimated term. We do not report QS
volume since this is a hosted application that

11

enables customers to create and run their own markets, and as a result, we do
not believe that volume from these markets can be adequately validated.

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

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

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

REVENUE RECOGNITION

We generate revenues under service and access agreements with our
customers. Our FullSource service agreements typically provide revenues from
fixed monthly fees, and may also include performance incentive payments based on
volume and/or savings. The structure in a particular service agreement may vary,
depending upon the needs of our customer and the conventional practices in the
supply market where our customer obtains its materials, commodities or services.
The monthly fees that we receive are for the use of our technology, supplier and
supply market information, market making and market operations staff and
facilities. Negotiated monthly fees vary by customer, and reflect both the
anticipated volume and the staffing, expertise and technology we anticipate
committing to complete the services requested by our customers. Fixed monthly
fees from our FullSource offering constitute a majority of our revenues, and we
expect that these fixed fees will continue to constitute a majority of our
revenues in the foreseeable future. However, fixed fees as a percentage of total
revenues may vary in any given period due to a number of factors, including
variations in up-front commitments by customers in response to changing economic
conditions and the introduction of new products. We recognize revenues from our
fixed monthly FullSource fees ratably as we provide access to our services over
the related contract period. Our agreements range in length from a few months to
as many as five years. At any given time, we have agreements of varying lengths
with staggered expirations. Some of our service agreements permit early
termination by our customers without penalty.

Many of the service agreements for our FullSource offering include
performance incentive payments that are contingent upon our customer achieving
specific volume and/or savings, as set forth in the respective agreements. We
recognize these revenues as the thresholds are achieved. We expect that if our
volume continues to grow, the revenues attributable to these incentive payments
may also grow in terms of absolute dollars, but not necessarily as a percentage
of revenues.

The agreements for our QS offering provide for revenues from fixed monthly
fees. The monthly fees that we receive are for providing access to our
technology and for add-on services. Negotiated monthly access fees for our QS
offering vary by customer, and reflect the anticipated number of customer users
and add-on services. We recognize revenues from our QS offering as we provide
access or add-on services.

12

Reimbursements, including those related to travel and other out-of-pocket
expenses, are included in revenues, and an equivalent amount of reimbursable
expenses are included in cost of revenues.

In April 2000, we entered into a five-year agreement with Visteon that
provides for fixed monthly fees, and, if specified volume thresholds are
exceeded, additional variable fees in return for our FullSource software and
services. We exclude from revenues the amounts that we earn under this contract.
At the time we executed this service contract, we granted a warrant for 1.75
million shares to Visteon with an exercise price of $.01 per share, and we
receive ongoing marketing and public relations benefits as a result of our
relationship with Visteon. The warrant was valued at $95.6 million using the
Black-Scholes pricing model at the date of the grant in April 2000. As a result
of a review by the SEC staff, we exclude from our revenues the fees we earn from
this contract, and we allocate those fees as payment for the warrant. However,
we view our relationship with Visteon as a customer relationship, and for all
business and operational purposes in which revenue is a factor in the decision,
including budgets, forecasts, allocation of resources, sales compensation, bonus
decisions and other performance indicators, we treat the fees we earn from this
contract in the same manner as revenues from other customers. Accordingly, we
have referred, where applicable, to "revenues and fees" throughout Management's
Discussion and Analysis of Financial Condition and Results of Operations in
order to accurately describe our analysis of our operations.

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

Our relationship with Visteon is a standard customer relationship (except
for the warrant). We do not expect to recognize revenues under this Visteon
service contract for either the fixed or any variable fees we earn during the
term of the contract, which expires in 2005, because we have determined, as a
result of a review by the staff of the SEC, that we must allocate those fees as
payment for the warrant that we granted to Visteon.

13

RESULTS OF OPERATIONS

The following table sets forth condensed consolidated statements of
operations data as a percentage of revenues and fees for the periods indicated:

THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001

All references to "Q3 2002" and "Q3 2001" are for the three months ended
September 30, 2002 and 2001, respectively. All references to "Nine Months 2002"
and "Nine Months 2001" are for the nine months ended September 30, 2002 and
2001, respectively.

REVENUES AND FEES

Revenues and fees increased 2% from $42.5 million in Q3 2001 to $43.2
million in Q3 2002, and increased 17% from $117.1 million in Nine Months 2001 to
$136.6 million in Nine Months 2002. The increase in revenues and fees is
primarily attributable to an increased use of our services by existing
customers, as well as the addition of new customers for which we conducted
FullSource markets. The number of customers served increased 10% from 124 in Q3
2001 to 137 in Q3 2002. As an indicator of our increased services, our
FullSource market volume grew 7% from $4.2 billion in Q3 2001 to $4.5 billion in
Q3 2002, and increased 29% from $11.4 billion in Nine Months 2001 to $14.7
billion in Nine Months 2002. To a lesser extent, the increased revenues were
also attributable to the introduction of our QS offering in early 2001.

Although customers and FullSource volume increased from Q3 2001 to Q3 2002,
revenues per customer have decreased over the same period. This decrease is
primarily related to a more diversified international mix of customers, as well
as a change in the mix of products deployed by our customers. With the
introduction of QS in early 2001, several FullSource-only customers have
expanded their use of our products to include a broader mix of FullSource, QS
and QS services. As customers gain experience with our sourcing solutions,
certain entities

14

have migrated a portion of their sourcing requirements to our self-service
technologies. In some cases, increased sales of additional products and services
to existing customers have resulted in lower total revenues due to this
migration. However, we still anticipate that our FullSource offering will
continue to account for a substantial majority of our revenues in the
foreseeable future. We do expect that the continued introduction of new products
and services over time will drive customer acquisition, customer share expansion
and overall revenue gains.

Also included in revenues are reimbursements of $1.8 million in Q3 2001 and
$1.2 million in Q3 2002, and $5.9 million in Nine Months 2001 and $3.9 in Nine
Months 2002. An equivalent amount of reimbursable expenses is included in cost
of revenues.

As discussed earlier in "Revenue Recognition", we exclude from revenues the
fees earned from our contract with Visteon, which was $2.8 million in each of Q3
2001 and Q3 2002 and $8.4 million in each of Nine Months 2001 and Nine Months
2002.

OPERATING COSTS AND EXPENSES

COST OF REVENUES. Cost of revenues decreased from $20.0 million in Q3 2001
to $18.7 million in Q3 2002, and from $57.9 million in Nine Months 2001 to $56.9
million in Nine Months 2002. As a percentage of revenues and fees, cost of
revenues decreased from 47% in Q3 2001 to 43% in Q3 2002 and from 49% in Nine
Months 2001 to 42% in Nine Months 2002. The decrease in cost of revenues for all
periods is primarily the result of increased staff productivity as our personnel
became more specialized in various market making activities, as well as a
decrease in incentive compensation and consulting costs in 2002. Also, we have
attained some operating efficiencies from our investments in information tools
to automate portions of our market making process, as well as organizing our
market making staff in such a way to take advantage of our domain supply
vertical expertise in various supply markets. We expect that cost of revenues as
a percentage of revenues and fees in Q4 2002 will be consistent with Q3 2002.

RESEARCH AND DEVELOPMENT. Research and development costs increased from
$4.7 million, or 11% of revenues and fees in Q3 2001 to $7.0 million, or 16% of
revenues and fees in Q3 2002, and from $15.4 million, or 13% in Nine Months 2001
to $19.0 million, or 14% in Nine Months 2002. The increase for all periods
relates primarily to increased headcount and consulting fees to fund ongoing
investments in our product development pipeline. We expect that research and
development costs as a percentage of revenues and fees in Q4 2002 will be higher
than Q3 2002 due to a continued increase in our investment to fund the
development of new products.

SALES AND MARKETING. Sales and marketing costs decreased from $12.7
million, or 30% of revenues and fees in Q3 2001 to $10.7 million, or 25% of
revenues and fees in Q3 2002, and from $38.2 million, or 33% in Nine Months 2001
to $34.6 million, or 25% in Nine Months 2002. The decrease for all periods is
primarily attributable to reduced advertising expenses and relocation costs in
2002 compared to 2001. The decrease is also attributable to a slight decrease in
the average number of sales and marketing staff. We expect that our sales and
marketing costs as a percentage of revenues and fees in Q4 2002 will be
consistent with Q3 2002.

GENERAL AND ADMINISTRATIVE. General and administrative costs decreased
from $7.2 million, or 17% of revenues and fees in Q3 2001 to $5.4 million, or
13% of revenues and fees in Q3 2002, and from $25.4 million, or 22% in Nine
Months 2001 to $18.0 million, or 13% in Nine Months 2002. The decrease for all
periods is primarily attributable to a 8% and 22% decrease in Q3 2002 and Nine
Months 2002, respectively, in the average number of personnel in the areas of
human resources, finance and facilities management in 2002 compared to 2001, as
well as the net effect of reducing the cost of our satellite offices. We expect
that general and administrative costs as a percentage of revenues and fees in Q4
2002 will be consistent with Q3 2002. Reduced professional fees and relocation
costs in 2002 also contributed to the decrease of general and administrative
costs.

STOCK COMPENSATION AND WARRANT COSTS. In April 2000, we recorded $95.6
million of unearned warrant costs related to a warrant granted to Visteon. This
value was calculated using the Black-Scholes pricing model at the date of grant
and is being amortized over a five-year period ending April 2005. In each of Q3
2001 and Q3 2002, $4.8 million was amortized related to this warrant, with $2.8
million reflected as a reduction to our revenues (reducing the revenues under
the Visteon service contract to zero) and $2.0 million as stock compensation and
warrant costs. In each of Nine Months 2001 and Nine Months 2002, $14.3 million
was

15

amortized related to this warrant, with $8.4 million reflected as a reduction to
our revenues (reducing the revenues under the Visteon service contract to zero)
and $5.9 million as stock compensation and warrant costs.

INVESTMENT WRITE-DOWN. In Q3 2002, we recorded a $371,000 loss on our
investment in Adexa. The loss was based on a valuation determined by financing
completed by Adexa in July 2002. Also, in Q1 2002, we recorded a $4.7 million
loss on our investment in Adexa based on our review of Adexa's financial results
and general market conditions. We concluded after each of these reviews that
there was an other-than-temporary decline in the value of our investment in
Adexa. As of September 30, 2002, the remaining carrying value of our original
$6.0 million investment in Adexa was $889,000.

RESTRUCTURING CHARGES AND TERMINATED MERGER-RELATED COSTS. In Q3 2002, we
re-evaluated our office space in one of our foreign offices and made an
adjustment to the restructuring reserve in the amount of $278,000. In Q2 2001,
we recorded a $6.4 million restructuring charge covering the severance and
facility closing costs related to our Austin office, as well as severance costs
associated with other employees who have left the Company. In February 2001, we
signed a merger agreement to acquire Adexa. However, in June 2001, both parties
mutually agreed to terminate their proposed merger without payment of any
termination fees due to the challenging economic and market conditions. We
incurred merger-related costs of approximately $3.4 million related to financial
advisor and other professional fees, which were all expensed in Q2 2001.

GOODWILL AMORTIZATION AND IMPAIRMENT. In connection with our acquisitions
of iMark and Surplus Record in March 2000, we recorded goodwill of $354.3
million, of which $1.5 million and $46.3 million were amortized in Q3 2001 and
Nine Months 2001. In Q2 2001, we re-evaluated our product and technology
strategy and determined that we would no longer use the technology platform or
the market strategy that we acquired with iMark. As a result of this
determination and the closing of our Austin facility, we recorded a $204.3
million impairment charge in Q2 2001. In Q1 2002, we adopted SFAS No. 141,
"Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible
Assets", and no longer record goodwill amortization. For further discussion, see
Note 9 to the Condensed Consolidated Financial Statements.

INTEREST AND OTHER INCOME, NET

Interest and other income decreased from $699,000 in Q3 2001 to $611,000 in
Q3 2002, and from $2.7 million in Nine Months 2001 to $2.4 million in Nine
Months 2002. The decrease in each period is attributable to a reduced
weighted-average rate of return due to general market conditions, partially
offset by increased average cash and marketable investments in 2002 compared to
2001. In Q3 2001, we earned $870,000 at a rate of return of 3.9%, compared to
$758,000 at 2.4% in Q3 2002. In Nine Months 2001, we earned $3.8 million at a
rate of return of 4.8%, compared to $2.3 million at 2.7% in Nine Months 2002.

PROVISION FOR INCOME TAXES

Provision for income taxes was $109,000 in Q3 2001 and $181,000 in Q3 2002,
and $394,000 in Nine Months 2001 and $527,000 in Nine Months 2002, all of which
is comprised of foreign income taxes.

CUMULATIVE EFFECT OF ACCOUNTING CHANGE FOR GOODWILL

In Q1 2002, in connection with the implementation of SFAS No. 141,
"Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible
Assets", we tested goodwill for impairment, and based on estimated future cash
flows, recorded an impairment charge of $5.3 million. For further discussion,
see Note 9 to the Condensed Consolidated Financial Statements.

LIQUIDITY AND CAPITAL RESOURCES

We have historically satisfied our cash requirements primarily through a
combination of revenues and equity financing transactions, and to a much lesser
extent bank borrowings. In December 1999, we completed our IPO, which resulted
in net proceeds of $182.2 million. As of September 30, 2002, we had cash and
cash equivalents of $97.2 million and marketable investments of $30.4 million,
for total cash and investments of $127.6 million and

16

working capital of $123.0 million. Our average days sales outstanding ("DSO")
were 57 days in both Q3 2001 and Q3 2002.

Net cash used in operating activities totaled $26.6 million in Nine Months
2001, compared to net cash provided by operating activities of $14.3 million in
Nine Months 2002. The use of cash in Nine Months 2001 related primarily to the
operating losses generated by our investment in the growth of our business,
including an increase in personnel from 968 at December 31, 2000 to 988 at
September 30, 2001. Improved cash provided by operating activities in Nine
Months 2002 is due to cash collections on revenues and fees that are 17% higher
than Nine Months 2001 and to improvements in DSO for the Nine Months 2002
compared to Nine Months 2001. Additionally, operating costs excluding non-cash
stock-based costs, investment write-down and goodwill-related charges have
decreased $8.4 million, or 6% between these periods. Net cash from operating
activities in Nine Months 2001 and Nine Months 2002 does not reflect $9.4
million and $10.3 million, respectively, received under our service contract
with Visteon.

Net cash provided by investing activities totaled $23.2 million in Nine
Months 2001, compared to net cash used in investing activities of $12.4 million
in Nine Months 2002. In Nine Months 2001 and Nine Months 2002, we incurred $13.0
million and $5.0 million, respectively, of capital expenditures primarily
related to our continued expansion of information technology hardware, and to a
lesser extent certain office space improvements. As a result of the significant
investments we have made in our operations, infrastructure and personnel in 2000
and 2001, we expect our capital expenditures in fiscal 2002 will continue to be
lower than 2001. In Nine Months 2001, we also made a $6.0 million investment in
Adexa. In all periods, our investing activities reflect the investment of funds
in the normal course of our treasury management activities, which includes the
movement of funds in and out of cash and cash equivalents and marketable
investments to maximize our overall rate of return. The net cash inflow of these
funds in Nine Months 2001 was $39.7 million, compared to net cash outflow into
marketable investments of $7.5 million in Nine Months 2002.

Net cash provided by financing activities totaled $11.5 million in Nine
Months 2001 and $14.9 million in Nine Months 2002. The positive financing cash
flows in both years primarily reflect the $9.4 million and $10.3 million,
respectively, received in each of Nine Months 2001 and Nine Months 2002 under
our service contract with Visteon. We have determined, based on a review by the
SEC staff in 2001, that we are required to classify these receipts as payment
for the warrant that we granted to Visteon in April 2000. The net positive
financing cash flow in each period is also attributable to proceeds from the
issuance of stock under the employee stock purchase plan and proceeds from the
exercise of stock options.

In November 2000, we entered into a one-year revolving credit facility with
a maximum borrowing base of $25.0 million. In October 2001, we amended our bank
credit facility to consist of a revolving credit facility with a maximum
borrowing base of $20.0 million and a $4.0 million term loan to be paid in 36
monthly installments, $3.7 million of which was used to retire borrowings under
the old revolving credit facility. Borrowings under the revolving credit
facility and the term loan bear interest at the lender's prime rate and prime
rate +0.50%, respectively. As of September 30, 2002, $2.9 million was
outstanding under the term loan and the interest rate was 5.25%. At September
30, 2002, $12.7 million was available under the revolving credit facility based
on eligible accounts receivable.

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

We will continue to invest in the growth of our business. For the remainder
of 2002, we expect to continue to generate positive cash flows. However, we may
decide to use cash resources to fund acquisitions of complementary businesses
and technologies and, if we do so, we may experience negative cash flows. Our
allocation between cash and cash equivalents and marketable investments reflects
our anticipated cash flow requirements in the future. As of September 30, 2002,
our marketable investment allocation represents 24% of total cash and
investments, compared to 22% at December 31, 2001, and is due to improved
operating cash flows in 2002. If we are unable to continue to control costs, our
resources may be depleted more quickly than we

17

currently anticipate. In the event that we are required to obtain additional
financing, we may not be able to raise it on terms acceptable to us, if at all.

There have been no material changes in our contractual obligations and
commercial commitments during the three months ended September 30, 2002 that
would require an update to the disclosure in our Annual Report on Form 10-K, as
filed with the SEC in March 2002.

RECENTLY ADOPTED ACCOUNTING STANDARDS

As discussed in Note 9 to the Condensed Consolidated Financial Statements,
we implemented new accounting standards related to accounting for goodwill and
intangible assets, impairments and disposals of long-lived assets and
reimbursements for expenses incurred in connection with providing services
beginning January 1, 2002.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There have been no material changes in our market risk exposure during the
three months ended September 30, 2002 that would require an update to the
disclosure in our Annual Report on Form 10-K, as filed with the SEC in March
2002.

ITEM 4. CONTROLS AND PROCEDURES

(a) As of a date (the "Evaluation Date") within 90 days prior to the filing
of this Form 10-Q, the company carried out an evaluation, under the
supervision and with the participation of the company's management,
including the chief executive officer and the chief financial officer,
of the effectiveness of the company's disclosure controls and
procedures. Based on this evaluation, the company's chief executive
officer and chief financial officer concluded that, as of the
Evaluation Date, the company's disclosure controls and procedures were
effective. As defined in Rule 13a-14(c) under the Securities Exchange
Act of 1934, as amended, "disclosure controls and procedures" means
controls and other procedures of an issuer that are designed to ensure
that information required to be disclosed by the issuer in the reports
that it files or submits under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the rules
and forms of the SEC.

(b) There have been no significant changes in the company's internal
controls or in other factors that could significantly affect these
controls subsequent to the date of the evaluation.

18

PART II -- OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

See Note 10 to the Condensed Consolidated Financial Statements

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

(b) Reports on Form 8-K.

None.

* * * * * *

19

SIGNATURE

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized in the City of
Pittsburgh, Commonwealth of Pennsylvania on November 14, 2002.

FREEMARKETS, INC.

By: /s/ JOAN S. HOOPER
------------------------------------
JOAN S. HOOPER
Executive Vice President, Chief
Financial Officer,
Secretary and Treasurer
(Principal Financial and Accounting
Officer)

20

CERTIFICATIONS UNDER SECTION 302 OF SARBANES/OXLEY ACT

I, Glen T. Meakem, certify that:

1. I have reviewed this quarterly report on Form 10-Q of FreeMarkets, Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of and for the periods presented in this
quarterly report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant, and
we have:

a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;

b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and

c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):

a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and

b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.

Date: November 14, 2002
/s/ Glen T. Meakem
--------------------------------------
Glen T. Meakem
Chief Executive Officer and Chairman
of the Board

21

CERTIFICATIONS UNDER SECTION 302 OF SARBANES/OXLEY ACT

I, Joan S. Hooper, certify that:

1. I have reviewed this quarterly report on Form 10-Q of FreeMarkets, Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of and for the periods presented in this
quarterly report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant, and
we have:

a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;

b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and

c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):

a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and

b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.

Date: November 14, 2002
/s/ Joan S. Hooper
--------------------------------------
Joan S. Hooper
Executive Vice President, Chief
Financial Officer,
Secretary and Treasurer

22