##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION    FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the Quarterly Period Ended March 31, 2004 OR
 [  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the Transition Period Fromto.   Commission File Number: 000-25781 NET PERCEPTIONS, INC.  Delaware
(State or other jurisdiction of
incorporation or organization)
    
    41-1844584
(I.R.S. Employer
Identification Number)
 7700 France Avenue South
Edina, Minnesota 55435
(Address of principal executive offices, Zip Code) (952) 842-5000
(Registrants telephone number, including area code) Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [  ] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [  ] No [X] As of April 30, 2004, there were outstanding 28,283,347 shares of the
registrants Common Stock, $0.0001 par value.




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NET PERCEPTIONS, INC.
FORM 10-Q
For the Quarter Ended March 31, 2004 TABLE OF CONTENTS  
 PagePART I. FINANCIAL INFORMATIONItem 1. Financial StatementsConsolidated Balance Sheets as of March 31, 2004 and December 31, 2003
    
    
    3Consolidated Statements of Operations for the Three Months Ended March 31, 2004 and 2003
    
    
    4Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2004 and 2003
    
    
    5Notes to the Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    12Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    24Item 4. Controls and Procedures
    
    
    24PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    25Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
    
    
    26Item 4. Submission of Matters to a Vote of Security Holders
    
    
    26Item 6. Exhibits and Reports on Form 8-K
    
    
    27SIGNATURES
    
    
    28EXHIBIT INDEX
    
    
    292% Convertible Subordinated NoteRegistration Rights AgreementConvertible Note Purchase AgreementCertification of Principal Executive OfficerCertification of Principal Financial OfficerCertification of Principal Executive OfficerCertification of Principal Financial Officer
  2




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##### Table of Contents



PART I. FINANCIAL INFORMATION 
 Item 1. Financial Statements NET PERCEPTIONS, INC. 
 CONSOLIDATED BALANCE SHEETS  March 31,
    
    December 31,2004
    
    2003(Unaudited)AssetsCurrent assets:Cash and cash equivalents
    
    $
    13,004
    
    
    $
    11,932Accounts receivable, net
    
    
    35
    
    
    
    355Prepaid expenses and other current assets
    
    
    223
    
    
    
    481Total current assets
    
    
    13,262
    
    
    
    12,768Other assets
    
    
    35
    
    
    
    35Total assets
    
    $
    13,297
    
    
    $
    12,803Liabilities and Stockholders EquityCurrent liabilities:Accounts payable
    
    $
    240
    
    
    $
    Accrued liabilities
    
    
    139
    
    
    
    751Deferred revenue
    
    
    259
    
    
    
    380Accrued restructuring costs
    
    
    18
    
    
    
    37Total current liabilities
    
    
    656
    
    
    
    1,168Total liabilities
    
    
    656
    
    
    
    1,168Commitments and contingenciesStockholders equity:Common stock
    
    
    2
    
    
    
    2Additional paid-in capital
    
    
    233,789
    
    
    
    233,761Accumulated deficit
    
    
    (221,150
    )
    
    
    (222,128
    )Total stockholders equity
    
    
    12,641
    
    
    
    11,635Total liabilities and stockholders equity
    
    $
    13,297
    
    
    $
    12,803
 See accompanying notes to the consolidated financial statements. 3




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NET PERCEPTIONS, INC. 
 CONSOLIDATED STATEMENTS OF OPERATIONS  Three Months EndedMarch 31,2004
    
    2003Revenues:Product
    
    $
    354
    
    
    $
    138Service and maintenance
    
    
    146
    
    
    
    478Total revenues
    
    
    500
    
    
    
    616Cost of revenues:Product
    
    
    
    
    
    
    Service and maintenance
    
    
    102
    
    
    
    216Total cost of revenues
    
    
    102
    
    
    
    216Gross Margin
    
    
    398
    
    
    
    400Operating expenses:Sales and marketing
    
    
    
    
    
    
    706Research and development
    
    
    250
    
    
    
    665General and administrative
    
    
    1,028
    
    
    
    436Gain on sale of patents
    
    
    (1,800
    )
    
    
    Restructuring related charges
    
    
    (7
    )
    
    
    1,200Total operating expenses
    
    
    (529
    )
    
    
    3,007Operating income (loss)
    
    
    927
    
    
    
    (2,607
    )Other income (expense):Interest income
    
    
    26
    
    
    
    216Other income (expense)
    
    
    25
    
    
    
    (8
    )Total other income, net
    
    
    51
    
    
    
    208Net income (loss)
    
    $
    978
    
    
    $
    (2,399
    )Net income (loss) per share:Basic
    
    $
    0.03
    
    
    $
    (0.09
    )Diluted
    
    $
    0.03
    
    
    $
    (0.09
    )Shares used in computing basic
and diluted net income (loss)
per share:Basic
    
    
    28,206
    
    
    
    27,365Diluted
    
    
    28,641
    
    
    
    27,365
 See accompanying notes to the consolidated financial statements. 4




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NET PERCEPTIONS, INC. 
 CONSOLIDATED STATEMENTS OF CASH FLOWS  Three Months EndedMarch 31,2004
    
    2003Cash flows from operating activities:Net income (loss)
    
    $
    978
    
    
    $
    (2,399
    )Reconciliation of net income (loss) to net cash used in operating
activities:Gain on sale of patents
    
    
    (1,800
    )
    
    
    Depreciation and amortization
    
    
    
    
    
    
    274Provision for (recovery of) doubtful accounts
    
    
    (25
    )
    
    
    6Restructuring related charges
    
    
    
    
    
    
    1,200Amortization of premiums on investments
    
    
    
    
    
    
    77Changes in assets and liabilities:Accounts receivable
    
    
    345
    
    
    
    247Prepaid expenses and other assets
    
    
    258
    
    
    
    49Accounts payable
    
    
    240
    
    
    
    (50
    )Accrued expenses and other liabilities
    
    
    (631
    )
    
    
    (880
    )Deferred revenue
    
    
    (121
    )
    
    
    71Other long-term liabilities
    
    
    
    
    
    
    (9
    )Net cash used in operating activities
    
    
    (756
    )
    
    
    (1,414
    )Cash flows from investing activities:Proceeds from sale of patents
    
    
    1,800
    
    
    
    Purchases of short-term investments
    
    
    
    
    
    
    (16,121
    )Sales and maturities of short-term investments
    
    
    
    
    
    
    8,000Net cash provided by (used in) investing activities
    
    
    1,800
    
    
    
    (8,121
    )Cash flows from financing activities:Proceeds from exercise of stock options, net of stock repurchases
    
    
    28
    
    
    
    68Proceeds from issuance of stock under employee stock purchase plan
    
    
    
    
    
    
    Net cash provided by financing activities
    
    
    28
    
    
    
    68Net increase (decrease) in cash and cash equivalents
    
    
    1,072
    
    
    
    (9,467
    )Cash and cash equivalents at beginning of period
    
    
    11,932
    
    
    
    39,729Cash and cash equivalents at end of period
    
    $
    13,004
    
    
    $
    30,262
 See accompanying notes to the consolidated financial statements. 5




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NET PERCEPTIONS, INC. 
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts) Note 1. Basis of Presentation In the opinion of management, the accompanying unaudited financial
statements contain all adjustments necessary to fairly present the Companys
financial position, results of operations and cash flows for the periods
presented. These adjustments consist of normal, recurring items. The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts therein. Due to the
inherent uncertainty involved in making estimates, actual results in future
periods may differ from those estimates. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted. These financial statements should
be read in conjunction with the Companys financial statements and notes
thereto for the year ended December 31, 2003, which are contained in the
Companys Annual Report on Form 10-K filed with the Securities and Exchange
Commission on April 13, 2004. The results of operations for the interim periods
presented are not necessarily indicative of results that may be expected for
any other interim period or for the full fiscal year. The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries. All significant inter-company accounts and
transactions have been eliminated. The Company views its operations and
manages its business as one segment, the development and marketing of computer
software and related services. Factors used to identify the Companys single
operating segment include the organizational structure of the Company and the
financial information available for evaluation by the chief operating decision
maker in making decisions about how to allocate resources and assess
performance. In addition, the Company does not allocate operating expenses to
any segments nor does it allocate specific assets to any segments. Therefore,
segment information is identical to the consolidated balance sheet and
consolidated statement of operations. Accumulated other comprehensive income (loss) consists entirely of
unrealized gain (loss) on available-for-sale investments. Changes in unrealized
gain (loss) on available-for-sale investments were $0 and $(2) during first
quarter of 2004 and 2003, respectively. Comprehensive income equaled net income
for the three months ended March 31, 2004. Comprehensive loss was $2,401 for
the three months ended March 31, 2003. Note 2. Stock-based compensation In December 2002, the FASB issued SFAS 148, Accounting for Stock-Based
CompensationTransition and Disclosure, an Amendment to FASB Statement No.
123. The Company has chosen to continue with its current practice of applying
the recognition and measurement principles of Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees. The Company has
adopted the disclosure requirements of SFAS No. 148 in its discussion of
stock-based employee compensation but the alternative transition options made
available by the standard have not been implemented. The intrinsic value method is used to account for stock-based compensation
plans. If compensation expense had been determined based on the fair value
method, net income (loss) and net income (loss) per share would have been
adjusted to the pro forma amounts indicated below: 6




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Three Months EndedMarch 31,2004
    
    2003Net income (loss), as reported
    
    $
    978
    
    
    $
    (3,472
    )Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards
    
    
    (62
    )
    
    
    (485
    )Pro forma net income (loss)
    
    $
    916
    
    
    $
    (2,884
    )Net income (loss) per share:BasicAs reported
    
    $
    0.03
    
    
    $
    (0.13
    )Pro forma
    
    $
    0.03
    
    
    $
    (0.11
    )DilutedAs reported
    
    $
    0.03
    
    
    $
    (0.09
    )Pro forma
    
    $
    0.03
    
    
    $
    (0.11
    )
 Note 3. Per Share Data Basic earnings per share is computed using net income (loss) and the
weighted average number of common shares outstanding. Diluted earnings per
share reflects the weighted average number of common shares outstanding plus
any potentially dilutive shares outstanding during the period. Potentially
dilutive shares consist of shares issuable upon the exercise of stock options.
Shares used in the diluted net income (loss) per share for the three months
ended March 31, 2004 and March 31, 2003, exclude the impact of 289 and 2,499
potential common shares from exercise of stock options, respectively, which
were anti-dilutive. Three Months EndedMarch 31,2004
    
    2003Basic earnings per share calculation:Net income (loss)
    
    $
    978
    
    
    $
    (2,399
    )Weighted average common shares  basic
    
    
    28,206
    
    
    
    27,365Basic net income (loss) per share
    
    $
    0.03
    
    
    $
    (0.09
    )Diluted earnings per share calculation:Net income (loss)
    
    $
    978
    
    
    $
    (2,399
    )Weighted average common shares  basic
    
    
    28,206
    
    
    
    27,365Effect of dilutive stock options
    
    
    435
    
    
    
    Weighted average common shares  diluted
    
    
    28,641
    
    
    
    27,365Diluted net income (loss) per share
    
    $
    0.03
    
    
    $
    (0.09
    )
 7




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Note 4. Restructuring Related Charges and Impairments During 2003, 2002 and 2001, the Company instituted certain restructuring
plans to better align its cost structure with its business outlook and general
economic conditions. Under the restructuring plans, the Company recorded
restructuring related charges totaling $2,300, $768 and $15,600 during 2003,
2002 and 2001, respectively. In March 2001 the Company reduced its workforce by approximately 46%, or
124 positions throughout the organization, and recorded a charge of $13,920 to
reorganize the Company and exit certain facilities in various United States and
international locations. This $13,920 charge included $10,200 related to
facility consolidation, $1,190 of employee termination costs and $2,530 of
losses on the disposal of assets and other restructuring charges. During the
third quarter of 2001, the Company reduced its workforce by 45 employees and
recorded an additional $1,771 restructuring related charge. This $1,771 charge
included $878 for estimated losses on the disposal of fixed assets, $449 for
leasehold write-offs related to facility consolidation and $444 for employee
severance payments. During the fourth quarter of 2001, the total restructuring
charge was decreased by $140 to reflect the actual costs of exiting certain
marketing activities in connection with the restructuring. In the first quarter of 2002 the Company further reduced its workforce by
15% or 15 positions, and recorded $367 in related employee termination costs.
During the second quarter of 2002 the Company recorded restructuring related
charges of $401, of which $139 related to employee termination costs due to a
reduction in workforce by 18 positions or 21%, $291 represented the write-down
of certain fixed assets and $(29) was a reversal of previously recorded
restructuring related charges resulting from revised estimates of other costs. The Company recorded restructuring related charges of $1,200 in the first
quarter of 2003 related primarily to the closure of operations in three
satellite offices, employee termination costs due to a reduction of workforce
by 22 positions and $413 for estimated losses on the disposal of fixed assets.
The Company recorded additional restructuring related charges of $1,051 in the
third quarter of 2003 related primarily to the termination of three real estate
lease agreements, and employee termination costs due to a reduction of
workforce by 12 positions. The aggregate cash payments for the lease
terminations were approximately $5.4 million. The Companys remaining commitments as of March 31, 2004 consisted
primarily of obligations under one operating lease. The following table
summarizes this contractual lease obligation as of March 31, 2004: 2004Operating leases
    
    $
    33Executed sublease agreements
    
    
    (15
    )Net contractual cash obligation
    
    $
    18
 The operating lease obligation relates to one remaining vacated facility
in San Francisco, CA, the majority of which is sublet. The Company currently
occupies approximately 1,500 square feet of office space pursuant to a
month-to-month lease in Edina, Minnesota. The following table presents a summary of the restructuring related
activities and accrued restructuring charges as of March 31, 2004: 8




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Employee
    
    
    
    
    
    FixedLease
    
    Severance
    
    
    
    
    
    AssetCommitments
    
    and
    
    
    
    
    
    Disposalsand Related
    
    Termination
    
    
    
    
    
    and OtherItems
    
    Costs
    
    Subtotal
    
    Costs
    
    TotalRestructuring Related Charges and Impairments Net of Reversal
    
    $
    10,649
    
    
    $
    1,634
    
    
    $
    12,283
    
    
    $
    3,268
    
    
    $
    15,551Restructuring Payments
    
    
    (2,233
    )
    
    
    (1,523
    )
    
    
    (3,756
    )
    
    
    (195
    )
    
    
    (3,951
    )Sublease Income and proceeds from the Sale of Fixed Assets
    
    
    280
    
    
    
    
    
    
    
    280
    
    
    
    261
    
    
    
    541Non-Cash Asset Disposals and Deferred Rent Write-Off
    
    
    (1,800
    )
    
    
    
    
    
    
    (1,800
    )
    
    
    (2,908
    )
    
    
    (4,708
    )Accrued Restructuring as of December 31, 2001
    
    $
    6,896
    
    
    $
    111
    
    
    $
    7,007
    
    
    $
    426
    
    
    $
    7,433Restructuring Related Charges and Impairments
    
    
    
    
    
    
    506
    
    
    
    506
    
    
    
    262
    
    
    
    768Restructuring Payments
    
    
    (4,024
    )
    
    
    (547
    )
    
    
    (4,571
    )
    
    
    (66
    )
    
    
    (4,637
    )Sublease Income and Proceeds from the Sale of Fixed Assets
    
    
    1,299
    
    
    
    
    
    
    
    1,299
    
    
    
    68
    
    
    
    1,367Non Cash Asset Disposals
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (642
    )
    
    
    (642
    )Reclassification of Accrued Lease Exit Costs
    
    
    383
    
    
    
    
    
    
    
    383
    
    
    
    
    
    
    
    383Accrued Restructuring as of December 31, 2002
    
    $
    4,554
    
    
    $
    70
    
    
    $
    4,624
    
    
    $
    48
    
    
    $
    4,672Restructuring Related Charges and Impairments
    
    
    1,249
    
    
    
    589
    
    
    
    1,838
    
    
    
    413
    
    
    
    2,251Restructuring Payments
    
    
    (8,094
    )
    
    
    (652
    )
    
    
    (8,746
    )
    
    
    (51
    )
    
    
    (8,797
    )Sublease Income and Proceeds from the Sale of Fixed Assets
    
    
    1,832
    
    
    
    
    
    
    
    1,832
    
    
    
    165
    
    
    
    1,997Non Cash Asset Disposals and Deferred Rent Write-Off
    
    
    489
    
    
    
    
    
    
    
    489
    
    
    
    (575
    )
    
    
    (86
    )Accrued Restructuring as of December 31, 2003
    
    $
    30
    
    
    $
    7
    
    
    $
    37
    
    
    $
    
    
    
    $
    37Restructuring Related Reversal
    
    
    
    
    
    
    (7
    )
    
    
    (7
    )
    
    
    
    
    
    
    (7
    )Restructuring Payments
    
    
    (12
    )
    
    
    
    
    
    
    (12
    )
    
    
    
    
    
    
    (12
    )Accrued Restructuring as of March 31, 2004
    
    $
    18
    
    
    $
    
    
    
    $
    18
    
    
    $
    
    
    
    $
    18
 Note 5. Commitments and Contingencies Litigation On November 2, 2001, Timothy J. Fox filed a purported class action lawsuit
against the Company, FleetBoston Robertson Stephens, Inc., the lead underwriter
of the Companys April 1999 initial public offering, several other underwriters
who participated in the initial public offering, Steven J. Snyder, the
Companys then president and chief executive officer, and Thomas M. Donnelly,
the Companys chief financial officer. The lawsuit was filed in the United
States District Court for the Southern District of New York and has been
assigned to the judge who is also the pretrial coordinating judge for
substantially similar lawsuits involving more than 300 other issuers. An
amended class action complaint, captioned In re Net Perceptions, Inc. Initial
Public Offering Securities Litigation,01 Civ. 9675 (SAS), was filed on April
22, 2002, expanding the basis for the action to include allegations relating to
the Companys March 2000 follow-on public offering in addition to those
relating to its initial public offering. The amended complaint generally alleges that the defendants violated
federal securities laws by not disclosing certain actions taken by the
underwriter defendants in connection with the Companys initial public offering
and follow-on public offering. The amended complaint alleges specifically that
the underwriter defendants, with the Companys direct participation and
agreement and without disclosure thereof, conspired to and did raise and
increase their underwriters compensation and the market prices of the
Companys common stock following its initial public offering and in its
follow-on public offering by requiring their customers, in exchange for
receiving allocations of shares of the Companys common stock sold in its
initial public offering, to pay excessive commissions on transactions in other
securities, to purchase additional shares of the Companys common stock in the
initial public offering aftermarket at pre-determined prices above the initial
public offering price, and to purchase shares of the Companys common stock in
its follow-on public offering. The amended complaint seeks unspecified monetary
damages and certification of a plaintiff class consisting of all persons who
acquired the Companys common stock between April 22, 1999 and December 6,
2000. The plaintiffs have since agreed to dismiss the claims against Mr. Snyder
and Mr. Donnelly without prejudice, in return for their agreement to toll any
statute of limitations applicable to those claims; and those claims have been
dismissed without prejudice. On July 15, 2002, all of the issuer defendants
filed a joint motion to dismiss the plaintiffs claims in all of the related
cases. On February 19, 2003, the court ruled against the Company on this
motion. 9




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A special committee of the Companys board of directors has authorized the
Company to negotiate a settlement of the pending claims substantially
consistent with a memorandum of understanding negotiated among class
plaintiffs, issuer defendants and their insurers. Any such settlement would be
subject to approval by the court. The Company believes that the allegations against it are without merit.
However, the Company is unable to predict the outcome or ultimate effect of
this litigation. On October 29, 2003, a purported class action lawsuit was filed against
the Company, its current directors and unnamed defendants in the District
Court, Fourth Judicial District, of the State of Minnesota, County of Hennepin
captioned Don Blakstad, on Behalf of Himself and All others Similarly Situated,
vs. Net Perceptions, Inc., John F. Kennedy, Ann L. Winblad, John T. Riedl and
Does 1-25, inclusive,File No. 03-17820. The complaint alleged, among other
things, that defendants breached their fiduciary duties of loyalty, due care,
independence, good faith and fair dealing and sought to enjoin the proposed
liquidation of the Company and to recover reasonable attorneys and experts
fees. On November 24, 2003, defendants filed a motion to dismiss the lawsuit,
and by order dated March 8, 2004, the court dismissed the complaint with
prejudice. By letter dated March 9, 2004, the plaintiff requested the courts
permission to file a motion to reconsider the decision dismissing the complaint
with prejudice. On March 18, 2004, the court denied the plaintiffs request. On
April 9, 2004, the plaintiff filed a notice of appeal and statement of the case
with the Court of Appeals of the State of Minnesota and, on April 22, 2004,
defendants filed their statement of the case with the Court of Appeals.
Defendants continue to believe that the claims in this lawsuit are without
merit, and are in fact moot, and intend to continue to vigorously defend them
during this appeals process. Contingencies As permitted under Delaware law, the Company has agreements whereby it
indemnifies its officers and directors for certain events or occurrences while
the officer or director is, or was serving, at its request in such capacity.
The term of the indemnification period is for the officers or directors
lifetime. The maximum potential amount of future payments the Company could be
required to make under these indemnification agreements is unlimited; however,
the Company has insurance that limits its exposure and enables the Company to
recover a portion of any future amounts paid. As a result of the insurance
coverage, the Company believes the estimated fair value of these
indemnification agreements is minimal. All of these indemnification agreements
were grandfathered under the provisions of FIN No. 45 as they were in effect
prior to December 31, 2002. Accordingly, the Company believes the liability for
these agreements as of March 31, 2004 is not material. In the past, the Company entered into standard indemnification agreements
from time to time in the ordinary course of its business. Pursuant to these
agreements, the Company indemnifies, holds harmless, and agrees to reimburse
the indemnified party for losses suffered or incurred by the indemnified party,
which is generally the business partner or customer, in connection with any
U.S. patent, or any copyright or other intellectual property infringement claim
by any third party with respect to the use of the Companys products. The term
of these indemnification agreements is generally perpetual. The maximum
potential amount of future payments the Company could be required to make under
these indemnification agreements is unlimited. The Company has never incurred
any costs to defend lawsuits or settle claims related to these indemnification
agreements. As a result, the Company believes the estimated fair value of
these agreements is minimal. Accordingly, the Company believes the liability
for these agreements as of March 31, 2004 is not material. Note 6. Income Taxes For federal income tax purposes, the Company has available federal net
operating loss carry-forwards of approximately $119,000 and research and
development credit carry-forwards of $151 at December 31, 2003. The net
operating loss and research and development credit carry-forwards expire in
2011 through 2022 if not previously utilized. The utilization of these
carry-forwards may be subject to limitations based on past and future changes
in ownership of the Company pursuant to Internal Revenue Code Section 382. A
sale of the Company at this time may result in a substantial limitation to
these net operating loss carry-forwards under Internal Revenue Code Section
382. Future tax benefits have not been recognized in the financial statements,
as their utilization is considered uncertain based on the weight of available
information. Note 7. Recently Issued Accounting Pronouncements In January 2003, the FASB issued Interpretation No. (FIN) 46,
Consolidation of Variable Interest Entities, an Interpretation of Accounting
Research Bulletin No. 51. FIN No. 46 requires certain variable interest
entities, or VIEs, 10




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to be consolidated by the primary beneficiary of the entity if the equity
investors in the entity do not have the characteristics of a controlling
financial interest, or do not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support from
other parties. In December 2003, the FASB issued FIN No. 46-R, Consolidation
of Variable Interest Entities, which represents a revision to FIN No. 46. The
provisions of FIN No. 46-R are effective for interests in VIEs as of the first
interim or annual period ending after December 15, 2003. The Company currently
has no contractual relationship or other business relationship with a variable
interest entity and therefore the adoption of FIN No. 46 and FIN No. 46-R did
not have a material effect on its consolidated financial position, results of
operations or cash flows. Note 8. Gain on Sale of Patents On March 31, 2004, the Company completed the sale of its patent portfolio
to Thalveg Data Flow LLC for $1,800 pursuant to a patent purchase agreement
entered into on December 30, 2003 and amended on March 31, 2004. The patent
purchase agreement includes a royalty-free, non-exclusive license back to the
Company. The license is transferable, subject to certain restrictions
applicable to the transferee relating to revenues that can be generated by
products covered by the license. Note 9. Subsequent Events On April 21, 2004, the Company announced the simultaneous signing and
closing of a strategic investment into the Company by Olden Acquisition LLC
(Olden), an affiliate of Kanders & Company, Inc., for the purpose of
initiating a strategy to redeploy the Companys assets and use its cash and
cash equivalent assets to enhance stockholder value. As part of the Companys
asset redeployment strategy, the Company will attempt to sell or otherwise
dispose of the remaining assets used in its historical operating business. The
Company issued and sold to Olden a 2% ten-year Convertible Subordinated Note,
which is convertible after one year (or earlier upon a call by the Company and
in certain other circumstances) at a conversion price of $0.45 per share of the
Companys common stock into approximately 19.9% of the outstanding common
equity of the Company as of the closing date. Proceeds to the Company from
this transaction totaled approximately $2.5 million before transaction
expenses. Interest on the note accrues semi-annually but is not payable
currently or upon conversion of the note. In addition, on April 21, 2004, the Companys board of directors voted to
increase its size from three to four members. Ann Winblad resigned as a
director and Warren B. Kanders and Nicholas Sokolow were appointed to fill the
vacancies, so that the Board is now comprised of the two new directors and John
F. Kennedy and John T. Riedl. In addition, Mr. Kanders was appointed as the
Executive Chairman of the Board and Nigel P. Ekern was appointed as Chief
Administrative Officer and Secretary to oversee the Companys operations and to
assist with the Companys asset redeployment strategy. Effective April 21,
2004, Thomas M. Donnelly resigned as the Companys President. Effective upon
the filing with the Securities and Exchange Commission of this Quarterly Report
on Form 10-Q, Mr. Donnelly will resign as Chief Financial Officer and
Treasurer, at which time he will receive severance payments in accordance with
a separation agreement with the Company. Mr. Donnelly will continue to serve
as a part-time consultant for a limited transition period. In connection with this transaction, the Company also entered into a
Registration Rights Agreement, which requires the Company, upon request of the
purchaser of the note or its assignee, to register under the Securities Act of
1933, as amended, the resale of the shares of common stock into which the note
is convertible. Also in connection with this transaction, the board of directors adopted
an amendment to the Companys Rights Agreement such that the transaction would
not trigger the rights thereunder. 11




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Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations Special Note Regarding Forward-Looking Statements This Quarterly Report on Form 10-Q (including exhibits and information
incorporated by reference herein) contains both historical and forward-looking
statements that involve risks, uncertainties and assumptions. The statements
contained in this report that are not purely historical are forward-looking
statements within the meaning of Section 21E of the Securities Exchange Act of
1934, as amended, including statements regarding our expectations, beliefs,
intentions or strategies for the future. All forward-looking statements
included in this Quarterly Report on Form 10-Q (including exhibits and
information incorporated by reference herein) are based on information
available to us on the date hereof, and we assume no obligation to update any
such forward-looking statements. Our actual results and actual events could
differ materially from those described in our forward-looking statements.
Factors that could cause or contribute to such differences include, but are not
limited to, those discussed in Item 2 of this report (Managements Discussion
and Analysis of Financial Condition and Results of Operations) under the
heading Risk Factors That May Affect Our Future Results and those described
in our previous filings with the Securities and Exchange Commission. Readers
are cautioned not to place undue reliance on these forward-looking statements,
which speak only as of the date that they were made. We undertake no obligation
to publicly release any revisions to these forward-looking statements to
reflect events or circumstances after the date of this Quarterly Report on Form
10-Q or to reflect the occurrence of unanticipated events. References in this Quarterly Report on Form 10-Q to Net Perceptions, the
Company, we, our and us refer to Net Perceptions, Inc. and, if so
indicated or the context so requires, includes our wholly owned subsidiary
Knowledge Discovery One, Inc. (which we refer to in this report as KD1). On
September 9, 2003, KD1 was merged with and into the Company. OVERVIEW The following discussion and analysis should be read in conjunction with
the consolidated financial statements and notes thereto appearing elsewhere in
this report. We were incorporated in Delaware in July 1996, and our initial product was
shipped in January 1997. From inception through late 2000, we expanded our
organization by hiring personnel in key areas, particularly marketing, sales
and research and development. Our total number of employees was 315 on December
31, 2000. During 2001, 2002 and 2003, we instituted certain restructuring plans
to align our cost structure with our business outlook and general economic
conditions. In connection with our restructuring activities, our total number
of employees was reduced to 98 as of December 31, 2001, 52 as of December 31,
2002, and 9 as of December 31, 2003. As of May 7, 2004, the Company has four
employees, three of whom are executive officers. We have sustained losses on an annual basis since inception. As of March
31, 2004, we had an accumulated deficit of $221 million. Our net loss was $5.3
million for the year ended December 31, 2003, compared to a net loss of $16.7
million in the prior year. The losses referred to in this paragraph resulted
from costs incurred in the development and marketing of our products and
services, significant costs incurred related to restructuring activities,
significant costs for outside professional services related to the exploration
of various strategic alternatives for the Company, as well as a decline in our
revenues since the third quarter of 2000. In February 2003, we engaged Piper Jaffray to act as our financial advisor
in connection with the potential sale of the Company. On September 2, 2003, we
paid a return of capital cash distribution to stockholders of record as of
August 18, 2003 in the amount of $1.50 per share or a total of approximately
$42.2 million, which was reflected as a reduction to additional paid-in
capital. We also reduced our workforce by twelve positions to ten full-time
employees. In addition, as a result of the cash distribution paid on September
2, 2003, our board of directors approved an adjustment to our outstanding
options that took effect on the close of business on September 3, 2003. The
adjustment was to in no event reduce the exercise price of any options to less
than $0.01 per share or increase the number of shares subject to such options
to a number exceeding the number of shares of common stock that are registered
and available for issuance. In accordance with Financial Accounting Standards
Board Interpretation No. 44, Accounting for Certain Transactions Involving
Stock Compensation  an Interpretation of APB No. 25, there was no accounting
consequence due to the changes made to the exercise price or the number of
shares other than future potential dilution to stockholders because the
aggregate intrinsic value of each award immediately after the 12




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change was not greater than the aggregate intrinsic value of the award
immediately before the change and the ratio of the exercise price per share to
the market value per share was not reduced. On October 21, 2003, we announced that our board of directors had
unanimously approved a Plan of Complete Liquidation and Dissolution, referred
to as the plan of liquidation. The plan of liquidation was submitted to the
Companys stockholders for approval and adoption at a special meeting of
stockholders originally scheduled for March 12, 2004, which was adjourned and
was reconvened on March 23, 2004. At the reconvened special meeting, the
proposal to approve and adopt the plan of liquidation did not receive the
affirmative vote of a majority of the 28,145,338 shares of common stock
outstanding as of the record date for the special meeting required to approve
the proposal. Of the 15,773,134 shares represented in person or by proxy at the
reconvened special meeting, 13,810,233 shares voted in favor of the proposal,
1,925,694 shares voted against and 37,207 shares abstained. On March 31, 2004, we and Thalveg Data Flow, LLC, (Thalveg) executed an
amendment to the patent purchase agreement which had been entered into on
December 30, 2003, and we completed the sale of our patent portfolio provided
for therein for a purchase price of $1.8 million in cash. The patent purchase
agreement, as amended, includes a royalty-free, non-exclusive license back to
us. The license is transferable, subject to certain restrictions applicable to
the transferee relating to revenues that can be generated by products covered
by the license. This transaction did not involve any of our other intellectual
property rights or assets, including our proprietary software products. In addition, on March 31, 2004 we announced that we had granted to a
software company a non-exclusive source code license to a portion of the
Companys intellectual property and sold certain technology related to a
product discontinued in 2002. The aggregate consideration for this sale and
license was $325,000. On
April 1, 2004, we entered into an agreement with Tornago Systems, Inc., or
Tornago, a corporation formed by three non-officer former employees, to fulfill
existing prepaid customer support obligations in exchange for future cash
payments of approximately $60,000. This amount represents approximately 60% of
the remaining prepaid deferred maintenance revenue amounts under the existing
end user contracts when measured from April 1, 2004. The Company will continue
to recognize the deferred revenue as earned and the $60,000 will be reflected
as cost of revenue. Under the terms of the agreement, Tornago received a
non-transferable license to relevant intellectual property solely to provide
support and consulting services to end users of our products. Under the
agreement, we will receive a 15% royalty on any follow-on services sold by
Tornago through April 1, 2006. In connection with the agreement with Tornago, we terminated the
employment of the remaining members of our engineering staff, effective March
31, 2004, and paid severance to these employees in accordance with existing
agreements. While we expect to continue to service our existing customers through
Tornago and may continue to derive a declining level of revenues from software
licenses and royalties, software maintenance and professional services relating
to existing customers, we are no longer actively marketing or directly
supporting our products and have not retained any employees to do so. We expect
that the size of our customer base will decline and we do not expect that
future product or service revenues, if any, will be significant. We anticipate
that our operating expenses will continue to decline in 2004, but will continue
to constitute a material use of our cash resources. We expect to incur
additional losses and continued negative cash flow for the foreseeable future.
While we reported a net profit for the first quarter of 2004 due to the Thalveg
transaction, we do not expect to generate an operating profit for 2004 or the
foreseeable future. Our ability to become profitable will depend, among other
things, on our identification and acquisition of a new operating business and
the success of that business. RECENT DEVELOPMENTS On April 21, 2004, we announced the simultaneous signing and closing of a
strategic investment into the Company by Olden Acquisition LLC (Olden), an
affiliate of Kanders & Company, Inc., for the purpose of initiating a strategy
to redeploy our assets and use our cash and cash equivalent assets to enhance
stockholder value. As part of our asset redeployment strategy, we will attempt
to sell or otherwise dispose of the remaining assets used in our historical
operating business. We issued and sold to Olden a 2% ten-year Convertible
Subordinated Note, which is convertible after one year (or earlier upon a call
by the Company and in certain other circumstances) at a conversion price of
$0.45 per share of Company common stock into approximately 19.9% of the
outstanding common equity of Net Perceptions as of the closing date. Proceeds
to the Company from this transaction totaled approximately $2.5 million before
transaction expenses. Interest on the note accrues semi-annually but is not
payable currently or upon conversion of the note. 13




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In addition, on April 21, 2004, our board of directors voted to increase
its size from three to four members. Ann Winblad resigned as a director and
Warren B. Kanders and Nicholas Sokolow were appointed to fill the vacancies, so
that the Board is now comprised of the two new directors and John F. Kennedy
and John T. Riedl. In addition, Mr. Kanders was appointed as the Executive
Chairman of the Board and Nigel P. Ekern was appointed as Chief Administrative
Officer and Secretary to oversee our operations and to assist with our asset
redeployment strategy. Effective April 21, 2004, Thomas M. Donnelly resigned
as our President. Effective upon the filing with the Securities and Exchange
Commission of this Quarterly Report on Form 10-Q, Mr. Donnelly will resign as
Chief Financial Officer and Treasurer, at which time he will receive severance
payments in accordance with a separation agreement with the Company. Mr.
Donnelly will continue to serve as a part-time consultant for a limited
transition period. As part of our asset redeployment strategy, we are currently working to
identify suitable merger or acquisition opportunities that can serve as a
platform for future growth. Although we are not targeting specific business
industries for potential mergers or acquisitions, we plan to seek businesses
with cash flow, experienced management teams, and operations in markets
offering stability and growth potential. In addition, we believe that our
common stock, which is publicly traded on the NASDAQ Small Cap Market, offers us flexibility as acquisition
currency and will enhance our attractiveness to potential merger partners or
acquisition candidates. Period-to-period comparisons of our operating results should not be relied
upon as predictive of future performance. Our prospects must be considered in
light of the foregoing and the risks identified below under the heading
Factors That May Affect Our Future Results. We may not be successful in
addressing these risks. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Our discussion and analysis of financial condition and results of
operations is based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. On an on-going basis, we evaluate our estimates, including
those related to bad debts, investments, intangible assets, restructuring
liabilities, contingencies and litigation. We base our estimates on historical
experience and on various other assumptions that are believed to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions. We believe the following critical accounting policies affect significant
judgments and estimates used in the preparation of our consolidated financial
statements. Events occurring subsequent to the preparation of the consolidated
financial statements, such as those described in the section of this report
entitled Managements Discussion and Analysis of Financial Condition and
Results of Operations  Overview, may cause us to re-evaluate these policies. Revenue Recognition.Our revenues are recognized in accordance with the
American Institute of Certified Public Accountants Statement of Position
(SOP) 97-2, Software Revenue Recognition, as amended by SOP 98-4 and SOP
98-9, as well as Technical Practice Aids issued from time to time by the
American Institute of Certified Public Accountants and in accordance with the
Securities and Exchange Commission Staff Accounting Bulletin (SAB) No. 104,
Revenue Recognition in Financial Statements. We derive revenues from software
licenses, software maintenance and professional services. Maintenance includes
telephone and Web-based technical support, bug fixes and rights to unspecified
upgrades on a when-and-if available basis. Professional services include
project planning, implementation and testing, consulting, and ongoing customer
support. For software arrangements that include multiple software products,
maintenance or services, we allocate the total arrangement fee using the
residual method. Under the residual method, the fair value of the undelivered
maintenance and services elements, as determined by vendor-specific objective
evidence, is deferred and the remaining (residual) arrangement fee is
recognized as software product revenue. For software arrangements in which we
do not have vendor-specific objective evidence of undelivered elements, revenue
is deferred until the earlier of when vendor-specific objective evidence is
determined for the undelivered elements or when all elements for which we do
not have vendor-specific objective evidence have been delivered. 14




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Revenues from license fees are recognized when a non-cancelable agreement
has been executed, the product has been shipped or electronically delivered,
there are no uncertainties surrounding product acceptance, the fee is fixed or
determinable and collection of the related receivable is considered probable.
If the fee due from the customer is not fixed or determinable, revenues are
recognized as payments become due from the customer. If we do not consider
collection to be probable, then revenues are recognized when the fee is
collected. License revenues related to license terms of less than twenty-four months
are recognized ratably over the term of the license period. When we offer
products and services on a hosted basis, up front set-up fees are deferred and
recognized ratably over the estimated service period. We recognize revenues allocable to maintenance ratably over the term of
the agreement. We evaluate arrangements that include professional and/or data
processing services to determine whether those services are essential to the
functionality of other elements of the arrangement. If services are considered
essential, revenues from the arrangement are recognized using contract
accounting, generally on a percentage-of-completion basis. When we do not
consider the professional services to be essential, we recognize the revenues
allocable to the services as they are performed. Revenue recognition rules for software companies are very complex. We
follow specific and detailed guidelines in determining the proper amount of
revenue to be recorded; however, certain judgments affect the application of
our revenue recognition policy. The most significant judgments for revenue recognition typically involve
whether there are any significant uncertainties regarding customer acceptance
and whether collectibility can be considered probable. In addition, our
transactions often consist of multiple element arrangements that must be
analyzed to determine the relative fair value of each element, the amount of
revenue to be recognized upon shipment, if any, and the period and conditions
under which deferred revenue should be recognized. Litigation.We have not recorded an estimated liability related to the
pending class action lawsuit related to our initial and follow-on public
offerings in which we are named. For a discussion of this matter, see the
section of this report entitled Legal Proceedings. Due to the uncertainties
related to both the likelihood and the amount of any potential loss, no
estimate was made of the liability that could result from an unfavorable
outcome. As additional information becomes available, we will assess the
potential liability and make or revise our estimate(s) accordingly, which could
materially impact our results of operations and financial position. RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2004 AND MARCH 31,
2003 The following table sets forth certain items in the Companys consolidated
statements of operations as a percentage of total revenues for the periods
indicated: 15




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Three Months EndedMarch 31,2004
    
    2003Revenues:Product
    
    
    71
    %
    
    
    22
    %Service and maintenance
    
    
    29
    
    
    
    78Total revenues
    
    
    100
    
    
    
    100Cost of revenues:Product
    
    
    
    
    
    
    Service and maintenance
    
    
    20
    
    
    
    35Total cost of revenues
    
    
    20
    
    
    
    35Gross Margin
    
    
    80
    
    
    
    65Operating expenses:Sales and marketing
    
    
    
    
    
    
    115Research and development
    
    
    50
    
    
    
    108General and administrative
    
    
    205
    
    
    
    71Gain on sale of patent rights
    
    
    (360
    )Restructuring related charges
    
    
    (1
    )
    
    
    195Total operating expenses
    
    
    (106
    )
    
    
    489Operating income (loss)
    
    
    186
    
    
    
    (424
    )Other income, net:
    
    
    10
    
    
    
    34Net loss
    
    
    196
    %
    
    
    (390
    )%
 REVENUES Total revenues. Total revenues decreased 19% to $500,000 for the three
months ended March 31, 2004, from $616,000 for the same period in 2003.
Revenues from sales in the United States were $462,000 in the first quarter of
2004 compared to $541,000 in the same period of 2003, representing 92% and 88%
of total revenues respectively. Revenues from international sales in the first
quarter of 2004 were $38,000, or 8% of total revenues, compared to $75,000, or
12% of total revenues in the same period of 2003. As a result of the downsizing
of our business and operations, we no longer maintain a direct sales force.
International sales have generally been denominated in United States dollars. As described in this Item 2 under Overview, we are no longer actively
marketing our products, and we do not expect that future revenues from these
products or services related to these products, if any, will be significant. Product revenues. Product revenues increased 157% to $354,000 for the
three months ended March 31, 2004, compared to $138,000 for the same period of
2003. Product revenues comprised 71% of total revenues for the first quarter of
2004 compared to 22% for the same period of 2003. The increase in product
revenues is primarily attributable to a single transaction where we granted a
software company a non-exclusive source code license to a portion of our
intellectual property and sold certain technology related to a product
discontinued in 2002. The aggregate consideration for this sale and license was
$325,000. We expect limited product revenues for the foreseeable future. Service and maintenance revenues.Service and maintenance revenues consist
primarily of professional and maintenance services. Our professional service
revenues include business consulting, implementation support, and educational
services and are generally offered on a time and materials basis. Maintenance
revenues are generally derived from annual service agreements and are
recognized ratably over the term of the agreement. Service and maintenance
revenues decreased 69% to $146,000 for the quarter ended March 31, 2004 from
$478,000 for the 16




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quarter ended March 31, 2003. Service and maintenance revenues comprised
29% and 78% of total revenues for the quarters ended March 31, 2004 and 2003,
respectively.The decrease in service and maintenance revenues in absolute
dollars reflected lower levels of consulting and maintenance services due to
the combined effect of fewer new customer acquisitions and a decline in our
customer base, as well as customer perceptions about our ability to support our
products in the future. As described in this Item 2 under Overview, we
entered into an agreement on April 1, 2004 with Tornago, Inc. to fulfill our
existing prepaid customer support obligations. We do not anticipate entering
into additional service and maintenance agreements with customers. Therefore,
we expect service and maintenance revenues to continue to decline in 2004. COST OF REVENUES Cost of product revenues. Cost of product revenues consists primarily of
the cost of royalties paid to third-party vendors and amortization of acquired
technology costs. No royalties were payable to third parties and no
amortization expense existed during the periods presented related to intangible
assets which historically represented the costs of product revenues. We do not
expect any future costs of product revenues to be significant. Cost of service and maintenance revenues. Cost of service and maintenance
revenues consists primarily of personnel-related and infrastructure costs
incurred in providing telephone and Web-based support of our software products,
as well as professional, consulting and educational related services to
customers. Cost of service and maintenance revenues decreased 53% to $102,000
for the quarter ended March 31, 2004 from $216,000 for the quarter ended March
31, 2003. Cost of service and maintenance revenue in 2004 and 2003 represented
70%, and 45% of the related service and maintenance revenues, respectively. The
decrease in cost of services and maintenance revenues in absolute dollars and
as a percentage of revenues is primarily due to continued headcount reductions
in our technical organization as a result of our restructuring efforts and
significantly decreased use of third-party consultants to staff consulting
engagements. Due to the further headcount reductions undertaken in August 2003
and thereafter, and, as described above in this Item 2 under Overview,
because we entered into a contract with Tornago to fulfill certain prepaid
support obligations and in connection therewith terminated the employment of
the remaining members of our engineering staff, we expect that our cost of
service and maintenance revenues will continue to decrease in 2004. OPERATING EXPENSES As described in this Item 2 under Overview, we are no longer actively
marketing or directly supporting our products and do not expect to incur
significant operating expenses in 2004 relating to sales and marketing and
research and development. Also as described under Item 2 under Recent
Developments, on April 21, 2004 we announced the simultaneous signing and
closing of a strategic investment into the Company by Olden Acquisition LLC for
the purpose of initiating a strategy to redeploy our assets and use our cash
and cash equivalent assets to enhance stockholder value. As part of our asset redeployment strategy, we are currently working to
identify suitable merger or acquisition opportunities that can serve as a
platform for future growth. Although we are not targeting specific business
industries for potential mergers or acquisitions, we plan to seek businesses
with cash flow, experienced management teams, and operations in markets
offering stability and growth potential. We anticipate that we may incur
significant expenses in connection with this process, consisting principally of
professional fees and expenses, as well as costs associated with maintaining
our public company status. Sales and marketing. Historically, our sales and marketing expenses have
consisted primarily of salaries, other employee-related costs, commissions and
other incentive compensation, travel and entertainment and expenditures for
marketing programs such as collateral materials, trade shows, public relations
and creative services. Sales and marketing expenses decreased 100% to $0 for
the three month period ended March 31, 2004 compared to $706,000 for the three
months ended March 31, 2003. Sales and marketing expenses were 0% and 115% of
total revenues for the three months ended March 31, 2004 and 2003,
respectively. The decrease in sales and marketing expenses in absolute dollars
is primarily due to headcount reductions as a result of our restructuring
efforts and our decision to no longer actively market our products. We expect
sales and marketing expenses will be minimal, if any, for the balance of 2004. Research and development. Research and development expenses consist
primarily of salaries, other employee-related costs and consulting fees related
to the development of our products. Research and development expenses decreased
62% to $250,000 for the three months ended March 31, 2004 compared to $665,000
for the three months ended March 31, 2003. Research and development expenses
were 50%, and 108% of total revenues for the three 17




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months ended March 31, 2004 and 2003, respectively. The decrease in
research and development expenses in absolute dollars is primarily due to
continued headcount reductions as a result of our restructuring efforts. As
described above in this Item 2 under Overview, we terminated the employment
of the remaining members of our engineering staff effective March 31, 2004. We
expect to incur minimal, if any, research and development expenses for the
balance of 2004. General and administrative. General and administrative expenses consist
primarily of salaries, other employee-related costs, provision for doubtful
accounts and professional service fees. General and administrative expenses
increased 134% to $1.0 million for the three months ended March 31, 2003
compared to $436,000 for the three months ended March 31, 2003. General and
administrative expenses were 205% and 71% of total revenue for the three months
ended March 31, 2004 and 2003, respectively. The increase in general and
administrative expenses during the three months ended March 31, 2004 was
primarily due to increased professional fees associated with our continued
exploration and negotiation of asset disposition and license agreements, fees
associated with an unsolicited exchange offer for the Company by Obsidian
Enterprises, Inc., costs associated with our special stockholders meeting to
vote on the plan of liquidation, including in connection with Obsidians proxy
solicitation opposing the plan of liquidation, defense costs associated with
the Blakstad litigation described in Item 1 of Part II of this report, and our
continued consideration and evaluation of strategic alternatives. Although we
expect personnel-related and other general and administrative expenses to
decline in 2004, continued high levels of outside professional fees, and other
costs, such as directors and officers liability insurance, associated with
continuing as a public reporting company, may offset any such decrease. Gain on sale of patents.On March 31, 2004, the Company completed the
sale of its patent portfolio to Thalveg Data Flow LLC for $1.8 million pursuant
to a patent purchase agreement entered into on December 30, 2003 and amended on
March 31, 2004. The patent purchase agreement includes a royalty-free,
non-exclusive license back to the Company. The license is transferable, subject
to certain restrictions applicable to the transferee relating to revenues that
can be generated by products covered by the license. Restructuring related charges and impairments.We recorded restructuring
related charges of $1.2 million in the first quarter of 2003 related primarily
to the closure of operations in three satellite offices, and employee
termination costs due to a reduction of workforce by 22 positions. This
represented 195% of total revenue for the first quarter of 2003. During 2003,
2002 and 2001, we instituted certain restructuring plans to better align our
cost structure with our business outlook and general economic conditions. Under
the restructuring plans, we recorded restructuring related charges totaling
$2.3 million, $768,000 and $15.6 million during 2003, 2002 and 2001,
respectively. Substantially all restructuring related charges had been paid as
of March 31, 2004. Other income, net. Other income, net, consists of interest income,
interest expense, and foreign currency transaction losses or gains. Net other
income decreased 75% for the quarter ended March 31, 2004 to $51,000 from
$208,000 in 2003. The decrease in net other income was primarily due to lower
interest income due to lower cash and investment balances as a result of the
special cash distribution to stockholders on September 2, 2003. PROVISION FOR INCOME TAXES We have incurred significant operating losses from inception through
December 31, 2003. For income tax purposes, the Company has available federal
net operating loss carry-forwards of approximately $119 million and research
and development credit carry-forwards of approximately $151,000 at December 31,
2003. The net operating loss and research and development credit carry-forwards
expire in 2011 through 2023 if not previously utilized. The utilization of
these carry-forwards may be subject to limitations based on past and future
changes in ownership of the Company pursuant to Internal Revenue Code Section
382. If the Company were to be acquired at its recent stock value such that
Section 382 is applicable, this may eliminate the ability to use a substantial
majority of these carry-forwards. Further, if our historic business were not
substantially continued for two years after a Section 382 change in ownership,
the full amount of carry-forwards would be eliminated. Future tax benefits have
not been recognized in the financial statements, as their utilization is
considered uncertain based on the weight of available information. LIQUIDITY AND CAPITAL RESOURCES Since inception, we have financed our operations primarily through the
sale of equity securities. At March 31, 2004, we had $13.0 million of cash,
cash equivalents and short-term investments, compared to $61.5 million at March
31, 2003. This significant reduction was primarily due to the special cash
distribution paid on September 2, 2003 to record holders of our common stock on
August 18, 2003 in the aggregate amount of approximately $42.2 18




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million, the satisfaction of substantially all of our accrued
restructuring obligations and operating losses incurred from March 31, 2003
through March 31, 2004. Cash used in operations was $756,000 for the three months ended March 31,
2004, compared to cash used in operations of $1.4 million for the same period
of 2003. Cash used in operations for the first quarter of 2004 resulted
primarily from net losses, as adjusted for non-cash expenses and the gain on
the sale of patent rights. We do not expect to receive any significant amounts
of cash from our current operations, and we expect that we will continue to
incur legal fees and other ongoing costs that will constitute a material use of
cash. A total of $1.8 million in net cash was provided by investing activities
for the three months ended March 31, 2004, compared to $8.1 million of net cash
used in investing activities in the same period for 2003. Cash provided by
investing activities during the first quarter of 2004 was primarily
attributable to the sale of our patent portfolio to Thalveg as described in
this Item 2 under Overview. Prior to September 2003, our investing
activities consisted primarily of net purchases of short-term investments and
marketable securities. Since the special cash distribution paid on September 2,
2003, we have held all of our cash in money market accounts and we plan to
continue this policy pending implementation of our asset redeployment strategy. Net cash provided in financing activities was $28,000 for the three months
ended March 31, 2004, compared to net cash provided in financing activities of
$68,000 for the three months ended March 31, 2003. Net cash was provided in
financing activities for both periods by proceeds from sales of our common
stock pursuant to the exercise of options. As described in Item 2 under Overview, on September 2, 2003, we paid a
return of capital cash distribution to stockholders of record as of August 18,
2003 in the amount of $1.50 per share, or an aggregate amount of approximately
$42.2 million. During 2003 and 2002 and 2001, we instituted certain restructuring plans
to better align our cost structure with our business outlook and general
economic conditions. Under the restructuring plans, we recorded restructuring
related charges totaling $2.3 million, $768,000 and $15.6 million during 2003,
2002 and 2001, respectively. A total of approximately $6.9 million was charged
against the restructuring reserve during 2003. As of March 31, 2004, the total
accrued restructuring liability was $18,000. Management estimates that 100% of
this reserve will be a use of cash in 2004 for remaining rent commitments, less
estimated sublease income, related to facilities we have vacated. Capital expenditures were $0 for the three months ended March 31, 2004 and
2003, respectively. Capital expenditures were higher in years prior to 2002 and
reflected a significantly larger employee base and level of operations. As of
March 31, 2004, we had no material long-term commitments for capital
expenditures and we do not anticipate entering into any further material
commitments for capital expenditures pending implementation of our asset
redeployment strategy. Since 1999, we have purchased property and equipment
with cash. From inception through 1998, we generally funded the purchase of
property and equipment with capital leases. As described above in this Item 2 under Recent Developments, on April
21, 2004, the Company issued and sold to Olden Acquisition LLC a 2% ten-year
Convertible Subordinated Note. Proceeds to the Company from this transaction
totaled approximately $2.5 million before transaction expenses. Interest on
the note accrues semi-annually but is not payable currently or upon conversion
of the note. Our remaining commitments as of March 31, 2004, consisted primarily of
obligations under one operating lease. The following summarizes this
contractual lease obligation at March 31, 2004. 2004
    
    Total(in thousands)Operating leases
    
    $
    33
    
    
    $
    33Executed sublease agreements
    
    
    (15
    )
    
    
    (15
    )Net contractual cash obligation
    
    $
    18
    
    
    $
    18
 The operating lease obligation relates to one remaining vacated facility
in San Francisco, California, the majority of which is sublet. We currently
occupy approximately 1,500 square feet of office space pursuant to a
month-to-month lease in Edina, Minnesota, which we will vacate by May 31, 2004.
Thereafter, we will relocate our offices to Stamford, Connecticut. 19




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We believe that existing cash and investments will be sufficient to meet
our expected working capital needs for the next twelve months. However,
uncertainties exist as to the amounts we will receive in connection with any
potential sales of assets, the costs of implementing our asset redeployment
strategy and the precise value of our existing obligations and liabilities,
which may exceed our available cash and cash equivalents. Furthermore, we may
be unable to settle or otherwise resolve our remaining obligations and
liabilities, and we may incur or be subject to additional obligations and
liabilities, which could collectively exceed our available cash and cash
equivalents. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS In January 2003, the FASB issued Interpretation No. (FIN) 46,
Consolidation of Variable Interest Entities, an Interpretation of Accounting
Research Bulletin No. 51. FIN No. 46 requires certain variable interest
entities, or VIEs, to be consolidated by the primary beneficiary of the entity
if the equity investors in the entity do not have the characteristics of a
controlling financial interest, or do not have sufficient equity at risk for
the entity to finance its activities without additional subordinated financial
support from other parties. In December 2003, the FASB issued FIN No. 46-R,
Consolidation of Variable Interest Entities, which represents a revision to
FIN No. 46. The provisions of FIN No. 46-R are effective for interests in VIEs
as of the first interim or annual period ending after December 15, 2003. The
Company currently has no contractual relationship or other business
relationship with a variable interest entity and therefore the adoption of FIN
No. 46 and FIN No. 46-R did not have a material effect on our consolidated
financial position, results of operations or cash flows. RISK FACTORS THAT MAY AFFECT OUR FUTURE RESULTS The risks and uncertainties described below are not the only ones we face.
Additional risks and uncertainties not presently known to us or which are
currently deemed immaterial may also impair our financial condition. If any of
these risks actually occur, our financial condition could be materially
adversely affected. We may be unable to redeploy our assets successfully. As part of our strategy to limit operating losses and enable us to
redeploy our assets and use our cash and cash equivalent assets to enhance
stockholder value, we will attempt to sell or otherwise dispose of the
remaining assets used in our historical operating business. We are pursuing a
strategy of identifying suitable merger partners and acquisition candidates
that will serve as a platform company. Although we are not targeting specific
business industries for potential acquisitions, we plan to seek businesses with
cash flow, experienced management teams, and operations in markets offering
growth opportunities. We may not be successful in acquiring such a business or
in operating any business that we acquire. Failure to redeploy our assets
successfully will result in our inability to become profitable. We will likely have no operating history in our new line of business, which is
yet to be determined, and therefore we will be subject to the risks inherent in
establishing a new business. We have not identified what our new line of business will be; therefore,
we cannot fully describe the specific risks presented by such business. It is
likely that we will have had no operating history in the new line of business
and any target company may have a limited operating history in its business.
Accordingly, there can be no assurance that our future operations will generate
operating or net income, and as such our success will be subject to the risks,
expenses, problems and delays inherent in establishing a new business. Such new
business may involve an unproven product, technology or marketing strategy, the
ultimate success of which cannot be assured. Any acquisitions that we attempt or complete could prove difficult to
integrate or require a substantial commitment of management time and other
resources. Any acquisitions that we attempt or complete may involve a number of
unique risks including: (i) executing successful due diligence; (ii) our
exposure to unforeseen liabilities of acquired companies; (iii) increased risk
of costly and time-consuming litigation, including stockholder lawsuits; and
(iv) our ability to successfully integrate and absorb the acquired company. We
may be unable to address these problems successfully. Moreover, our future
operating results will depend to a significant degree on our ability to
successfully manage operations while also controlling our expenses. In
addition, if we identify an appropriate acquisition opportunity, we may be
unable to negotiate favorable terms for that acquisition. We may be unable to
select, manage or absorb or integrate any future acquisitions successfully,
particularly acquisitions of large companies. Any acquisition, even if
effectively 20




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integrated, may not benefit our stockholders. We may be unable to realize the benefits of our net operating loss (NOL)
carryforwards. NOLs may be carried forward to offset federal income in future years and
eliminate income taxes otherwise payable on such taxable income, subject to
certain adjustments. Based on current federal corporate income tax rates, our
NOL and other carryforwards could provide a benefit to us, if fully utilized,
of significant future tax savings. However, our ability to use these tax
benefits in future years will depend upon the amount of our otherwise taxable
income. If we do not have sufficient taxable income in future years to use the
tax benefits before they expire, we will lose the benefit of these NOL
carryforwards permanently. Consequently, our ability to use the tax benefits
associated with our substantial NOL will depend significantly on our success in
identifying suitable merger partners and/or acquisition candidates, and once
identified, successfully consummating a merger with and/or acquisition of these
candidates. Additionally, if we underwent an ownership change, the NOL carryforward
limitations would impose an annual limit on the amount of the taxable income
that may be offset by our NOL generated prior to the ownership change. If an
ownership change were to occur, we would be unable to use a significant portion
of our NOL to offset taxable income. In general, an ownership change occurs
when, as of any testing date, the aggregate of the increase in percentage
points of the total amount of a corporations stock owned by 5-percent
stockholders within the meaning of the NOL carryforward limitations whose
percentage ownership of the stock has increased as of such date over the lowest
percentage of the stock owned by each such 5-percent stockholder at any time
during the three-year period preceding such date is more than 50 percentage
points. In general, persons who own 5% or more of a corporations stock are
5-percent stockholders, and all other persons who own less than 5% of a
corporations stock are treated, together, as a single, public group 5-percent
stockholder, regardless of whether they own an aggregate of 5% of a
corporations stock. The amount of NOL carryforwards that we have claimed has not been audited
or otherwise validated by the U.S. Internal Revenue Service. The IRS could
challenge our calculation of the amount of our NOL or our determinations as to
when a prior change in ownership occurred and other provisions of the Internal
Revenue Code, may limit our ability to carry forward our NOL to offset taxable
income in future years. If the IRS was successful with respect to any such
challenge, the potential tax benefit of the NOL carryforwards to us could be
substantially reduced. Future sales of our common stock could cause the price of our shares to
decline. As part of our growth strategy, we may issue additional shares of our
common stock, preferred stock, and/or warrants. We may file registration
statements with the Securities and Exchange Commission that we may use to
register shares of our common stock, preferred stock, and warrants issuable in
connection with acquisitions. To the extent that we are able to consummate
acquisitions through the issuance of our common or preferred stock or warrants
to purchase our common stock, the number of our outstanding shares of common
stock and/or preferred stock that will be eligible for sale may increase
substantially. To the extent persons receiving warrants or shares of our
common or preferred stock in connection with these acquisitions sell large
quantities of their warrants and stock, such sales could negatively affect the
price of our common stock. In addition, the potential issuance of additional
shares in connection with anticipated acquisitions could lessen demand for our
common stock and result in a lower price than might otherwise be obtained. Moreover, in connection with our issuance and sale of the convertible
subordinated note to Olden Acquisition LLC described in Item 2 under Recent
Developments, we entered into a Registration Rights Agreement that requires
us, upon the request of Olden or its assignee, to register on a shelf
registration statement pursuant to Rule 415 under the Securities Act of 1933,
as amended, the resale of the shares of common stock into which the note is
convertible, and to keep the registration statement effective until such time
as all of the shares underlying the note may be sold without any restriction
pursuant to Rule 144(k). Once and so long as this registration is effective,
the shares of common stock issuable to Olden upon conversion of the note will
be immediately available for resale. Resales of a substantial number of these
shares could cause the price of our common stock to decline. We do not expect to generate an operating profit for the foreseeable future. We had net losses of $5.0 million in 1998, $12.0 million in 1999, $53.5
million in 2000 (including $27.6 million of amortization of goodwill and other
intangibles related to the acquisition of KD1 and non-cash stock compensation
expense) and $123.8 million for the year ended December 31, 2001 (including
$15.6 million in 21




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restructuring related charges, $10.3 million of amortization of goodwill
and other intangibles and non-cash stock compensation expense and a $75.3
million charge for the impairment of goodwill and other intangibles). Our net
loss was $16.7 million for the year ended December 31, 2002 (including $768,000
in restructuring related charges, $299,000 of amortization of intangibles and
non-cash stock compensation expense and a $6.5 million charge for the
impairment of goodwill and other intangibles) and $5.3 million for the year
ended December 31, 2003). As of March 31, 2004, we had an accumulated deficit
of $222 million. As described in the section of this report entitled
Managements Discussion and Analysis of Financial Condition and Results of
Operations  Overview, we have ceased to actively market our products and we
do not expect to generate significant future operating revenues from our
historical business. We do not expect to generate an operating profit for 2004
or the foreseeable future. Our ability to become profitable will depend, among
other things, on our identification and acquisition of a new operating business
and the success of that business. We may be unable to realize additional proceeds from sale(s) of our remaining
assets. As described above in Item 2 under Overview, on March 31, 2004, we sold
our patent portfolio for a purchase price of $1.8 million in cash pursuant to a
patent purchase agreement entered into in December 2003 and amended as of March
31, 2004. The patent purchase agreement includes a royalty-free non-exclusive
license back to the Company under the transferred patents, patent licenses and
pending patent applications. The license back to the Company is transferable,
subject to certain restrictions applicable to the transferee relating to
revenues which can be generated by products covered by the license. This
transaction did not involve any of our other intellectual property rights or
assets, including our proprietary software product NetP7. However, we are
unable to predict whether any such rights or assets will be sold or, if such
sale(s) occur, the terms of such sale(s). The price(s) at which we may be able
to sell these assets will depend largely on factors beyond our control,
including, without limitation, the extent of actual or perceived competition
between, and the availability of financing for, prospective purchasers of the
assets and such prospective purchasers plans for our intellectual property and
products as integrated into their existing businesses. In addition, because
some of these remaining assets may decline in value over time, we may not be
able to consummate the sale of these assets in time to generate meaningful
value. Investors should not assume that we will be able to realize additional
proceeds from sale(s) of our remaining assets. Our Common Stock may be delisted from Nasdaq. On April 27, 2004, our application to transfer from the Nasdaq National
Market to the Nasdaq SmallCap Market was approved and our common stock is now
listed on the Nasdaq SmallCap Market. On April 28, 2004, the Nasdaq Stock
Market notified us by letter that as a result of this phase down to the
SmallCap Market, we would be afforded until October 11, 2004 to demonstrate
compliance with Nasdaqs $1.00 minimum bid price requirement. If we are unable
to demonstrate compliance with the minimum bid price requirement by this date,
or if we are otherwise unable to meet the Nasdaq SmallCap Markets other
quantitative listing requirements or qualitative standards, our common stock
may be delisted from the Nasdaq Small Cap Market. If this were to occur,
trading of our common stock, if any, would then be conducted on the
over-the-counter market in automated quotation systems, called the Pink
Sheets, and/or on the OTC Bulletin Board of the National Association of
Securities Dealers, Inc. In this event, stockholders may find it more difficult
to dispose of, or to obtain accurate quotations as to the price of, our common
stock, the liquidity of our stock may be reduced, making it difficult for a
stockholder to buy or sell our stock at competitive market prices or at all, we
may lose support from institutional investors and/or market makers that
currently buy and sell our stock and the price of our common stock could
decline. Securities class action claims have been filed against us and certain of our
current and former officers and directors. On November 2, 2001, Timothy J. Fox filed a purported class action lawsuit
against us, FleetBoston Robertson Stephens, Inc., the lead underwriter of our
April 1999 initial public offering, several other underwriters who participated
in our initial public offering, Steven J. Snyder, our then president and chief
executive officer, and Thomas M. Donnelly, our chief financial officer. The
lawsuit was filed in the United States District Court for the Southern District
of New York and has been assigned to the judge who is also the pretrial
coordinating judge for substantially similar lawsuits involving more than 300
other issuers. An amended class action complaint, captioned In re Net
Perceptions, Inc. Initial Public Offering Securities Litigation,01 Civ. 9675
(SAS), was filed on April 22, 2002, expanding the basis for the action to
include allegations relating to our March 2000 follow-on public offering in
addition to those relating to our initial public offering. The amended complaint generally alleges that the defendants violated
federal securities laws by not disclosing 22




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certain actions taken by the underwriter defendants in connection with our
initial public offering and our follow-on public offering. The amended
complaint alleges specifically that the underwriter defendants, with our direct
participation and agreement and without disclosure thereof, conspired to and
did raise and increase their underwriters compensation and the market prices
of our common stock following our initial public offering and in our follow-on
public offering by requiring their customers, in exchange for receiving
allocations of shares of our common stock sold in our initial public offering,
to pay excessive commissions on transactions in other securities, to purchase
additional shares of our common stock in the initial public offering
aftermarket at pre-determined prices above the initial public offering price,
and to purchase shares of our common stock in our follow-on public offering.
The amended complaint seeks unspecified monetary damages and certification of a
plaintiff class consisting of all persons who acquired our common stock between
April 22, 1999 and December 6, 2000. The plaintiffs have since agreed to
dismiss the claims against Mr. Snyder and Mr. Donnelly without prejudice, in
return for their agreement to toll any statute of limitations applicable to
those claims; and those claims have been dismissed without prejudice. On July
15, 2002, all of the issuer defendants filed a joint motion to dismiss the
plaintiffs claims in all of the related cases. On February 19, 2003, the Court
ruled against the Company on this motion. A special committee of our board of directors has authorized the Company
to negotiate a settlement of the pending claims substantially consistent with a
memorandum of understanding negotiated among class plaintiffs, issuer
defendants and their insurers. Any such settlement would be subject to approval
by the Court. We believe that the allegations against the Company are without
merit. However, we are unable to predict the outcome or ultimate effect of this
litigation. Our inability to reach cash break-even could give rise to securities class
action claims against us, which could adversely impact our ability to implement
our asset redeployment strategy. Securities class action claims have been brought against companies in the
past where the market price of the companys securities has fallen due to an
inability of the company to achieve operational profitability. In addition, the
Company was named in a purported class action described elsewhere in this
report. Any such litigation could be very costly and divert our resources from
being available to implement our asset redeployment strategy. To the extent
that we are unable to settle or resolve the currently pending litigation, and
we are not indemnified by other parties, or in the absence of sufficient
insurance coverage, any adverse determination in this kind of litigation could
deplete our cash position, which could negatively impact our ability to
implement our asset redeployment strategy. We may face intellectual property infringement claims that could be costly to
resolve. There has been a substantial amount of litigation in the software industry
regarding intellectual property rights. It is possible that third parties may
claim that our products infringe their intellectual property rights, including
under issued patents. Such claims may result in our being involved in
litigation. We could incur substantial costs to defend any claims relating to
proprietary rights, which would deplete our cash position. In addition, in all
of our paid software license agreements, we generally indemnify our customers
against losses attributable to intellectual property infringement by our
software. Should a third party bring a suit against a customer alleging that
the customers use of our software infringes its intellectual property rights,
we could incur substantial costs in defending and resolving the suit. If
someone asserts a claim against us relating to proprietary technology or
information, we might seek settlement of such claim. We might not be able to
agree to a settlement on reasonable terms, or at all. The failure to obtain a
settlement on acceptable terms could deplete our cash position and adversely
impact our ability to implement our asset redeployment strategy. We may be subject to potential product liability claims that could result in
costly and time-consuming litigation. Because our customers have used, and may continue to use, our products for
important applications, errors or defects in, or other performance problems
with, our products could result in financial or other damages to our customers.
Our customers could seek to recover from us for such damages and we no longer
maintain product liability insurance to cover such claims. Although our license
agreements typically contain provisions designed to limit our exposure to
product liability claims, existing or future laws or unfavorable judicial
decisions could negate these limitation of liability provisions. Any product
liability claim brought against us, even if unsuccessful, would likely be
time-consuming and costly. If someone asserts a claim against us relating to
product liability, we might seek settlement of such claim. We might not be able
to agree to a settlement on reasonable terms, or at all. 23




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Provisions of our corporate organizational documents and rights agreement could
delay or prevent a change of control, even if it would be beneficial to our
stockholders. Various provisions of our certificate of incorporation and bylaws could
have the effect of delaying or preventing a change in control and make it more
difficult for a third party to acquire us, even if doing so would be beneficial
to our stockholders. In addition, the rights issued under our rights agreement,
as amended, may be a substantial deterrent to a person acquiring 15% or more of
our common stock without the approval of our board of directors. These
provisions in our certificate of incorporation, bylaws and rights agreement
could reduce the price that investors might be willing to pay for shares of our
common stock in the future and result in the market price being lower than it
would be without these provisions. 
 Item 3. Quantitative and Qualitative Disclosures about Market Risk Through March 31, 2004, the majority of our recognized revenues were
denominated in United States dollars and were primarily from customers in the
United States, and our exposure to foreign currency exchange rate changes has
been immaterial. As described above in the section of this report entitled
Managements Discussion and Analysis of Financial Condition and Results of
Operations  Overview, we are no longer actively marketing our products.
Accordingly, we do not consider significant our exposure to foreign currency
exchange rate changes arising from revenues being denominated in foreign
currencies. Our historical exposure to market risk was otherwise limited to interest
income sensitivity, which is affected by changes in the general level of United
States interest rates, particularly because the majority of our investments
were in debt securities issued by corporations and the United States
government. However, at March 31, 2003, all of our cash was held in money
market accounts and therefore our future interest income sensitivity is
limited.. 
 Item 4. Controls and Procedures (a) Disclosure Controls and Procedures. The Companys management, with
the participation of the Companys Chief Administrative Officer and Chief
Financial Officer, has evaluated the effectiveness of the Companys disclosure
controls and procedures (as such term is defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange
Act)) as of the end of the period covered by this report. Based on such
evaluation, the Companys Chief Administrative Officer and Chief Financial
Officer have concluded that, as of the end of such period, the Companys
disclosure controls and procedures are effective to provide reasonable
assurance that information required to be disclosed by the Company in reports
that we file or submit under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the Commissions
rules and forms. (b) Internal Control Over Financial Reporting. There have not been any
changes in the Companys internal control over financial reporting (as such
term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during
the fiscal quarter to which this report relates that have materially affected,
or are reasonably likely to materially affect, the Companys internal control
over financial reporting. 24




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PART II. OTHER INFORMATION 
 Item 1. Legal Proceedings Initial and Follow-On Public Offering Securities Litigation On November 2, 2001, Timothy J. Fox filed a purported class action lawsuit
against us, FleetBoston Robertson Stephens, Inc., the lead underwriter of our
April 1999 initial public offering, several other underwriters who participated
in our initial public offering, Steven J. Snyder, our then president and chief
executive officer, and Thomas M. Donnelly, our chief financial officer. The
lawsuit was filed in the United States District Court for the Southern District
of New York and has been assigned to the judge who is also the pretrial
coordinating judge for substantially similar lawsuits involving more than 300
other issuers. An amended class action complaint, captioned In re Net
Perceptions, Inc. Initial Public Offering Securities Litigation,01 Civ. 9675
(SAS), was filed on April 22, 2002, expanding the basis for the action to
include allegations relating to our March 2000 follow-on public offering in
addition to those relating to our initial public offering. The amended complaint generally alleges that the defendants violated
federal securities laws by not disclosing certain actions taken by the
underwriter defendants in connection with our initial public offering and our
follow-on public offering. The amended complaint alleges specifically that the
underwriter defendants, with our direct participation and agreement and without
disclosure thereof, conspired to and did raise and increase their underwriters
compensation and the market prices of our common stock following our initial
public offering and in our follow-on public offering by requiring their
customers, in exchange for receiving allocations of shares of our common stock
sold in our initial public offering, to pay excessive commissions on
transactions in other securities, to purchase additional shares of our common
stock in the initial public offering aftermarket at pre-determined prices above
the initial public offering price, and to purchase shares of our common stock
in our follow-on public offering. The amended complaint seeks unspecified
monetary damages and certification of a plaintiff class consisting of all
persons who acquired our common stock between April 22, 1999 and December 6,
2000. The plaintiffs have since agreed to dismiss the claims against Mr. Snyder
and Mr. Donnelly without prejudice, in return for their agreement to toll any
statute of limitations applicable to those claims; and those claims have been
dismissed without prejudice. On July 15, 2002, all of the issuer defendants
filed a joint motion to dismiss the plaintiffs claims in all of the related
cases. On February 19, 2003, the Court ruled against the Company on this
motion. A special committee of our board of directors has authorized the Company
to negotiate a settlement of the pending claims substantially consistent with a
memorandum of understanding negotiated among class plaintiffs, issuer
defendants and their insurers. Any such settlement would be subject to approval
by the Court. We believe that the allegations against the Company are without merit.
However, we are unable to predict the outcome or ultimate effect of this
litigation. Blakstad Litigation On October 29, 2003, a purported class action lawsuit was filed against
the Company, its current directors and unnamed defendants in the District
Court, Fourth Judicial District, of the State of Minnesota, County of Hennepin
captioned Don Blakstad, on Behalf of Himself and All others Similarly Situated,
vs. Net Perceptions, Inc., John F. Kennedy, Ann L. Winblad, John T. Riedl and
Does 1-25, inclusive,File No. 03-17820. The complaint alleged, among other
things, that defendants breached their fiduciary duties of loyalty, due care,
independence, good faith and fair dealing and sought to enjoin the proposed
liquidation of the Company and to recover reasonable attorneys and experts
fees. On November 24, 2003, defendants filed a motion to dismiss the lawsuit,
and, by order dated March 8, 2004, the court dismissed the plaintiffs
complaint with prejudice. By letter dated March 9, 2004, the plaintiff
requested the courts permission to file a motion to reconsider the decision
dismissing the complaint with prejudice. On March 18, 2004, the court denied
plaintiffs request. On April 9, 2004, the plaintiff filed a notice of appeal
and statement of the case with the Court of Appeals of the State of Minnesota
and, on April 22, 2004, defendants filed their statement of the case with the
Court of Appeals. Defendants continue to believe that the claims in this
lawsuit are without merit, and are in fact moot, and intend to continue to
vigorously defend them during this appeals process. 25




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Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity
Securities On April 21, 2004, the Company issued and sold to Olden Acquisition LLC,
an affiliate of Kanders & Company, Inc., a 2% ten-year Convertible
Subordinated Note, which is convertible after one year (or earlier upon a call
by the Company and in certain other circumstances) at a conversion price of
$0.45 per share of the Companys common stock into approximately 19.9% of the
outstanding common equity of the Company as of the closing date. Proceeds to
the Company from this transaction totaled approximately $2.5 million before
transaction expenses. Interest on the note accrues semi-annually but is not
payable currently or upon conversion of the note. No underwriter was involved in the foregoing sale of securities. This
sale was made in reliance upon an exemption from the registration provisions of
the Securities Act of 1933, as amended, set forth in Section 4(2) thereof
relating to sales by an issuer not involving any public offering. 
 Item 4. Submission of Matters to a Vote of Security Holders The information contained in the Companys Current Report on Form 8-K
filed with the Securities and Exchange Commission on March 23, 2004 is
incorporated herein by reference. 26




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Item 6. Exhibits and Reports on Form 8-K (a) Exhibits ExhibitNumber
    
    Description3.1(a)
    
    Amended and Restated Certificate of Incorporation (1).3.1(b)
    
    Certificate of Amendment to the Amended and Restated Certificate of Incorporation (2).3.2
    
    Amended and Restated Bylaws as amended through August 5, 2003. (3)4.1
    
    Amended and Restated Investor Rights Agreement, dated December 18, 1997, among Net
Perceptions, Inc. and the investors and founders named therein, as amended (1).4.2
    
    Specimen common stock certificate (1).4.3
    
    Specimen common stock certificate (including Rights Agreement Legend) (4).4.4
    
    Rights Agreement between Net Perceptions, Inc. and Wells Fargo Bank Minnesota,
as Rights Agent (5).4.5
    
    Amendment No. 1 to Rights Agreement dated as of December 23, 2003 (6).4.6
    
    Amendment No. 2 to Rights Agreement dated as of April 21, 2004 (7).4.7
    
    Form of Certificate of Designation of Series A Junior Participating Preferred Stock
(attached as Exhibit A to the Rights Agreement filed as Exhibit 4.4 hereto) (5).4.8
    
    Form of Rights Certificate (attached as Exhibit B to the Rights Agreement filed as
Exhibit 4.4 hereto) (5).4.9
    
    2% Convertible Subordinated Note Due April 21, 2014 issued by Net Perceptions, Inc.
to Olden Acquisition LLC4.10
    
    Registration Rights Agreement, dated as of April 21, 2004, between Net Perceptions,
Inc. and Olden Acquisition LLC10.1
    
    Convertible Note Purchase Agreement, dated as of April 21, 2004, by and among Net
Perceptions, Inc. and Olden Acquisition LLC31.1
    
    Certification of Principal Executive Officer required by Rule 13a-14(a) or Rule
15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of Principal Financial Officer required by Rule 13a-14(a) or Rule
15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification of the Principal Executive Officer pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Certification of the Principal Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
  (1)
    
    Incorporated by reference to Net Perceptions Registration
Statement on Form S-1 (Registration No. 333-71919).(2)
    
    Incorporated by reference to Net Perceptions Annual Report on Form
10-K for the year ended December 31, 2002.(3)
    
    Incorporated by reference to Net Perceptions Quarterly Report on
Form 10-Q for the Quarter Ended June 30, 2003.(4)
    
    Incorporated by reference to Net Perceptions Quarterly Report on
Form 10-Q for the Quarter Ended June 30, 2001.(5)
    
    Incorporated by reference to Net Perceptions Registration
Statement on Form 8-A filed June 6, 2001 (File No. 000-25781).(6)
    
    Incorporated by reference to Net Perceptions Current Report on
Form 8-K filed on December 23, 2003.(7)
    
    Incorporated by reference to Amendment No. 2 to Net Perceptions
Registration Statement on Form 8-A/A filed April 21, 2004.  (b)
    
    Reports on Form 8-K On March 23, 2004, the Company filed a Current Report on Form 8-K to
report under Items 5 and 7 the outcome of the special meeting of stockholders
held on such date. 27




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##### Table of Contents



SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. Net Perceptions, Inc.Date: May 11, 2004
    
    By:
    
    
    
    /s/ Nigel P. EkernNigel P. EkernChief Administrative Officer(Duly authorized officer)/s/ Thomas M. DonnellyThomas M. DonnellyChief Financial Officer(Principal financial officer)
 28




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##### Table of Contents



NET PERCEPTIONS, INC.
FORM 10-Q
For the Quarter Ended March 31, 2004 
 EXHIBIT INDEX
 ExhibitNumber
    
    Description3.1(a)
    
    Amended and Restated Certificate of Incorporation (1).3.1(b)
    
    Certificate of Amendment to the Amended and Restated Certificate of Incorporation (2).3.2
    
    Amended and Restated Bylaws as amended through August 5, 2003. (3)4.1
    
    Amended and Restated Investor Rights Agreement, dated December 18, 1997, among Net
Perceptions, Inc. and the investors and founders named therein, as amended (1).4.2
    
    Specimen common stock certificate (1).4.3
    
    Specimen common stock certificate (including Rights Agreement Legend) (4).4.4
    
    Rights Agreement between Net Perceptions, Inc. and Wells Fargo Bank Minnesota,
as Rights Agent (5).4.5
    
    Amendment No. 1 to Rights Agreement dated as of December 23, 2003 (6).4.6
    
    Amendment No. 2 to Rights Agreement dated as of April 21, 2004 (7).4.7
    
    Form of Certificate of Designation of Series A Junior Participating Preferred Stock
(attached as Exhibit A to the Rights Agreement filed as Exhibit 4.4 hereto) (5).4.8
    
    Form of Rights Certificate (attached as Exhibit B to the Rights Agreement filed as
Exhibit 4.4 hereto) (5).4.9
    
    2% Convertible Subordinated Note Due April 21, 2014 issued by Net Perceptions, Inc.
to Olden Acquisition LLC4.10
    
    Registration Rights Agreement, dated as of April 21, 2004, between Net Perceptions,
Inc. and Olden Acquisition LLC10.1
    
    Convertible Note Purchase Agreement, dated as of April 21, 2004, by and among Net
Perceptions, Inc. and Olden Acquisition LLC31.1
    
    Certification of Principal Executive Officer required by Rule 13a-14(a) or Rule
15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of Principal Financial Officer required by Rule 13a-14(a) or Rule
15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification of the Principal Executive Officer pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Certification of the Principal Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
  (1)
    
    Incorporated by reference to Net Perceptions Registration
Statement on Form S-1 (Registration No. 333-71919).(2)
    
    Incorporated by reference to Net Perceptions Annual Report on Form
10-K for the year ended December 31, 2002.(3)
    
    Incorporated by reference to Net Perceptions Quarterly Report on
Form 10-Q for the Quarter Ended June 30, 2003.(4)
    
    Incorporated by reference to Net Perceptions Quarterly Report on
Form 10-Q for the Quarter Ended June 30, 2001.(5)
    
    Incorporated by reference to Net Perceptions Registration
Statement on Form 8-A filed June 6, 2001 (File No. 000-25781).(6)
    
    Incorporated by reference to Net Perceptions Current Report on
Form 8-K filed on December 23, 2003.(7)
    
    Incorporated by reference to Amendment No. 2 to Net Perceptions
Registration Statement on Form 8-A/A filed April 21, 2004. 29