Back to GetFilings.com

Table of Contents

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

(MARK ONE)

For The Fiscal Year Ended December 31, 2003

For The Transition Period From                                  To                                 

Commission File No. 000-28715

NEOFORMA, INC.

(Exact name of the Registrant as Specified in its Charter)

(408) 468-4000

(The Registrant’s telephone number, including area code)

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

None

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

Common Stock, $0.001 Par Value Per Share

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

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

As of June 30, 2003, the aggregate market value of the Registrant’s voting stock held by non-affiliates of the Registrant, based on the closing price for the Registrant’s common stock on The Nasdaq Stock Market on such date, was $76,007,052. This calculation does not reflect a determination that certain persons are affiliates of the Registrant for any other purposes.

The number of shares of the Registrant’s common stock outstanding on March 8, 2004 was 19,946,628.

Portions of the Registrant’s definitive Proxy Statement for its Annual Meeting of Stockholders scheduled to be held in May 2004 are incorporated by reference into Part III of this Annual Report on Form 10-K.

Table of Contents

TABLE OF CONTENTS

Neoforma, Neoforma.com, Neoforma Order Management Solution, Neoforma OMS, Neoforma Contract Management Solution, Neoforma CMS, Neoforma Data Management Solution, Neoforma DMS, Neoforma Materials Management Solution, Neoforma MMS, NeoConnect, Healthcare Products Information Services, HPIS, Med-ecom, Medcontrax and the Neoforma logo are some of our trademarks or service marks. Other trademarks or trade names appearing in this Annual Report on Form 10-K are the property of their respective owners.

2

Table of Contents

PART I

We make many statements in this Annual Report on Form 10-K, such as statements regarding our plans, objectives, expectations and intentions, that are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. In many cases you can identify these forward-looking statements by the use of words such as “will,” “may,” “might,” “could,” “should,” “believe,” “expect,” “anticipate,” “intend,” “plan,” “predict,” “project,” “estimate,” “potential,” “continue” and similar expressions. These forward-looking statements involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those we discuss in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Factors That May Affect Future Operating Results” and elsewhere in this Form 10-K. You should carefully review the risks described in other documents we file from time to time with the Securities and Exchange Commission. The forward-looking statements contained herein speak only as of the date we filed this Annual Report on Form 10-K with the Securities and Exchange Commission, and we caution you not to rely on these statements without also considering the risks and uncertainties associated with these statements and our business that are addressed in this Form 10-K. We undertake no obligation to publicly release any revisions to the forward-looking statements to reflect circumstances or events after the filing date of this Form 10-K.

ITEM 1.    Business

Our Company

We are a leading provider of supply chain management solutions for the healthcare industry. Through a combination of technology, information and services, our Web-based supply chain management solutions are designed to enable efficient collaboration among hospitals and suppliers, helping them to reduce operational inefficiencies and lower costs. The healthcare supply chain has a number of characteristics, including its large size, high degree of fragmentation, reliance on disparate technologies, dependence on manual processes and highly complex pricing structures, which have led to major inefficiencies. These inefficiencies lead to slower, error prone transactions and increased overhead and costs for suppliers and hospitals. In addition, the participants in the healthcare industry are under significant competitive and cost pressures and are seeking ways to increase efficiencies in their supply chain to improve their overall margins. Our Web-based solutions make it easier for the participants in the healthcare supply chain, principally hospitals, suppliers and group purchasing organizations, or GPOs, to improve communication, receive comprehensive and accurate information, improve day-to-day operations, accelerate order and contract implementations, enhance strategic planning and gain organization-wide visibility into supply chain activities. Using our solutions, these organizations can improve efficiencies, increase revenue, reduce costs and improve capital allocation.

Our solutions address the needs of our customers in four primary areas:

We serve over 1,600 customers, including many of the nation’s leading hospitals and suppliers. We have a contractual relationship with Novation, LLC, the supply chain management company for its GPO owners, VHA Inc. and University HealthSystem Consortium, or UHC, under which these organizations have named us as their exclusive e-commerce supply chain provider and from which we currently generate the significant majority of our business. The hospital members of VHA and UHC utilize Marketplace@Novation^™, a Web-based supply chain management, e-commerce and information solution that currently addresses the critical areas of order management and contract management.

3

Table of Contents

We were incorporated in California in 1996 and reincorporated in Delaware in 1998. Our headquarters is located at 3061 Zanker Road, San Jose, CA 95134, and our telephone number is (408) 468-4000. Our Web site is www.neoforma.com. We are not including the information contained on our Web site as a part of, or incorporating it by reference into, this Annual Report on Form 10-K. We make available free of charge through our Web site our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission.

Recent Developments

On November 30, 2003, we terminated the proposed acquisition of substantially all of the assets of the Health & Life Sciences business of I-many, Inc. Pursuant to the terms of the asset purchase agreement with I-many, we exercised our right to terminate the agreement if the closing did not occur by November 30, 2003.

On December 19, 2003, we repaid the remainder of our outstanding borrowings under our revolving credit agreement with VHA, which equaled $14 million. We also reduced the amount of funds available under the credit agreement from $25 million to $15 million.

Industry Background

The healthcare supply chain has a number of characteristics, including its large size, high degree of fragmentation, reliance on disparate technologies, dependence on manual processes and highly complex pricing structures, that have led to major inefficiencies. Supply chain costs represent the second largest expenditure category and approximately 25% to 30% of the average hospital’s operating expenses. There are thousands of suppliers selling to numerous healthcare provider sites, including approximately 5,800 hospitals in the United States. The technology investments made by hospitals and suppliers in materials management or information systems generally do not communicate with each other either within an organization or between organizations. Hospitals generally have made fewer technology investments in supply chain initiatives as compared to other industries, and their technologies are often out-of-date. As a result, many hospitals and their suppliers remain reliant on manual processes, primarily phone, fax and paper. In addition, healthcare supply chain participants frequently use complicated purchasing contracts and trade agreements, often negotiated by a GPO or supply management company, to facilitate the purchase of goods and services, adding another stakeholder and layer of complexity to the industry. Discrepancies in price, miscommunication and inaccurate or missing information lead to slower, error prone transactions for all participants, increased overhead for suppliers and higher costs for hospitals. An industry study, which we co-sponsored, entitled “The Value of eCommerce in the Healthcare Supply Chain,” dated June 2001, estimated that these inefficiencies result in overall waste of 2% to 10% of total spending in the industry.

Participants in the healthcare industry are also under significant competitive and cost pressures. For example, hospitals are faced with reduced Medicare and third-party payor reimbursement rates, increasing malpractice insurance costs, intense pressure to increase patient safety initiatives and new legislation requiring increased investment in technology. Suppliers are faced with an increasingly competitive environment and growing margin pressures, as well as a need to support the financial and operational health of their hospital customers. These industry participants are seeking ways to improve efficiencies in their supply chain to increase overall margins.

Our Solutions

We deliver Web-based supply chain management solutions, utilizing a combination of technology, information and services, to enable effective collaboration among hospitals and suppliers, helping them to reduce operational inefficiencies and lower costs.

4

Table of Contents

For hospitals, supply expenditures represent approximately 25% to 30% of the average hospital budget and the second largest expenditure category behind labor. Our supply chain management solutions help hospitals streamline their supply chain and reduce their supply costs by (i) automating manual, paper-based processes, (ii) increasing contract utilization and (iii) providing better supply chain information.

GPOs and supply management companies encounter a variety of purchasing and contracting challenges, including lengthy contracting processes, difficulties associated with providing accurate and timely contract information to their hospital members, reduced levels of contract compliance due to off-contract buying, incomplete member purchase history data and delayed supplier sales reporting. Through our solutions, GPOs and supply management companies can (i) gain access to detailed information regarding contract utilization, buying patterns and purchasing history, (ii) improve the quality and accuracy of their contract and related product information and (iii) provide information on their negotiated contracts to their hospital customers in a timelier manner. As a result, our solutions enable GPOs and supply management companies to improve their service offerings to their customers and reduce their operating costs.

Suppliers, both manufacturers and distributors, face increasing competition and growing margin pressures. Our supply chain management solutions help suppliers (i) reduce their expenses by automating manual processes, reducing transaction costs and providing contract management services, (ii) improve cash flow by decreasing accounts receivable aging, or days sales outstanding, or DSO, (iii) increase their service levels to their hospital customers and (iv) increase their revenue by increasing the efficiency of their sales people and more efficiently utilizing direct and indirect channel resources.

Our Web-based solutions are designed to enable hospitals, GPOs and suppliers to improve communication, receive comprehensive and accurate information, improve day-to-day operations, accelerate order and contract implementations and enhance strategic planning across organizational boundaries. Our solutions are designed to complement and augment our customers’ existing supply chain business processes, and we offer them individually or jointly. For example, we offer VHA and UHC member hospitals order management and contract management solutions as part of Marketplace@Novation.

We offer our customers solutions to address four main areas in the healthcare supply chain:

Neoforma Order Management Solution

We address the day-to-day order management aspect of the healthcare supply chain with Neoforma OMS. Neoforma OMS streamlines healthcare supply purchasing by simplifying and automating day-to-day activities. Combining Web-based functionality, discrepancy management tools and connectivity, Neoforma OMS is designed to generate significant savings for hospitals and suppliers through increased electronic transactions and by helping to resolve order discrepancies faster. In addition, Neoforma OMS provides hospitals and suppliers with valuable information to help them reduce supply chain costs. We deliver Neoforma OMS as part of Marketplace@Novation and receive payment from Novation for the services we provide, and we also sell Neoforma OMS to hospitals that are not members of VHA or UHC and to suppliers.

The key components and benefits of Neoforma OMS to hospitals and suppliers include:

5

Table of Contents

Neoforma OMS provides hospitals with electronic access to a broad group of suppliers as well as the ability to support multiple document types, enabling hospitals to increase automation and accuracy. Broader connectivity to suppliers enables hospitals to conduct more of their supply transactions electronically, creating significant time and cost savings.

For suppliers, electronic connections to their hospital customers increase automation and improve the accuracy of orders. Neoforma OMS enables suppliers to convert customers, with whom they previously communicated by phone or fax, to electronic connections, reducing the burden and expense of servicing their customers.

Neoforma Contract Management Solution

Neoforma CMS is a Web-based solution that enables hospitals to reduce supply costs through improved utilization of contracts, fewer price discrepancies and faster, better-informed decision-making. Additional services offered to suppliers provide contract administration and reporting of aggregated sales tracing information across multiple distributors to facilitate rebate processing and contract performance analysis.

6

Table of Contents

Neoforma CMS provides a secure, online environment that allows suppliers to communicate contract and product information with hospital customers and to collaborate with hospitals on new contract setup and price changes. Neoforma CMS is currently available for use by supplier customers that have contracts with Novation and that sell to VHA and UHC member hospitals, and to hospital customers that are members of VHA and UHC and participate in Novation’s purchasing program. Using Neoforma CMS, suppliers can reduce contract and marketing administration costs through more effective communication and fewer price discrepancies with their customers. We deliver Neoforma CMS as part of Marketplace@Novation and receive payment from Novation for the services we provide, and we also sell Neoforma CMS to suppliers.

The key components and benefits of Neoforma CMS to hospitals and suppliers include:

Suppliers can use Neoforma CMS to display comprehensive contract information and updates, provide a single, centralized place where their hospital customers can find complete contracts and related documents, enable their hospital customers to quickly search for contract information using simple and advance search techniques and provide supplier contact information so their hospital customers can more quickly implement contracts. These features can improve the hospital’s awareness of a supplier’s Novation contracts to improve the utilization and reduce the cost of administering contract purchases.

Neoforma CMS: Contract Administration and Reporting

In addition to the offering described above, we provide additional contract administration and reporting services primarily to healthcare manufacturers who sell through distributors. We initiated this offering with the

7

Table of Contents

acquisition of Med-ecorp, Inc. in July 2002. Our Neoforma CMS Contract Administration and Reporting includes the retrieval and preparation of sales tracing data from distributors and contract data from manufacturers, cross reference of that data and reporting on sales and rebate transactions from multiple distributors. Manufacturers use these services to keep track of products sold through distributors, across a range of distributors, and to improve the management of the contract pricing and rebate processes with their distributors.

Detailed services include:

Neoforma Data Management Solution

Neoforma DMS includes a data cleansing offering sold to hospitals and GPOs and market intelligence offerings sold to medical-surgical and pharmaceutical manufacturers who sell through distributors.

Data Cleansing

Neoforma DMS is a data cleansing and maintenance solution that enables hospitals to significantly improve the accuracy of their item master and vendor master data files. Hospitals typically have large amounts of item and vendor data stored in their MMIS or ERP systems. They are challenged by out-of-date product information, duplicate entries, inaccurately entered information, obsolete item and vendor records, incorrect prices and incorrect part numbers. Furthermore, the item data typically has poor descriptions and is often either not categorized or poorly categorized. For hospitals, these issues increase the potential to overspend when an order is placed, lead to price and item discrepancies that require intervention and resolution with their suppliers, make it difficult for users to source products and hamper their ability to perform meaningful spending analysis to prioritize their cost reduction efforts. Neoforma DMS cleanses, normalizes, enriches and categorizes MMIS master data. With improved item and vendor master files, hospitals can improve the return on their investment in MMIS and ERP systems, analyze variations in pricing and product orders, generate valuable reports, better analyze product utilization and standardize products to reduce supply costs. GPOs can utilize Neoforma DMS to cleanse and categorize contract and related product information that they publish to their hospital members.

The key components and benefits of Neoforma DMS to hospitals include:

8

Table of Contents

Market Intelligence

HPIS Market Intelligence

We provide market intelligence reporting as part of Neoforma DMS to medical-surgical manufacturers and distributors. We initiated our HPIS Market Intelligence offering with the acquisition of Medcontrax, Inc. in July 2002. HPIS Market Intelligence helps suppliers identify market opportunities, measure market share and evaluate sales force performance and management. The team in our HPIS business unit acquires detailed, transactional data from the leading medical-surgical distributor members of the Health Industry Distributors Association, or HIDA, and then aggregates, normalizes, indexes and reports on this transactional data. Healthcare manufacturers and distributors use this standardized and customized critical market intelligence to develop strategies to optimize their market performance.

For manufacturers, we provide:

For distributors, we provide:

Pharmaceutical Market Intelligence

We also provide market intelligence reporting to pharmaceutical manufacturers. Pharmaceutical Market Intelligence helps pharmaceutical manufacturers gain key strategic insights into sales volume and market share within the VHA and UHC member hospital base. This data is aggregated from a variety of pharmaceutical wholesalers and delivered to manufacturers in a series of reports that include purchasing volume by hospital and product, market share by generic equivalents and market share by American Hospital Formulary Service product category. These reports deliver visibility down to the facility level, which is important in helping pharmaceutical manufacturers understand and maximize the impact of their contracting and sales efforts to their Novation customer segment.

9

Table of Contents

Neoforma Materials Management Solution

Neoforma MMS enables hospitals to manage inventory and requisition, issue purchase orders, receive products and manage other components of the materials management process. Neoforma MMS is designed to offer hospitals superior flexibility, process control, ease of use and ease of implementation as compared to conventional materials management information systems. Neoforma MMS consists primarily of the technology we acquired from Revelocity Corporation in December 2002.

In addition to direct sales to hospitals, Neoforma MMS is sold to suppliers who either resell it to their hospital customers to support their inventory management or use it to provide fully outsourced inventory management services. Suppliers leverage browser-based and handheld inventory management capabilities to facilitate streamlined consignment tracking and replenishment in addition to outsourced hospital inventory management.

The key components and benefits of Neoforma MMS to hospitals and suppliers include:

Marketplace@Novation

We develop, implement and support supply chain management solutions for Marketplace@Novation, a proprietary online marketplace for VHA and UHC member hospitals and suppliers. Marketplace@Novation utilizes two of our solutions for order and contract management, Neoforma OMS and Neoforma CMS, respectively. We leverage our relationships with Novation hospitals and suppliers that have contracted with us to use Marketplace@Novation to cross-sell our other solutions. Marketplace@Novation currently accounts for the substantial majority of our fees, and we anticipate that this will continue for the foreseeable future.

10

Table of Contents

Strategic Relationships

In 2000, we entered into a 10-year strategic relationship with Novation, the supply chain management company for its GPO owners, VHA and UHC. Novation is an established healthcare industry participant, and we believe that this relationship has been, and will continue to be, instrumental to our success. Novation, VHA and UHC named us as the exclusive e-commerce solution they offer to VHA and UHC members, branded as Marketplace@Novation. VHA is a nationwide network of more than 2,200 community-owned healthcare organizations and their physicians. It comprises approximately 25% of the nation’s community hospitals. UHC is an alliance of 88 academic medical centers and 110 associate members that represent approximately 76% of the academic medical centers in the United States. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Strategic Relationships” of this Form 10-K for further discussion of our relationships with VHA, UHC and Novation.

In August 2001, we entered into a three-year agreement with Global Healthcare Exchange, LLC, or GHX, to provide connectivity to GHX’s supplier customers to help our hospital customers more quickly realize the benefits of e-commerce and minimize the costs of connectivity and information exchange. GHX was formed by five leading manufacturers to the healthcare industry: Abbott Laboratories, Baxter International, Inc., GE Medical Systems, Johnson & Johnson and Medtronic, Inc.

Marketing, Sales and Service

The marketing teams within our company lead our efforts to understand our customers and how our solutions can address their needs. These teams gather customer, partner and market input and prioritize our product development and service initiatives. Our outbound marketing activities include traditional and Internet-based vehicles such as direct mail, advertising, Web-based seminars, sponsorships and tradeshows. We also utilize a variety of public relations initiatives, including continuing to develop relationships with business, healthcare, Internet and technology media and industry analysts. These activities aim to increase awareness of our brand, to attract new customers to our solutions and to educate our customers on how to optimize their use of our solutions. We intend to continue to invest in these areas, because we believe a deep understanding of our customers and their business processes, and their awareness of our offerings, is critical to the success of our business.

We sell our solutions to suppliers and hospitals through a direct field sales force. The sales force consists of hospital specialists who primarily target the hospital market to sell our solutions and supplier specialists who focus on the sale of our solutions to manufacturers and distributors. Our field sales force has significant experience in the sale of medical products, medical equipment and supply chain and information technology systems to healthcare customers. We plan to continue to grow and develop our sales force as we expand the breadth of our solutions portfolio and our hospital and supplier customer base.

Our relationships with a number of our strategic partners provide for joint and cross selling and marketing of our solutions. For example, under our strategic relationship with Novation, VHA and UHC, the sales forces of these organizations actively promote our supply chain management solutions to hospitals and suppliers, which significantly aids in our selling and marketing efforts. We plan to expand the number and scope of our strategic relationships, including channel relationships, to support the sale of our solutions.

We provide extensive customer service and support for our hospital and supplier customers. Once a customer has signed an agreement with us, our customer care team manages the customer experience from implementation through ongoing support. Our services include technical integration and interfaces, data mapping and cleansing, Web-based training and 24x7 call center support. In addition to our centralized service and support resources, we employ a team of field-based account managers to work closely with our hospital and supplier customers at their facilities, where appropriate. Additionally, we utilize a value documentation team that currently assists our hospital customers in identifying and documenting actual dollar cost savings and other value

11

Table of Contents

received through the use of our solutions. We believe a commitment to providing a consistently superior customer experience, coupled with highly dependable, reliable systems, is and will continue to be an important differentiator for us.

Architecture, Product Development and Support

We intend to continue to expand and enhance the functionality of our solutions. We have invested in architecture, product development and support and management resources to enhance the technical infrastructure that supports our increasing volumes of data and customer usage. We intend to continue to augment our existing solutions that increase utility and value for healthcare manufacturers, distributors, hospitals and GPOs.

Our architecture group is responsible for establishing our enterprise architecture and corporate technology strategy. The product development and support group is responsible for translating customer needs into detailed technical specifications, configuring and developing technology solutions and testing and supporting these applications for our production environment. Depending on the number and complexity of current development projects underway, our staff is augmented using both independent contractors and consulting firms.

Currently, we are developing additional enterprise and supply chain analytics capabilities as a part of our solutions infrastructure. These capabilities will provide enhanced business intelligence and supply chain management information to our customers and partners in support of committed purchasing and supplier relationships.

For both our current and future product development activities, we plan to continue to leverage commercially available technology from new and existing partners to accelerate product delivery and minimize development risk.

For the years ended December 31, 2001, 2002 and 2003, our product development expenses were $16.9 million, $17.2 million and $18.6 million, respectively.

Proprietary Rights and Licensing

Our success and ability to compete depend 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 secret and copyright laws. In addition, we seek to avoid disclosure of our intellectual property by restricting access to our source code and by requiring employees and consultants with access to our proprietary information to execute confidentiality agreements with us. We have also applied for a patent of our Success Tracker customer value product.

We rely on technology that we license from third parties, including software that is integrated with internally developed software and used in our solutions to perform key functions. Such product licenses may expose us to increased risks, including risks associated with the assimilation of new products, the diversion of resources away from the development of our products, the inability to generate revenue from new products sufficient to offset associated acquisition costs and the maintenance of uniform, effective products. If we are unable to continue to license any of this software on commercially reasonable terms, we will face delays in releases of our services until we can identify, license or develop and integrate equivalent technology into our current technology. These delays, if they occur, could seriously harm our business.

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/or diversion of

12

Table of Contents

resources and could seriously harm our business. In addition, the laws of some foreign countries do not protect proprietary rights to the same extent as do the laws of the United States.

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 could be seriously harmed.

Competition

The market for supply chain management solutions in healthcare is rapidly evolving and highly competitive. Because of the breadth of our solutions, which include order management, contract management, data management and materials management for hospitals, GPOs and suppliers, we have a diverse set of competitors that compete with portions of our overall offering. To best serve our customers, we sometimes partner with our competitors in one segment of the market while competing with them in others. We believe that as our capabilities grow, we will continue to find areas of opportunity for both collaboration and competition with other companies in the market that target a segment of the overall healthcare supply chain. Our ability to manage these relationships to benefit our hospital, GPO and supplier customers is important to our success.

Some of our current and potential competitors include:

Companies in our market that compete to provide services to hospitals do so based on brand recognition, ability to integrate product offerings, cost, ease of use and convenience, number of suppliers with whom hospitals can conduct business and communicate and customer service.

We believe that companies in our market compete to provide services to suppliers based on brand recognition, number of hospitals using their services and the volume of their purchases, level of bias, or perceived bias, toward particular suppliers, existing relationships, compatibility with suppliers’ existing sales and distribution methods, cost, functionality, ease of use and convenience, ability to integrate their services with suppliers’ existing systems and software, and quality and reliability of their services.

Competition is likely to intensify as our market matures. As competitive conditions intensify, our competitors may enter into strategic or commercial relationships with larger, more established healthcare, medical products or Internet companies or with each other, secure services and products from suppliers on more favorable terms, devote greater resources to marketing and promotional campaigns, secure exclusive arrangements with hospitals that impede our sales and devote substantially more resources to Web site and systems development and research and development.

Our current and potential competitors’ services may achieve greater market acceptance than ours. Our current and potential competitors may have longer operating histories in the healthcare supply chain market,

13

Table of Contents

greater name recognition, larger customer bases or greater financial, technical and/or marketing resources than we do. As a result of these factors, our competitors and potential competitors may be able to respond more quickly to market forces, undertake more extensive marketing campaigns for their brands and services and make more attractive offers to hospitals and suppliers, potential employees and strategic partners. In addition, new technologies may increase competitive pressures. We cannot be certain that we will be able to expand our hospital and supplier base or retain our current hospital and supplier customers. We may not be able to compete successfully against our competitors, and competition could seriously harm our revenue, operating margins and market share.

Employees

As of December 31, 2003, we had 261 full-time employees, including 65 in sales and marketing, 30 in services, 76 in product development, 48 in operations and 42 in general and administrative functions. Our future success will depend, in part, on our ability to attract, train, retain, integrate and motivate highly qualified sales, technical and management personnel. Our employees are not represented by any collective bargaining unit and we have never experienced a work stoppage. We believe our relations with our employees are good. We also use independent contractors and consultants to support our services, primarily in product development and operations.

ITEM 2.    Properties

As of December 31, 2003, our executive, administrative and operating offices were located in 116,000 square feet of office space located in San Jose, California under a sublease scheduled to expire in March 2007. We occupy 84,300 square feet of this facility. In February 2002, we entered into a sublease with a corporation under which they subleased 20,000 square feet of this facility for the first year, increasing to 31,700 square feet for the remaining term of the sublease, which runs through February 2005.

We also lease facilities in three other locations in the United States. The total square footage under these leases is 30,000, and these leases expire on various dates through December 2005.

ITEM 3.    Legal Proceedings

In July 2001, we, along with Merrill Lynch, Pierce, Fenner & Smith, Bear Stearns and FleetBoston Robertson Stephens (certain of the underwriters of our initial public offering, or IPO) as well as our Chairman and Chief Executive Officer, Robert Zollars, and our former Chief Financial Officer, Frederick Ruegsegger, were named as defendants in two securities class action lawsuits filed in federal court in the Southern District of New York (No. 01 CV 6689 and No. 01 CV 6712) on behalf of those who purchased shares of our common stock from January 24, 2000 to December 6, 2000. These actions have since been consolidated, and a consolidated amended complaint was filed in the Southern District of New York on April 24, 2002. The amended complaint alleges that the underwriters solicited and received “undisclosed compensation” from investors in exchange for allocations of stock in our IPO, and that some investors in the IPO allegedly agreed with the underwriters to buy additional shares in the aftermarket to artificially inflate the price of our stock. We and Messrs. Zollars and Ruegsegger are named in the suits pursuant to Section 11 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5 promulgated thereunder, for allegedly failing to disclose in our IPO registration statement and prospectus that the underwriters had entered into the arrangements described above. The complaints seek unspecified damages. Approximately 300 other issuers and their underwriters have had similar suits filed against them, all of which are included in a single coordinated proceeding in the Southern District of New York. On July 1, 2002, the underwriter defendants moved to dismiss all of the IPO allocation litigation complaints against them, including the action involving us. On July 15, 2002, we, along with the other non-underwriter defendants in the coordinated cases, also moved to dismiss the litigation. Those motions were fully briefed on September 13 and September 27, 2002, respectively, and have not yet been decided. On October 9, 2002, all of the individual defendants, including Mr. Zollars and Mr. Ruegsegger, were dismissed from the

14

Table of Contents

action without prejudice. On June 30, 2003, our board of directors approved a proposed settlement for this matter, which is part of a larger global settlement between the issuers and plaintiffs. The acceptance of the settlement by the plaintiffs is contingent on a number of factors, including the percentage of issuers who approve the proposed settlement. We have agreed to undertake other responsibilities under the proposed settlement, including agreeing to assign away, not assert, or release certain potential claims we may have against our underwriters. Any direct financial impact of the proposed settlement is expected to be borne by our insurers. Due to the inherent uncertainties of litigation however, we cannot accurately predict the ultimate outcome of the lawsuits.

In August 2003, Accelerated Systems Integration, Inc., or ASI, filed suit in the United States District Court, Northern District of Ohio, Eastern Division (Case No. 1:03 CV 1969) against I-many, Inc., us and our wholly-owned acquisition subsidiary, Neocars, Inc., seeking (i) a preliminary injunction against the closing of the asset purchase transaction we had previously announced and (ii) further unspecified damages. ASI also made certain other allegations against I-many, and made a claim of interference with contractual rights against us for entering into the asset purchase agreement with I-many. On December 16, 2003, we settled the suit pursuant to a confidential settlement and release agreement with ASI.

ITEM 4.    Submission of Matters to a Vote of Security Holders

None.

15

Table of Contents

PART II

ITEM 5.    Market for Registrant’s Common Equity and Related Stockholder Matters

Price Range of Common Stock

Our common stock has been traded on The Nasdaq National Market under the symbol NEOF since January 24, 2000, the date of our IPO. Prior to that time, there was no public market for our common stock.

The following table sets forth the high and low sales prices for our common stock as reported on The Nasdaq National Market for the periods indicated.

The market price of our common stock has fluctuated significantly in the past and is likely to fluctuate in the future. In addition, the market prices of securities of other technology companies, particularly Internet-related companies, have been highly volatile. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Factors That May Affect Future Operating Results.”

Recent Sales of Unregistered Securities

On December 23, 2002, we completed the acquisition of substantially all of the assets of Revelocity. In connection with this acquisition, we issued 61,000 shares of our common stock to Revelocity at closing. Additionally, during 2003, we issued an additional 125,000 shares of our common stock as further consideration based on the achievement of certain revenue milestones by the acquired business, per the terms of the acquisition agreement. All issuances of our common stock in connection with this acquisition were done in reliance upon an exemption from the registration requirements of the Securities Act of 1933 provided by Section 4(2) of such Act. We did not utilize any underwriters in connection with this acquisition or the related issuances of common stock.

Holders of Record

As of March 8, 2004, there were approximately 7,100 holders of record of our common stock. This number includes an estimate of a number of stockholders for whom shares were held in a nominee or street name.

Dividends

We have never declared or paid any cash dividends on our capital stock and do not anticipate paying cash dividends in the foreseeable future. We currently intend to retain future earnings, if any, to fund the expansion and growth of our business. Payment of future dividends, if any, will be at the discretion of our board of directors after taking into account various factors, including our financial condition, operating results, current and anticipated cash needs and plans for expansion.

16

Table of Contents

ITEM 6.    Selected Financial Data

SELECTED FINANCIAL DATA

The selected Consolidated Balance Sheets data as of December 31, 2002 and 2003, and the selected Consolidated Statements of Operations data for each of the years ended December 31, 2001, 2002 and 2003, have been derived from our audited financial statements appearing in this Annual Report on Form 10-K. The selected Consolidated Balance Sheets data as of December 31, 1999, 2000 and 2001, and the selected Consolidated Statements of Operations data for the years ended December 31, 1999 and 2000, are derived from our audited financial statements not included in this Form 10-K. When you read this selected consolidated financial data, it is important that you also read the Consolidated Financial Statements and related notes included in this Form 10-K, as well as the section of this report entitled Management’s Discussion and Analysis of Financial Condition and Results of Operations. Historical results are not necessarily indicative of future results.

See Note 2 to the Notes to Consolidated Financial Statements for an explanation of the determination of the number of shares used in computing per share amounts.

17

Table of Contents

18

Table of Contents

ITEM 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

Company Background

We are a leading provider of supply chain management solutions for the healthcare industry. Through a combination of technology, information and services, our Web-based supply chain management solutions are designed to enable efficient collaboration among hospitals and suppliers, helping them to reduce operational inefficiencies and lower costs. The healthcare supply chain has a number of characteristics, including its large size, high degree of fragmentation, reliance on disparate technologies, dependence on manual processes and highly complex pricing structures, which have led to major inefficiencies. These inefficiencies lead to slower, error prone transactions and increased overhead and costs for suppliers and hospitals. In addition, the participants in the healthcare industry are under significant competitive and cost pressures and are seeking ways to increase efficiencies in their supply chain to improve their overall margins. Our Web-based solutions make it easier for the participants in the healthcare supply chain, principally hospitals, suppliers and GPOs, to improve communication, receive comprehensive and accurate information, improve day-to-day operations, accelerate order and contract implementations, enhance strategic planning and gain organization-wide visibility into supply chain activities. Using our solutions, these organizations can improve efficiencies, increase revenue, reduce costs and improve capital allocation.

Strategic Relationships

In 2000, we entered into a 10-year strategic outsourcing and operating agreement, or Outsourcing Agreement, with VHA, UHC, Novation and Healthcare Purchasing Partners International, LLC, or HPPI. Under the Outsourcing Agreement, we agreed to provide specific functionality to Marketplace@Novation, Novation’s e-commerce marketplace. Novation agreed to act as our exclusive agent to negotiate agreements with suppliers to offer their equipment, products, supplies and services through marketplaces sponsored by Novation or HPPI, including Marketplace@Novation. VHA, UHC, HPPI and Novation each agreed not to develop or promote any other Internet-based exchange for the acquisition or disposal of products, supplies, equipment or services by healthcare provider organizations.

In connection with the Outsourcing Agreement, we issued in July 2000 4.6 million and 1.1 million shares of our common stock to VHA and UHC, respectively. We also issued warrants to VHA and UHC, allowing VHA and UHC the opportunity to earn up to 3.1 million and 752,000 additional shares of our common stock, respectively, over a four-year period by meeting specified performance targets. These performance targets are based upon the historical purchasing volume of VHA and UHC member healthcare organizations that sign up to use Marketplace@Novation. In October 2000, we exchanged VHA’s warrant for 3.1 million restricted shares of our common stock and, in January 2001, we exchanged the unexercised portion of UHC’s performance warrant, to purchase 564,000 shares of our common stock, for 564,000 restricted shares of our common stock. Both VHA’s and UHC’s restricted shares are subject to forfeiture if the performance targets contained in their original warrants are not met. As of December 31, 2003, VHA and UHC had earned a significant amount of the restricted shares that are subject to forfeiture, and we expect them to earn substantially all of the total restricted shares by the expiration of the four-year period in June 2004.

We have amended and restated the Outsourcing Agreement from time to time. Under the current agreement, the Fourth Amended and Restated Outsourcing and Operating Agreement, or Fourth Amended Agreement, effective August 2003:

19

Table of Contents

In January 2001, we entered into stock purchase agreements with VHA, UHC and i2 Technologies, Inc., under which these entities purchased a total of 1.8 million shares of our common stock at a price of $16.90 per share. We raised a total of $30.5 million prior to costs associated with the sale of the shares, which were $1.1 million, including an advisory fee to our investment bankers.

In April 2001, we entered into a revolving credit agreement with VHA, which has subsequently been amended. Funds that we borrow under this credit agreement bear interest at the prime rate plus 2.75% per year and are secured by substantially all of our assets. Any amounts outstanding under this line of credit, both principal and interest, are due and payable on December 31, 2004, if not repaid sooner. The line of credit agreement also contains provisions that could potentially reduce the maximum we could borrow under the credit agreement in the event we entered into certain types of other debt or equity financing arrangements. In December 2003, we repaid all amounts outstanding under the line of credit, including accrued interest, and amended the line of credit to reduce its capacity from the original $25.0 million to $15.0 million.

During the years ended December 31, 2001, 2002 and 2003, the fees paid to us by Novation totaled $24.6 million, $68.8 million and $69.2 million, respectively. The fees paid to us by Novation in each of the last six quarters, including the quarter ended December 30, 2003, were limited by the quarterly maximums in those periods. Based on the levels of marketplace volume we are currently achieving, we expect that the fees we earn from Novation will continue to be limited by the quarterly maximums, above which additional volume will not result in increased fees. As a result, we expect to receive $61.0 million in fees from Novation in 2004.

Acquisitions

Med-Contrax and Med-ecorp

In July 2002, we acquired substantially all of the assets of data management companies MedContrax and Med-ecorp. MedContrax and Med-ecorp offered subscription-based services that identified market opportunities, measured market shares and evaluated sales force performance and management, as well as provided subscription-based contract management and administration products and services. The total purchase price was $1.5 million in cash. The acquisition was accounted for using the purchase method of accounting and, accordingly, the purchase price was allocated to the assets acquired and liabilities assumed on the basis of their respective fair values on the acquisition date. In the allocation of the purchase price, $336,000, $360,000, $340,000, $348,000 and $110,000 were allocated to tangible assets, a proprietary database, developed technology, goodwill and acquired in-process research and development, respectively. The proprietary database and developed technology are being amortized over their estimated useful lives of three years and five years, respectively. In accordance with Statement of Financial Accounting Standards, or SFAS, No. 142, goodwill is not being amortized, but is being assessed for impairment at least annually, or whenever an event or change in

20

Table of Contents

circumstance indicates that the carrying value may not be recoverable. The $110,000 allocated to acquired in- process research and development represented the estimated fair value, based on risk-adjusted cash flows, related to incomplete research and development projects. At the date of the acquisition, the development of these projects had not yet reached technological feasibility, and the research and development in progress had no alternative future use. Accordingly, the $110,000 was expensed as of the acquisition date. The results of operations of MedContrax and Med-ecorp are included in our Consolidated Statements of Operations from the date of acquisition.

Revelocity

In December 2002, we acquired substantially all of the assets of Revelocity, a developer of Web-based software products that provided supply chain management capabilities for hospitals and healthcare suppliers to help them streamline procurement processes, manage inventories, track project and patient costs, leverage bar-coding efficiencies in internal distribution and share replenishment demand information. The stock-based portion of the consideration for the acquisition was contingent upon the amount of revenue generated by the acquired business from the date of acquisition through December 31, 2003. We issued an aggregate of 186,000 shares of our common stock valued at $2.1 million as consideration for the acquisition. These shares were valued as earned. Accordingly, the amount of goodwill recognized in this acquisition was adjusted as the additional shares were earned. The purchase price also included forgiveness of a $500,000 note receivable from Revelocity and the assumption of liabilities of $235,000. The total purchase price was allocated to the assets acquired and liabilities assumed on the basis of their respective fair values on the acquisition date. In the initial allocation of the purchase price, $34,000, $2.0 million and $1.1 million were allocated to tangible assets, developed technology and goodwill, respectively. An additional $239,000 of goodwill was recorded in 2003 subsequent to the initial purchase price allocation as a result of the level of stock-based contingent consideration earned. The developed technology is being amortized over its estimated useful life of five years. In accordance with SFAS No. 142, goodwill is not being amortized, but is being assessed for impairment at least annually, or whenever an event or change in circumstance indicates that the carrying value may not be recoverable. The results of operations of Revelocity are included in our Consolidated Statements of Operations from the date of acquisition.

Other Matters

Since inception, we have incurred significant losses and, as of December 31, 2003, had an accumulated deficit of $692.7 million. We have a limited operating history on which to base an evaluation of our business and prospects. You must consider our prospects in light of the risks, expenses and difficulties frequently encountered by companies in the early stages of development, particularly companies in new and rapidly evolving markets such as the market for Web-based supply chain management solutions for the healthcare industry. To address these risks, we must, among other things, expand our customer base, enter into new strategic alliances, increase the functionality of our solutions, implement and successfully execute our business and marketing strategy, respond to competitive developments and attract, retain and motivate qualified personnel. We may not be successful in addressing these risks, and our failure to do so could seriously harm our business.

Critical Accounting Policies and Estimates

We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our Consolidated Financial Statements:

21

Table of Contents

Revenue Recognition

We derive our revenue from the solutions we provide to our customers. These solutions include Neoforma OMS, Neoforma CMS, Neoforma DMS and Neoforma MMS.

Related Party Revenue.    Related party revenue consists of fees paid by Novation under the fee level provisions of the Outsourcing Agreement, as amended, in connection with Neoforma OMS and Neoforma CMS that we provide as part of Marketplace@Novation, and hospital implementation fees earned by us when VHA and UHC member hospitals that have contracted with us are connected to Marketplace@Novation.

Hospital implementation fees are generated from VHA and UHC member hospitals that pay a one-time fee for implementation services when we connect them to Marketplace@Novation. Upon completion of the connection to Marketplace@Novation, we recognize the implementation fees ratably over the period of our agreement with the hospitals, which is typically two to three years.

As a result of the application of Emerging Issues Task Force Abstract, or EITF, No. 01-9, we offset the amortization of capitalized partnership costs resulting from the equity consideration provided to related parties against the fees received from those related parties, thereby resulting in a reduction of the related party revenue reported. As a result, our reported related party revenue does not reflect the level of fees received from related parties for those services. See Note 3 of the Notes to Consolidated Financial Statements for further discussion of the impact of the application of EITF No. 01-9 on our reported revenue.

Non-Related Party Revenue.    Non-related party revenue consists primarily of services fees, subscription fees, transaction-based fees and software license fees related to the sale and support of our solutions. Revenue is recognized when evidence of an arrangement exists, delivery has occurred, fees are fixed or determinable and collection is probable.

Services fees are primarily generated from suppliers, GPOs and healthcare providers that purchase Neoforma DMS and Neoforma CMS and include data cleansing services, market intelligence services and contract administration and reporting services. As our data cleansing services are generally provided on a project basis, with most projects taking in excess of 90 days to complete, and given the inherent risks with regards to estimating costs, we recognize services fees paid by providers and GPOs related to these types of agreements upon project completion. Services fees relating to market intelligence services and contract administration and reporting services are received for the delivery of specified reports or other data. We recognize the services fees related to these agreements upon delivery of the reports or, for time-based access to reports or data, over the period we provide that access to the customer under the agreement.

Subscription-based fees are generated from suppliers that pay a monthly, quarterly or annual subscription fee that is not based on marketplace volume in connection with the services we provide as part of Neoforma OMS and Neoforma CMS. For these suppliers, we recognize these subscription fees ratably over the period of the subscription agreement, as that is the period over which the services are performed. We also generate subscription fees through other agreements with suppliers that participate in Marketplace@Novation that pay a periodic subscription fee calculated as a percentage of their periodic product sales under Novation contracts. For the majority of these suppliers, their Novation contract sales information is generally not available for approximately 90 days after the products are sold. For these suppliers, we utilize estimates of their Novation contract sales as a basis for recognizing revenue. As our estimation process is based on historical Novation contract sales data for each supplier, and as those estimates are updated monthly, we believe that we have adequately demonstrated the ability to reasonably estimate the basis for these fees for revenue recognition purposes. As such, we recognize the revenue in the period that the contracted products are sold.

Transaction-based fees represent the negotiated percentage of the purchase price, or marketplace volume, of products in transactions between signed participants in Marketplace@Novation that are purchased by hospitals utilizing our connection solution, NeoConnect, in connection with the services we provide as part of Neoforma

22

Table of Contents

OMS and Neoforma CMS. The gross marketplace value of a transaction is the price of a product as agreed to by the buyer and the supplier. We recognize revenue for transaction fees on a net basis, as we do not believe that we act as a principal in connection with orders to be shipped or delivered by a supplier to a buyer because, among other things, we do not: (i) establish the prices of products paid by buyers; (ii) take title to products to be shipped from the supplier to the buyer, nor do we take title to or assume the risk of loss of products prior to or during shipment; (iii) bear the credit and collections risk of the buyer to the supplier; or (iv) bear the risk that the product will be returned.

Software license fees are generated primarily from suppliers and healthcare providers that license Neoforma MMS, either directly via the purchase of a license to the software or by entering into a subscription agreement with us whereby we provide them access to a hosted version of the software. We also have generated software license revenue related to a technology license agreement we entered into in August 2001 with GHX. The revenue related to this agreement is being recognized ratably over the three-year term of the agreement. We apply the provisions of Statement of Position No. 97-2, “Software Revenue Recognition,” as amended, to all transactions involving the sale of software products. We recognize revenue from the sale of software licenses when persuasive evidence of an arrangement exists, the product has been delivered, the fee is fixed or determinable and collection of the resulting receivable is probable. For contracts with multiple obligations (e.g., license, maintenance and other services), revenue is allocated to each component of the contract using the residual method based on the price when sold separately. We recognize revenue allocated to maintenance fees, including amounts allocated from product revenue, for ongoing customer support and product updates ratably over the period of the maintenance contract. Payments for maintenance fees are generally made in advance and are non-refundable. For revenue allocated to consulting services, and consulting services sold separately, such as training, we recognize revenue as the related services are performed. Revenue from hosted services is recognized as the services are performed.

Amortization Period of Capitalized Partnership Costs

Capitalized partnership costs consist of the fair value of common stock and restricted common stock issued and capitalized in connection with our Outsourcing Agreement, as amended, with Novation, VHA, UHC and HPPI. See Note 16 of the Notes to Consolidated Financial Statements for further discussion of both the Outsourcing Agreement, as amended, and the related stock that has been issued and capitalized.

The initial shares of common stock issued to VHA and UHC in connection with the Outsourcing Agreement were capitalized at their fair value on the date of issuance and are being amortized ratably over the estimated useful life of the agreement. At the time of issuance, management estimated the useful life of the 10-year agreement to be five years for accounting purposes. The primary basis for the five-year estimate was the significant risk associated with whether this new relationship would continue for the full 10-year term of the agreement in the form in which it was originally contemplated, represented among others, by:

Management periodically assesses the useful life of this asset to ensure that any changes in our relationship with Novation, VHA and UHC, or any changes in the broader market conditions that may impact the useful life of the agreement, are factored into our estimate of the useful life of the agreement and the resulting amortization. As of December 31, 2003, management continued to believe that the initial estimated useful life of the agreement of five years was appropriate given the remaining uncertainty with regards to the continuing high level of

23

Table of Contents

performance and future functionality deliverables required of us under the terms of the Outsourcing Agreement, as amended.

Estimating the Allowance for Doubtful Accounts Receivable and Notes Receivable

Our management must make estimates of the collectability of both our accounts receivable and our notes receivable. Management analyzes accounts receivable and historical bad debts, customer concentrations, customer credit-worthiness, current economic trends and changes in our customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. As of December 31, 2003, our total accounts receivable balance was $4.2 million, net of allowance for doubtful accounts of $235,000. Management also analyzes the financial condition of debtors for which we hold notes receivable based on all available information. If the financial condition of our customers or debtors were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances might be required. As of December 31, 2003, our notes receivable balance was $1.5 million, against which no allowance has been provided.

Estimating Litigation Reserves and Other Accrued Liabilities

Management’s estimate of the liability related to our pending litigation is based on claims and other information known to us and management’s assessment of the probability of loss. As additional information becomes available, we reassess and revise our estimates as appropriate. Revisions in our estimates of the potential liability could materially impact our results of operation and financial position in the period such revisions are made. As of December 31, 2003, we had accrued $34,000 for potential liabilities related to our pending litigation.

Valuation of Goodwill and Intangible Assets

We assess the impairment of intangible assets, which currently consist of capitalized partnership costs and acquired database, developed technology and customer lists, whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors we consider important which could trigger an impairment review include the following:

If we determine that the carrying value of an intangible asset may not be recoverable based upon the existence of one or more of the above indicators of impairment, we will measure any impairment based on a projected discounted cash flow method using a discount rate determined by our management to be commensurate with the risk inherent in our current business model. Capitalized partnership costs, net of amortization, and acquisition related intangible assets, net of amortization, amounted to $106.0 million and $2.0 million, respectively, as of December 31, 2003.

In addition, we assess goodwill for impairment at least annually and whenever an event or change in circumstance indicates that the carrying value may not be recoverable. Factors we consider important which could trigger an impairment review include the following:

24

Table of Contents

If we determine that the carrying value of goodwill may not be recoverable based upon our annual impairment test or the existence of one or more of the above indicators of impairment, we would determine the fair value of our reporting unit utilizing discounted cash flows and relative market multiples for comparable businesses. We would then compare the fair value of our reporting unit to its carrying value. If this evaluation indicated that impairment might exist for the reporting unit, we would then compare the carrying amount of goodwill in the reporting unit to the implied fair value of the goodwill to determine the amount of any impairment loss. Goodwill amounted to $1.7 million at December 31, 2003.

Results of Operations

Overview

As our operations have grown, the fees we receive from customers and our recognized revenue have also increased. Our fees from related parties increased from $24.8 million in 2001 to $69.5 million in 2002 and to $70.0 million in 2003. However, as a result of the application of EITF No. 01-9, under which we offset related party revenue by amortization of partnership costs, we eliminated 100%, 100% and 99% of related party revenue in 2001, 2002 and 2003, respectively (see Note 3 to the Notes to Consolidated Financial Statements for further discussion of the impact of the application of EITF No. 01-9). Our reported revenue increased 42% from 2001 to 2002 and 159% from 2002 to 2003. In 2001, 2002 and 2003, one single customer represented 17%, 27% and 10%, respectively, of our revenue. Because of the impact of EITF No. 01-9 on our related party revenue, our total revenue growth has been a result of increases in non-related party revenue. In 2003 as compared to 2002, this growth in non-related party revenue was primarily due to increases in revenue from solutions we sell to suppliers and from sales of Neoforma DMS to hospitals.

We expect certain revenue trends that our business has experienced in the past two years to continue in 2004. In 2004, we expect our revenue to continue to grow as a result of increases in non-related party revenue from sales of our solutions to hospital, GPO and supplier customers. In addition, we expect that the fees we generate in connection with our related party relationship in 2004 will be fully offset by amortization of partnership costs, resulting in zero reported related party revenue during the year. Additionally, under the terms of the Fourth Amended Agreement, there is a scheduled decrease in the quarterly maximum payments from Novation, which total $61.0 million in 2004 as compared to $69.2 million in 2003. Based on the levels of marketplace volume we are currently achieving, we expect the fees we earn from Novation will continue to be limited to the quarterly maximums. As a result, we expect lower total fees from related parties in 2004 as compared to 2003. Under the terms of the Fourth Amended Agreement, additional marketplace volume above a certain level does not result in incremental fees to us from Novation.

While our revenue has increased over the last three years, our operating expenses have decreased significantly over that same period. In 2001, we incurred a total of $184.8 million in expenses related to amortization of intangibles assets, amortization of partnership costs, write-off of purchased software, restructuring, impairment of intangibles, impairment of assets held for divestiture and write-down of non-marketable investments. In 2002 and 2003, these expenses totaled $10.3 million and $1.4 million, respectively. Further, amortization of deferred compensation decreased from $16.3 million in 2001 to $5.8 million and $2.1 million in 2002 and 2003, respectively. In addition to the decreases in these expenses over the last three years, we have improved our operational execution and the use of our resources.

Despite the decrease in total expenses over the past three years, we have made a number of investments to support our growth, primarily in personnel, and the number of our employees increased from 196 as of December 31, 2001 to a high of 295 as of November 2003. The growth in the number of our employees resulted in increases in total salaries we paid to our employees in both 2002 and 2003. However, as a result of reduced bonus levels in

25

Table of Contents

2003 as compared to 2002, our total payroll costs were flat in 2003 relative to 2002. At the beginning of 2003, we completed an internal reorganization, under which we reallocated a significant portion of our workforce to more directly facing customer positions, resulting in certain operating expense categories declining and selling and marketing expenses increasing in 2003 as compared to 2002. Additionally, during the year, we made investments in selling and marketing and product development to enhance our solutions and to grow our non-related party revenue, resulting in increases in expenses in these categories during 2003. At the end of 2003, to lower our overall costs and to enable us to invest in certain areas to support our anticipated growth, we reduced the size of our workforce by approximately 35 individuals.

In 2004, we do not expect our operating expenses to continue to decrease as they have in prior years. We expect total operating expenses to be relatively flat in 2004 as compared to 2003, and we expect a decrease in depreciation expense to be offset by an increase in amortization of partnership costs classified as an operating expense. The expected reduction in depreciation is the result of certain large software licenses acquired in 2000 being fully depreciated as of December 31, 2003. The expected increase in amortization of partnership costs classified as an operating expense is the result of the anticipated decrease in fees from related parties, which will result in a decrease in the amount of the offset to the gross amortization of partnership costs.

26

Table of Contents

For the Years Ended December 31, 2001, 2002 and 2003

Revenue

Effective with our fourth quarter and full year 2003 financial results, we have reclassified our revenue presentation on our Consolidated Statements of Operations to reflect revenue in two categories: related party revenue and non-related party revenue. One customer accounted for 17%, 27% and 10% of our revenue in 2001, 2002 and 2003, respectively, while another customer accounted for 13% of our revenue in 2002.

Related Party Revenue.    Related party revenue consists of fees paid by Novation under the fee level provisions of the Outsourcing Agreement, as amended, and hospital implementation fees earned by us when VHA and UHC member hospitals that have contracted with us are connected to Marketplace@Novation. As a result of the adoption of EITF No. 01-9, amortization of partnership costs resulting from the equity consideration issued to VHA and UHC, the owners of Novation, is classified as an offset against related party revenue, as opposed to being classified as an operating expense, up to the lesser of such related party revenue or amortization of partnership costs in any given period. Due to the offset of $24.8 million and $69.5 million of amortization of partnership costs against related party revenue for the years ended December 31, 2001 and 2002, respectively, there was no net related party revenue for either period. In the year ended December 31, 2003, the fees paid by Novation and VHA and UHC member hospitals exceeded the amortization of partnership costs in certain quarters, resulting in $825,000 of related party revenue for the year. See Note 3 to the Notes to Consolidated Financial Statements for further discussion of the impact of the application of EITF No. 01-9. During the remaining term of the Fourth Amended Agreement, the quarterly maximums on the fees we may earn from Novation are $61.0 million per year. As we expect gross amortization of partnership costs to be in excess of $61.0 million in 2004, we expect related party revenue to be $0 in 2004.

Non-Related Party Revenue.    Non-related party revenue includes revenue earned from non-related party healthcare providers, GPOs and suppliers, including revenue from solutions sold to VHA and UHC member hospitals outside the scope of the Fourth Amended Agreement, as well as periods governed by previous versions of the agreement. Non-related party revenue increased from 2001 to 2002 primarily due to increased revenue generated from suppliers related to their participation in Marketplace@Novation, an increase in revenue related to the sale of a license to GHX to utilize portions of our NeoConnect platform and revenue generated from our market intelligence and contract administration and reporting services for suppliers. These market intelligence and contract administration and reporting services were introduced in connection with our acquisition of substantially all of the assets of MedContrax and Med-ecorp in July 2002. These increases in 2002 were partially offset by a decrease of $1.1 million as a result of the divestiture of certain assets in late 2001. Substantially all of the non-related party revenue for 2001 was related to the divested assets. Additionally, revenue decreased by $728,000 from 2001 to 2002 as a result of the divestiture of our EquipMD, Inc. operations in March 2002. In 2003, non-related party revenue increased as compared with 2002, primarily due to increases in revenue generated from sales of our data cleansing services to hospitals and market intelligence services for suppliers, both components of Neoforma DMS, sales of our solutions to suppliers related to their participation in Marketplace@Novation and from new revenue generated from Neoforma MMS. Neoforma MMS was introduced in connection with our December 2002 acquisition of substantially all of the assets of Revelocity.

27

Table of Contents

Operating Expenses

Cost of Services

Cost of services consists primarily of the costs to perform hospital and supplier implementation activities, personnel and other related costs associated with delivering Neoforma DMS and direct costs to obtain data for our solutions. These expenditures consist primarily of technology costs, software licenses, salaries and other personnel expenses for our services personnel and fees for independent contractors and consultants and companies to which we outsource services. The decrease in cost of services from 2001 to 2002 was primarily due to the fact that in the latter half of 2001 and in fiscal 2002, our services group utilized fewer contractors and consultants, resulting in a reduction of the related expenses by $2.7 million in 2002. Additionally, the number of full time employees in our services group decreased from 49 at the beginning of 2001 to 18 as of December 31, 2001, although it subsequently increased to 28 as of December 31, 2002. As a result, payroll related expenses decreased by $1.4 million during 2002 as compared to 2001. The decrease in cost of services from 2002 to 2003 was primarily due to a decrease in payroll related costs of $1.2 million due to a decrease in bonus levels and a $910,000 decrease in allocable expenses, including depreciation and deferred compensation amortization, allocated to cost of services. This decrease was partially offset by an increase in fees paid for outsourced services utilized to support increased revenue in 2003.

Operations

Operations expenses consist primarily of expenditures for the operation and maintenance of our solutions and our technology infrastructure, including customer service. These expenditures consist primarily of technology costs, software licenses, salaries and other personnel expenses for our operations personnel and fees paid to independent contractors and consultants. Operations expenses increased from 2001 to 2002 primarily due to a $5.0 million increase in depreciation expense allocated to operations relating to assets that were placed into service during 2002. The decrease in operations expenses from 2002 to 2003 was primarily due to a $2.3 million decrease in payroll related costs, which was driven by a decrease in bonus levels and a decrease in headcount in the operations group from 79 as of December 31, 2002 to 54 as of December 31, 2003. The lower headcount in operations for 2003 was primarily the result of an internal reorganization in early 2003 in which a significant portion of our resources were reallocated to more directly customer facing positions. The decrease in operations expenses was partially offset by a $1.6 million increase in costs allocated to operations in 2003 versus 2002, which primarily consisted of depreciation.

Product Development

Product development expenses consist primarily of personnel expenses, fees to consultants and contractors and technology costs associated with the development and enhancement of our solutions. Product development expenses were relatively flat from 2001 to 2002 but increased slightly from 2002 to 2003. This increase was

28

Table of Contents

primarily due to an increase in payroll and related expenses due to an increase in headcount in the product development group from 61 as of December 31, 2002 to 80 as of December 31, 2003.

Selling and Marketing

Selling and marketing expenses consist primarily of salaries and commissions for sales and marketing personnel, as well as advertising, promotions and other related marketing costs. Selling and marketing expenses decreased from 2001 to 2002 primarily due to a reduction in headcount in our selling and marketing groups from 99 at the beginning of 2001 to 49 as of December 31, 2001 and to 39 as of December 31, 2002, as well as due to a reduction of $8.8 million in the amortization of deferred compensation associated with selling and marketing personnel. In 2002, we focused the majority of our resources on product development and implementation and integration efforts, which contributed to the reduction in our selling and marketing costs. Selling and marketing expenses increased from 2002 to 2003 primarily due to an increase in payroll related costs of $3.8 million due to an increase in headcount for the selling and marketing groups from 39 as of December 31, 2002 to 55 as of December 31, 2003. Additionally, our increased sales and marketing efforts in 2003, which included updating our corporate image and promoting our solutions in early 2003, resulted in an increase in travel and entertainment and other advertising costs of $1.5 million from 2002.

General and Administrative

General and administrative expenses consist of expenses for executive and administrative personnel, facilities, professional services and other general corporate activities. General and administrative expenses decreased from 2001 to 2002 primarily due to a $2.0 million reduction in amortization of deferred compensation related to general and administrative personnel, partially offset by increased costs associated with the prior year audits conducted in 2002 in conjunction with the restatement of our fiscal 2000 and 2001 financial statements. General and administrative expenses decreased from 2002 to 2003 primarily due to a $2.4 million decrease in deferred compensation expense allocated to the general and administrative group and a $1.3 million decrease in payroll related costs that were primarily a result of reduced bonus levels.

Amortization of Intangibles.    We amortize intangibles on a straight-line basis over a period of three to five years. Amortization of intangibles decreased from $30.1 million for the year ended December 31, 2001 to $90,000 for the year ended December 31, 2002. During the fourth quarter of 2001, we wrote down the intangible assets related to our acquisition of Pharos Technologies, Inc., or Pharos, and substantially all of the intangible assets relating to our acquisition of EquipMD, operated as NeoMD, as a result of our plans to divest these non-core operations. As a result of our divestiture of these operations, we did not incur amortization expenses related to Pharos and NeoMD after 2001. During 2002, we recorded intangible assets, excluding goodwill, of $2.7 million in connection with the acquisition of substantially all of the assets of MedContrax, Med-ecorp and Revelocity. The amortization of intangibles of $90,000 and $588,000 for the years ended December 31, 2002 and 2003, respectively, related to these intangible assets. The increase in amortization of intangibles from 2002 to 2003 was due to the fact that the MedContrax and Med-ecorp acquisitions occurred in July 2002 and the Revelocity acquisition occurred in December 2002. We expect the amortization of these intangible assets in 2004

29

Table of Contents

to be relatively flat as compared to 2003, as these assets are being amortized on a straight line basis and 2003 represented a full year of amortization for all of these intangible assets.

Amortization of Partnership Costs

Amortization of partnership costs represents the amortization of the shares of our common stock issued to VHA and UHC. As of December 31, 2003, capitalized partnership costs represented the capitalized valuation of common stock and earned restricted common stock issued to VHA and UHC in connection with our entering into the Outsourcing Agreement, as amended, with those entities and with Novation. The value of the initial common stock issued is being amortized over a five-year estimated useful life. The restricted common stock is being valued, and the related valuation is being capitalized, as the shares are earned. The capitalized partnership costs relating to the restricted common stock are being amortized over the term of the agreement with the healthcare organizations that resulted in the shares being earned, generally two to three years. The decrease in amortization of partnership costs classified as an operating expense from 2001 to 2002 was the result of the increase in fees received from related parties as, under EITF No. 01-9, amortization of partnership costs is classified as an offset against related party revenue, as opposed to being classified as an operating expense, up to the lesser of such related party revenue or amortization of partnership costs in any given period. The decrease in amortization of partnership costs classified as an operating expense from 2002 to 2003 was due to a decrease in gross amortization of partnership costs. The amortization of partnership costs reported as an operating expense is reflected as an adjustment to reconcile net loss to cash from operating activities in our Consolidated Statements of Cash Flows. Under EITF No. 01-9, we account for the fees being paid by Novation under the terms of the Outsourcing Agreement and subsequent amendments as if they were payments made for the equity consideration we provided to VHA and UHC as opposed to payments for services. As a result, the amortization of partnership costs that is offset against related party revenue is reported as a cash flow from financing activities in our Consolidated Statements of Cash Flows.

Although there were incremental partnership costs capitalized from the date we entered into the Outsourcing Agreement, as amended, through December 31, 2003 related to the earning of the restricted common stock by VHA and UHC, certain of the capitalized partnership costs relating to the restricted stock earned by VHA and UHC when the first hospitals signed up to participate in Marketplace@Novation in 2000 had been fully amortized as of December 31, 2002. Those partnership costs that had been fully amortized as of December 31, 2002 were generally capitalized at higher levels than those that have been capitalized in more recent periods due to the fact that (i) there has been a relatively lower number of restricted shares earned by VHA and UHC during more recent periods and (ii) the capitalized value of each restricted share earned was higher in historical periods than in more recent periods. As a result, the overall gross amortization of partnership costs associated with the restricted common stock decreased in the year ended December 31, 2003 as compared to the year ended December 31, 2002. We expect the total gross amortization of partnership costs, excluding the impact of EITF 01-9, to decrease slightly in 2004 as compared to 2003. However, net of the offset of related party revenue required under EITF 01-9, we expect that amortization of partnership costs classified as an operating expense will increase in 2004 as compared to 2003. We expect this increase will be due to decreases in the level of related

30

Table of Contents

party revenue we will receive in 2004 as a result of the scheduled decrease in the maximum fees payable from Novation under the terms of the Fourth Amended Agreement from $69.2 million in 2003 to $61.0 million in 2004. See Note 3 to the Notes to Consolidated Financial Statements for further discussion of the impact of the application of EITF No. 01-9. See “Liquidity and Capital Resources” for a further discussion of the Outsourcing Agreement, as amended, and the related cash and accounting implications.

Amortization of Deferred Compensation

Deferred compensation represents the aggregate difference, at the date of grant, between the cost to the employee of equity-based compensation and the estimated fair value of the underlying equity instrument. In the case of stock options, deferred compensation is calculated as the difference between the exercise price of the option and the deemed fair value of the underlying stock on the date the option was granted. We amortize deferred compensation from stock option grants on an accelerated basis over the vesting period of the underlying options, generally four years. In connection with the grant of stock options to employees during fiscal 1998, 1999 and 2000, prior to our IPO, we recorded deferred compensation of $65.2 million. Amortization of deferred compensation is reversed for any amounts recognized on options that do not vest due to employee terminations or employee attrition. During the years ended December 31, 2001, 2002 and 2003, we recorded $2.4 million, $244,000 and $82,000, respectively, in reductions of deferred compensation. We recorded amortization of this deferred compensation, net of reversals relating to forfeitures, of $7.7 million, $3.4 million and $1.1 million during the years ended December 31, 2001, 2002 and 2003, respectively.

In connection with the assumption of certain stock options granted to employees of EquipMD prior to our acquisition of EquipMD in April 2000, we recorded deferred compensation of $23.1 million, representing the difference between the estimated fair value of the common stock for accounting purposes and the option exercise price of these options at the date of announcement of the acquisition. This amount was presented as a reduction of stockholders’ equity and was being amortized over the vesting period of the applicable options using an accelerated method of amortization. During the years ended December 31, 2001 and 2002, we recorded $4.9 million and $1.2 million, respectively, in reductions of this deferred compensation as a result of employee terminations and employee attrition in this business, which we divested in March 2002. We recorded amortization of this deferred compensation, net of reversals relating to forfeitures, related to these options of $8.4 million and $51,000 during the years ended December 31, 2001 and 2002, respectively. We no longer employ any EquipMD employees due to the divestiture of the EquipMD assets. As such, we do not have any remaining deferred compensation related to these employees and are no longer incurring amortization expenses relating to this deferred compensation.

During 2001, 2002 and 2003, in connection with the award of restricted stock to certain employees and officers, we recorded deferred compensation of $3.6 million, $249,000 and $320,000, respectively, representing the fair value of the underlying common stock at the date of grants. The restrictions on the stock lapse on various dates through February 2005 and are subject to the continuous employment of the employees and officers with Neoforma through those dates. This amount is presented as a reduction of stockholders’ equity and will be amortized ratably over the period from the date of grant through the vesting date using the straight line method of amortization. Amortization of deferred compensation is reversed for any amounts recognized on shares of restricted stock that do not vest due to employee terminations. During the years ended December 31, 2001, 2002

31

Table of Contents

and 2003, we recorded $0, $0 and $146,000, respectively, in reductions of the deferred compensation as a result of employee terminations and the resulting forfeiture of restricted stock. We recorded amortization of deferred compensation related to these shares of $146,000, $2.3 million and $1.0 million during the years ended December 31, 2001, 2002 and 2003, respectively.

The remaining total deferred compensation of $218,000 at December 31, 2003 is expected to be amortized as follows: $205,000 during fiscal 2004 and $13,000 during fiscal 2005. The amortization expense relates to options and restricted stock awarded to employees and officers in all operating expense categories. The amount of amortization of deferred compensation has been separately allocated to these operating expense categories in the Consolidated Statements of Operations. We expect we will continue to use restricted stock grants as a means of compensation for employees in 2004 as we have in prior years. As a result, we expect to capitalize and to amortize additional deferred compensation in 2004 related to those grants.

Write-Off of Purchased Software.    During the years ended December 31, 2001 and 2002 we recorded charges of $1.5 million and $458,000, respectively, to write off purchased software licenses that we were no longer utilizing. There were no such write-offs during the year ended December 31, 2003.

Restructuring.    Restructuring costs consist primarily of severance payments resulting from the streamlining and reorganizing of our operations and the divestitures of certain operations. Restructuring costs also include accrued rent relating to idle facilities. During the year ended December 31, 2001, in connection with our decision to divest certain assets, we recorded a restructuring charge of $600,000, of which $539,000 related to a revision of our estimate of the time required to sublease idle facilities of the Auction operations and $61,000 related to severance costs for employees of the Auction operations. There were no additional restructuring charges related to these operations during the years ended December 31, 2002 or 2003.

In December 2001, we recorded a restructuring charge of $350,000 in connection with our decision to divest the assets of EquipMD. Of that amount, $311,000 related to the severance of seven employees and $39,000 related to idle facilities and related costs. Of the employees terminated, all seven were in our selling and marketing groups. During the year ended December 31, 2002, we reversed $68,000 of restructuring accruals, as we determined that restructuring costs would be less than originally anticipated. EquipMD was sold in the first quarter of 2002. No restructuring charges related to these operations were recorded during the years ended December 31, 2002 or 2003.

Impairment of Intangibles.    Impairment of intangibles represents the reduction of the carrying value of our investment in Pharos to our estimate of its fair market value as of December 31, 2001. During fiscal 2001, we were unsuccessful in our efforts to identify a buyer for the technology we acquired as part of our acquisition of Pharos. In addition, in the fourth quarter of 2001, we terminated our use of the technology acquired. Based on these factors, we concluded that the carrying value of the intangible assets was not recoverable as of December 31, 2001. As a result, we recorded an impairment charge of $11.9 million during the fourth quarter of 2001 to write off these intangible assets. There were no such impairment charges during the years ended December 31, 2002 or 2003.

Impairment of Assets Held for Divestiture.    Impairment of assets held for divestiture consists of impairment charges that are the direct result of pending divestitures of certain of our operations and relate to any charges required to adjust the carrying value of the assets to be divested to the net realizable value.

During the fourth quarter of 2001, we obtained board approval to explore strategic alternatives for the divestiture of our NeoMD operations to continue to maintain our focus on delivering core customer solutions and to increase our resource commitment to the acute care business. These operations consisted primarily of the assets of EquipMD. As a result, we recorded a charge of $81.1 million to write down these assets to the estimated net realizable disposal value. There were no such impairment charges recorded in 2002 or 2003.

32

Table of Contents

Write-Down of Non-Marketable Investments.    Pointshare, Inc. was a privately held business-to-business administration services company in which we invested $3.0 million in March 2000. Based on our discussions with Pointshare’s management in September 2001, we felt that it was highly unlikely that we would recover any material portion of our initial investment. As such, we wrote off our $3.0 million investment in Pointshare during the third quarter of 2001. During fiscal 2002, we received $211,000 from the bankruptcy trustee for Pointshare, which was recorded as a credit to write-down of non-marketable investments in our Consolidated Statements of Operations in 2002.

During the fourth quarter of 2001, we wrote off our $5.4 million investment in CarePortal.com, LLC, formerly known as IntraMedix, LLC, a privately held corporation. Due to uncertainties regarding the financial position of CarePortal, the resulting decline in the value of this investment and our belief that the decline in value was other than temporary in nature, we concluded that the investment in CarePortal had no future realizable value as of December 31, 2001.

In December 2002, we received notice from Attainia, Inc. that it had completed a round of financing at an offering price less than the cost per share of our investment in Attainia. As such, we wrote down our investment in Attainia by $662,000 during the year ended December 31, 2002.

Net (Gain)/Loss on Divested Businesses.    Net gain on divested businesses during the year ended December 31, 2001 consisted of the net gain realized as a result of the divestitures of certain assets during that period. The gain on divested businesses is calculated by reducing the consideration paid to us for the divested operations by the net book value of all assets and liabilities transferred with the divested operations. The divestiture of U.S. Lifeline, Inc. resulted in a gain of $307,000 on the sale of the net assets, the divestiture of FDI, Inc. resulted in a loss of $1.1 million on the sale of the net assets and the divestiture of Neoforma GAR, Inc., or GAR, resulted in a gain of $872,000 on the sale of the net assets. The resulting net gain on divested businesses during the year ended December 31, 2001 was $55,000. During the year ended December 31, 2002, the loss on divested businesses consisted of a loss of $59,000 incurred as a result of the sale of the NeoMD operations.

Write-Off of Acquired In-Process Research and Development.    For the year ended December 31, 2002, we recorded a charge of $110,000 to write off acquired in-process research and development in connection with the MedContrax and Med-ecorp acquisition in July 2002. There were no such write-offs during the years ended December 31, 2001 or 2003.

Write-Down of Notes Receivable.    In September 2002, we entered into a confidential settlement agreement with Med-XS Solutions, Inc. and Med-XS Asset Services, Inc., or Med-XS, to settle the suit we had filed against Med-XS, and the subsequent counterclaim filed by Med-XS against us, in connection with their failure to make payments to us under a $2.4 million promissory note executed as partial payment for their purchase of our now divested subsidiary, GAR. We wrote down the note receivable by $1.1 million in the third quarter of 2002 to reflect the collectible value of the note based on the terms of the settlement agreement.

During 2001, as part of our operating and outsourcing agreement with Canadian Health Marketplace, or CHM, we provided CHM with $50,000 under the terms of a note receivable due to us the later of December 31, 2003 or upon us providing CHM with certain specifically identified marketplace functionality. In the fourth quarter of 2003, we became aware of certain factors that caused us to conclude that the value of the note receivable was no longer recoverable. As such, we wrote off the $50,000 note receivable in the fourth quarter of 2003.

Abandoned Acquisition Costs.    In July 2003, we entered into a definitive asset purchase agreement with I-many to acquire substantially all the assets of I-many’s Health & Life Sciences business. In November 2003, we exercised our right to terminate the acquisition pursuant to the terms of the asset purchase agreement. As a result of the termination of the acquisition, we expensed $551,000 in acquisition-related costs that were previously capitalized during the due diligence and acquisition process, including legal advisory fees and

33

Table of Contents

financial and accounting fees, which no longer had any realizable future value. As the termination occurred in November 2003, we expensed all such costs in the fourth quarter of the year ended December 31, 2003.

Income Taxes.    As of December 31, 2003, we had federal and state net operating loss carryforwards of $371.0 million and $247.0 million, respectively, which may be available to reduce future taxable income. These net operating loss carryforwards expire on various dates through 2023. A valuation allowance has been recorded for the entire deferred tax asset as a result of uncertainties regarding the realization of the asset due to our lack of earnings history. Federal and state tax laws impose significant restrictions on the amount of the net operating loss carryforwards that we may utilize in a given year. Under the Tax Reform Act of 1986, the amount of benefits from net operating loss carryforwards may be impaired or limited in certain circumstances. Events which cause limitations in the amount of net operating losses that we may utilize in any one year include, but are not limited to, a cumulative ownership change of more than 50%, as defined, over a three-year period.

Liquidity and Capital Resources

In January 2000, we completed our IPO and issued 805,000 shares of our common stock at an IPO price of $130.00 per share. Net cash proceeds to us from the IPO were $95.3 million. From our inception until our IPO, we financed our operations primarily through private sales of preferred stock through which we raised net proceeds of $88.5 million.

In January 2001, we completed a $30.5 million private round of financing in which we sold 1,804,738 shares of our common stock at $16.90 per share to three strategic investors, VHA, UHC and i2 Technologies, Inc.

In April 2001, we entered into a revolving credit agreement with VHA. Under this credit agreement, as amended in February 2002, December 2002 and December 2003, we are able to borrow funds until December 31, 2004, up to an amount based on a specified formula dependent on the gross volume of transactions through Marketplace@Novation. Funds that we borrow under this credit agreement bear interest at the prime rate plus 2.75% per year and are secured by substantially all of our assets. All amounts outstanding under this line of credit, both principal and interest, are due and payable on December 31, 2004, if not repaid sooner. In the event that we (i) sell any of our stock as part of an equity financing, (ii) obtain funding in connection with a debt financing or other lending transaction that is either unsecured or subordinate to the lien of VHA under the credit agreement or (iii) enter into a debt financing or other lending transaction secured by assets we owned as of the date we entered into the credit agreement, then the maximum we could potentially borrow under the credit agreement will be reduced by an amount equal to the cash proceeds we receive from any of these transactions. During 2003, we repaid all amounts outstanding under the line of credit including accrued interest and amended the line of credit to reduce its capacity from the original $25.0 million to $15.0 million. As of December 31, 2003, there was no balance outstanding and there was $15.0 million of remaining capacity available to us under the line of credit.

In July 1999, Comdisco, Inc. provided us with a $2.5 million loan and lease facility to finance computer hardware and software equipment. Amounts borrowed to purchase hardware bore interest at 9% per annum and were payable in 48 monthly installments, consisting of interest only payments for the first nine months and principal and interest payments for the remaining 39 months, with a balloon payment of the remaining principal payable at maturity. Amounts borrowed to purchase software bore interest at 8% per annum and were payable in 30 monthly installments consisting of interest only payments for the first four months and principal and interest payments for the remaining 26 months, with a balloon payment of the remaining principal payable at maturity. The computer equipment purchased with the proceeds of the loans secured this facility. We had repaid this lease in full as of December 31, 2003.

In August 1999, in connection with the GAR acquisition, we issued a promissory note in the principal amount of $7.8 million payable monthly over five years bearing interest at a rate of 7% per year. In July 2001,