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UNITED STATESSECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


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FORM 10-Q

|                                                                                                
|------------------------------------------------------------------------------------------------
|(Mark One)                                                                                      
|                                                                                                
|xbox      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2002

OR

|                                                                                                 
|-------------------------------------------------------------------------------------------------
|box      
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934

For the Transition Period From _____ to _____.

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Commission File Number: 000-25781

NET PERCEPTIONS, INC.

(Exact name of Registrant as specified in its charter)


|                                                                        |  |                                                   
|----------------------------------------------------------------------- |  | --------------------------------------------------
|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  xbox      No  box

The number of shares of the registrants common stock outstanding as of July
31, 2002 was 27,299,333.







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TABLE OF CONTENTS



|                                                 |                                                                                               |                                                |  |  |  |  |  | 
|------------------------------------------------ | --------------------------------------------------------------------------------------------- | ---------------------------------------------- |  |  |  |  |  | 
|PART I. FINANCIAL INFORMATION                   
|                                                 | Item 1. Financial Statements                                                                 
|                                                 |                                                                                               | CONSOLIDATED BALANCE SHEETS                   
|                                                 |                                                                                               | CONSOLIDATED STATEMENTS OF OPERATIONS         
|                                                 |                                                                                               | CONSOLIDATED STATEMENTS OF CASH FLOWS         
|                                                 |                                                                                               | NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
|                                                 | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                                                 | Item 3. Quantitative and Qualitative Disclosures about Market Risk                           
|PART II. OTHER INFORMATION                      
|                                                 | Item 1. Legal Proceedings                                                                    
|                                                 | Item 2. Changes in Securities and Use of Proceeds                                            
|                                                 | Item 3. Defaults Upon Senior Securities                                                      
|                                                 | Item 4. Submission of Matters to a Vote of Security Holders                                  
|                                                 | Item 5. Other Information                                                                    
|                                                 | Item 6. Exhibits and Reports on Form 8-K                                                     
|SIGNATURES                                      
|EXHIBIT INDEX                                   
|EX-99.1 Certification of Chief Executive Officer
|EX-99.2 Certification of Chief Financial Officer



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##### Table of Contents



NET PERCEPTIONS, INC.
FORM 10-Q
For the Quarter Ended June 30, 2002



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TABLE OF CONTENTS

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|                              |         |  |                                                                                                 |  |      |    | 
|----------------------------- | ------- |  | ----------------------------------------------------------------------------------------------- |  | ---- | -- | 
|                              |         |  |                                                                                                 |  | Page
|                              |         |  |                                                                                                 |  |     
|PART I. FINANCIAL INFORMATION
|                             
|                             
|                             
|                             
|                              | Item 1. |  | Financial Statements                                                                            |  |      |    | 
|                             
|                             
|                             
|                             
|                              |         |  | Consolidated Balance Sheets as of June 30, 2002 and December 31, 2001                           |  |      | 4  | 
|                             
|                             
|                             
|                             
|                              |         |  | Consolidated Statements of Operations for the Three and Six Months Ended
June 30, 2002 and 2001 |  |      | 5  | 
|                             
|                             
|                             
|                             
|                              |         |  | Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2002
and 2001           |  |      | 6  | 
|                             
|                             
|                             
|                             
|                              |         |  | Notes to the Consolidated Financial Statements                                                  |  |      | 7  | 
|                             
|                             
|                             
|                             
|                              | Item 2. |  | Managements Discussion and Analysis of Financial Condition and Results of Operations           |  |      | 10 | 
|                             
|                             
|                             
|                             
|                              | Item 3. |  | Quantitative and Qualitative Disclosures about Market Risk                                      |  |      | 29 | 
|                             
|                             
|                             
|                             
|PART II. OTHER INFORMATION   
|                             
|                             
|                             
|                             
|                              | Item 1. |  | Legal Proceedings                                                                               |  |      | 30 | 
|                             
|                             
|                             
|                             
|                              | Item 2. |  | Changes in Securities and Use of Proceeds                                                       |  |      | 30 | 
|                             
|                             
|                             
|                             
|                              | Item 3. |  | Defaults Upon Senior Securities                                                                 |  |      | 30 | 
|                             
|                             
|                             
|                             
|                              | Item 4. |  | Submission of Matters to a Vote of Security Holders                                             |  |      | 30 | 
|                             
|                             
|                             
|                             
|                              | Item 5. |  | Other Information                                                                               |  |      | 30 | 
|                             
|                             
|                             
|                             
|                              | Item 6. |  | Exhibits and Reports on Form 8-K                                                                |  |      | 30 | 
|                             
|                             
|                             
|                             
|SIGNATURES                    |         |  | 32                                                                                              | 
|                             
|                             
|                             
|                             
|EXHIBIT INDEX                 |         |  | 33                                                                                              | 

2



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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 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  Managements Discussion and Analysis of Financial
Condition and Results of Operations under the heading Risks That May Affect
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).

3



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##### Table of Contents






PART I. FINANCIAL INFORMATION




Item 1. Financial Statements




NET PERCEPTIONS, INC.

CONSOLIDATED BALANCE SHEETS
(in thousands)

|                                              |                                               |                                            |                           |          |             |        |              |          |        |        | 
|--------------------------------------------- | --------------------------------------------- | ------------------------------------------ | ------------------------- | -------- | ----------- | ------ | ------------ | -------- | ------ | ------ | 
|                                             
|                                             
|                                              |                                               |                                            |                           |          | June 30,    |        | December 31,
|                                              |                                               |                                            |                           |          | 2002        |        | 2001        
|                                             
|                                              |                                               |                                            |                           |          | (Unaudited) |        |              |          |       
|Assets                                        |                                               |                                            |                           |          |             |        |              |         
|                                             
|                                             
|                                             
|                                             
|Current assets:                               |                                               |                                            |                           |          |             |        |              |         
|                                             
|                                             
|                                             
|                                             
|                                              | Cash and cash equivalents                     |                                            | $                         | 13,116   |             |        | $            | 14,929   |       
|                                             
|                                             
|                                             
|                                             
|                                              | Short-term investments                        |                                            |                           | 51,504   |             |        |              | 58,676   |       
|                                             
|                                             
|                                             
|                                             
|                                              | Accounts receivable, net                      |                                            |                           | 1,768    |             |        |              | 1,309    |       
|                                             
|                                             
|                                             
|                                             
|                                              | Prepaid expenses and other current assets     |                                            |                           | 2,316    |             |        |              | 2,301    |       
|                                             
|                                              |                                               |                                            | Total current assets      |          |             | 68,704 |              |          |        | 77,215 | 
|                                             
|                                             
|                                             
|                                             
|Property and equipment, net                   |                                               |                                            | 1,902                     |          |             |        | 3,679        |         
|                                             
|                                             
|                                             
|                                             
|Goodwill and other intangible assets, net     |                                               |                                            | 6,674                     |          |             |        | 6,802        |         
|                                             
|                                             
|                                             
|                                             
|Other assets                                  |                                               |                                            | 1,004                     |          |             |        | 1,182        |         
|                                             
|                                              |                                               |                                            | Total assets              |          | $           | 78,284 |              |          | $      | 88,878 | 
|                                             
|Liabilities and Stockholders Equity          |                                               |                                            |                           |          |             |        |              |         
|                                             
|                                             
|                                             
|                                             
|Current liabilities:                          |                                               |                                            |                           |          |             |        |              |         
|                                             
|                                             
|                                             
|                                             
|                                              | Accounts payable                              |                                            | $                         | 571      |             |        | $            | 314      |       
|                                             
|                                             
|                                             
|                                             
|                                              | Accrued liabilities                           |                                            |                           | 2,416    |             |        |              | 3,215    |       
|                                             
|                                             
|                                             
|                                             
|                                              | Deferred revenue                              |                                            |                           | 1,790    |             |        |              | 1,835    |       
|                                             
|                                             
|                                             
|                                             
|                                              | Accrued restructuring costs                   |                                            |                           | 5,534    |             |        |              | 7,433    |       
|                                             
|                                             
|                                             
|                                             
|                                              | Current portion of long-term liabilities      |                                            |                           | 8        |             |        |              | 97       |       
|                                             
|                                              |                                               |                                            | Total current liabilities |          |             | 10,319 |              |          |        | 12,894 | 
|                                             
|                                             
|                                             
|                                             
|Long-term liabilities, net of current portion |                                               |                                            | 543                       |          |             |        | 577          |         
|                                             
|                                              |                                               |                                            | Total liabilities         |          |             | 10,862 |              |          |        | 13,471 | 
|                                             
|Commitments and contingencies                 |                                               |                                            |                           |          |             |        |              |         
|                                             
|                                             
|                                             
|                                             
|Stockholders equity:                         |                                               |                                            |                           |          |             |        |              |         
|                                             
|                                             
|                                             
|                                             
|                                              | Common stock                                  |                                            |                           | 2        |             |        |              | 2        |       
|                                             
|                                             
|                                             
|                                             
|                                              | Additional paid-in capital                    |                                            |                           | 275,008  |             |        |              | 274,869  |       
|                                             
|                                             
|                                             
|                                             
|                                              | Accumulated other comprehensive income (loss) |                                            |                           | 323      |             |        |              | 637      |       
|                                             
|                                             
|                                             
|                                             
|                                              | Accumulated deficit                           |                                            |                           | (207,911 | )           |        |              | (200,101 | )     
|                                             
|                                              |                                               | Total stockholders equity                 |                           |          | 67,422      |        |              |          | 75,407 |       
|                                             
|                                              |                                               | Total liabilities and stockholders equity |                           | $        | 78,284      |        |              | $        | 88,878 |       
|                                             

See accompanying notes to the consolidated financial statements.

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##### Table of Contents






NET PERCEPTIONS, INC.

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

|                                                              |                                              |                          |        |                    |       |                  |        |       |       |      |        |       |       |   |          |        |         | 
|------------------------------------------------------------- | -------------------------------------------- | ------------------------ | ------ | ------------------ | ----- | ---------------- | ------ | ----- | ----- | ---- | ------ | ----- | ----- | - | -------- | ------ | ------- | 
|                                                             
|                                                             
|                                                              |                                              |                          |        | Three Months Ended |       | Six Months Ended
|                                                              |                                              |                          |        | June 30,           |       | June 30,        
|                                                              |                                              |                          |        | 2002               |       | 2001             |        | 2002  |       | 2001
|                                                             
|                                                              |                                              |                          |        | (Unaudited)        |       | (Unaudited)     
|Revenues:                                                     |                                              |                          |        |                    |       |                  |        |       |       |      |        |       |       |   |          |       
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              | Product                                      |                          | $      | 902                |       |                  | $      | 386   |       |      | $      | 945   |       |   | $        | 1,394  |        
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              | Service and maintenance                      |                          |        | 697                |       |                  |        | 2,096 |       |      |        | 1,794 |       |   |          | 4,423  |        
|                                                             
|                                                              |                                              | Total revenues           |        |                    | 1,599 |                  |        |       | 2,482 |      |        |       | 2,739 |   |          |        | 5,817   | 
|                                                             
|                                                             
|                                                             
|                                                             
|Cost of revenues:                                             |                                              |                          |        |                    |       |                  |        |       |       |      |        |       |       |   |          |       
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              | Product                                      |                          |        | 63                 |       |                  |        | 80    |       |      |        | 186   |       |   |          | 521    |        
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              | Service and maintenance                      |                          |        | 539                |       |                  |        | 1,301 |       |      |        | 1,309 |       |   |          | 3,593  |        
|                                                             
|                                                              |                                              | Total cost of revenues   |        |                    | 602   |                  |        |       | 1,381 |      |        |       | 1,495 |   |          |        | 4,114   | 
|                                                             
|                                                             
|                                                             
|                                                             
|Gross Margin                                                  |                                              |                          | 997    |                    |       |                  | 1,101  |       |       |      | 1,244  |       |       |   | 1,703    |       
|                                                             
|                                                             
|                                                             
|                                                             
|Operating expenses:                                           |                                              |                          |        |                    |       |                  |        |       |       |      |        |       |       |   |          |       
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              | Sales and marketing                          |                          |        | 1,376              |       |                  |        | 3,041 |       |      |        | 2,857 |       |   |          | 11,011 |        
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              | Research and development                     |                          |        | 1,624              |       |                  |        | 2,262 |       |      |        | 3,584 |       |   |          | 6,295  |        
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              | General and administrative                   |                          |        | 935                |       |                  |        | 2,129 |       |      |        | 1,677 |       |   |          | 4,416  |        
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              | Lease abandonment expense                    |                          |        |                   |       |                  |        |      |       |      |        |      |       |   |          | 225    |        
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              | Restructuring related charges                |                          |        | 401                |       |                  |        |      |       |      |        | 768   |       |   |          | 13,920 |        
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              | Amortization of intangibles                  |                          |        | 27                 |       |                  |        | 798   |       |      |        | 55    |       |   |          | 8,054  |        
|                                                             
|                                                             
|                                                             
|                                                             
|                                                              | Impairment of goodwill and other intangibles |                          |        |                   |       |                  |        |      |       |      |        |      |       |   |          | 75,298 |        
|                                                             
|                                                              |                                              | Total operating expenses |        |                    | 4,363 |                  |        |       | 8,230 |      |        |       | 8,941 |   |          |        | 119,219 | 
|                                                             
|Loss from operations                                          |                                              |                          | (3,366 | )                  |       |                  | (7,129 | )     |       |      | (7,697 | )     |       |   | (117,516 | )     
|                                                             
|                                                             
|                                                             
|                                                             
|Other income (expense), net                                   |                                              |                          | (972   | )                  |       |                  | 1,295  |       |       |      | (113   | )     |       |   | 2,888    |       
|                                                             
|Net loss                                                      |                                              | $                        | (4,338 | )                  |       | $                | (5,834 | )     |       | $    | (7,810 | )     |       | $ | (114,628 | )     
|                                                             
|Net loss per share:                                           |                                              |                          |        |                    |       |                  |        |       |       |      |        |       |       |   |          |       
|                                                             
|                                                             
|                                                             
|                                                             
|Basic and diluted                                             |                                              | $                        | (0.16  | )                  |       | $                | (0.22  | )     |       | $    | (0.29  | )     |       | $ | (4.26    | )     
|                                                             
|                                                             
|                                                             
|                                                             
|Shares used in computing basic and diluted net
loss per share |                                              |                          | 27,257 |                    |       |                  | 26,986 |       |       |      | 27,200 |       |       |   | 26,892   |       
|                                                             

See accompanying notes to the consolidated financial statements.

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NET PERCEPTIONS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

|                                                     |                                                                      |                                                                      |                                                     |                                                     |         |                  |        |          |         |        |         |  
|---------------------------------------------------- | -------------------------------------------------------------------- | -------------------------------------------------------------------- | --------------------------------------------------- | --------------------------------------------------- | ------- | ---------------- | ------ | -------- | ------- | ------ | ------- | -
|                                                    
|                                                    
|                                                     |                                                                      |                                                                      |                                                     |                                                     |         | Six months Ended
|                                                     |                                                                      |                                                                      |                                                     |                                                     |         | June 30,        
|                                                     |                                                                      |                                                                      |                                                     |                                                     |         | 2002             |        | 2001    
|                                                    
|                                                     |                                                                      |                                                                      |                                                     |                                                     |         | (Unaudited)     
|Cash flows from operating activities:                |                                                                      |                                                                      |                                                     |                                                     |         |                  |        |         
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     | Net loss                                                             |                                                                      | $                                                   | (7,810                                              | )       |                  | $      | (114,628 | )      
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     | Reconciliation of net loss to net cash used in operating activities: |                                                                      |                                                     |                                                     |         |                  |        |          |        
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     |                                                                      |                                                                      | Depreciation and amortization                       |                                                     |         | 1,262            |        |          |         | 10,345 |        
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     |                                                                      |                                                                      | Provision for doubtful accounts                     |                                                     |         | 65               |        |          |         | 1,016  |        
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     |                                                                      |                                                                      | Lease abandonment expense                           |                                                     |         |                 |        |          |         | 225    |        
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     |                                                                      |                                                                      | Compensation expense related to stock options       |                                                     |         | 26               |        |          |         | 158    |        
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     |                                                                      |                                                                      | Restructuring related charges                       |                                                     |         | 768              |        |          |         | 13,920 |        
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     |                                                                      |                                                                      | Impairment of goodwill and other intangibles        |                                                     |         |                 |        |          |         | 75,298 |        
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     |                                                                      |                                                                      | Amortization of premiums (discounts) on investments |                                                     |         | 201              |        |          |         | (233   | )      
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     |                                                                      |                                                                      | Changes in assets and liabilities:                  |                                                     |         |                  |        |          |         |        |        
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     |                                                                      |                                                                      |                                                     | Accounts receivable                                 |         |                  | (524   | )        |         |        | 4,387   |  
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     |                                                                      |                                                                      |                                                     | Royalties receivable                                |         |                  |       |          |         |        | 671     |  
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     |                                                                      |                                                                      |                                                     | Prepaid expenses & other current assets             |         |                  | (15    | )        |         |        | (1,555  | )
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     |                                                                      |                                                                      |                                                     | Other assets                                        |         |                  | 178    |          |         |        | 432     |  
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     |                                                                      |                                                                      |                                                     | Accounts payable                                    |         |                  | 257    |          |         |        | (929    | )
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     |                                                                      |                                                                      |                                                     | Accrued expenses                                    |         |                  | (2,811 | )        |         |        | (2,678  | )
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     |                                                                      |                                                                      |                                                     | Deferred revenue                                    |         |                  | (45    | )        |         |        | (1,309  | )
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     |                                                                      |                                                                      |                                                     | Other long-term liabilities                         |         |                  | (33    | )        |         |        | (61     | )
|                                                    
|                                                     |                                                                      |                                                                      |                                                     | Total adjustments                                   |         |                  | (671   | )        |         |        | 99,687  |  
|                                                    
|                                                     |                                                                      |                                                                      |                                                     | Net cash used in operating activities               |         |                  | (8,481 | )        |         |        | (14,941 | )
|                                                    
|                                                    
|                                                    
|                                                    
|Cash flows from investing activities:                |                                                                      |                                                                      |                                                     |                                                     |         |                  |        |         
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     |                                                                      | Purchases of short-term investments                                  |                                                     |                                                     | (22,535 | )                |        |          | (93,884 | )     
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     |                                                                      | Sales and maturities of short-term investments                       |                                                     |                                                     | 29,192  |                  |        |          | 117,237 |       
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     |                                                                      | Purchases of property and equipment                                  |                                                     |                                                     |        |                  |        |          | (148    | )     
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     |                                                                      |                                                                      |                                                     | Net cash provided by investing activities           |         |                  | 6,657  |          |         |        | 23,205  |  
|                                                    
|                                                    
|                                                    
|                                                    
|Cash flows from financing activities:                |                                                                      |                                                                      |                                                     |                                                     |         |                  |        |         
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     |                                                                      | Proceeds from exercise of stock options, net of stock repurchases    |                                                     |                                                     | 62      |                  |        |          | 38      |       
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     |                                                                      | Proceeds from issuance of stock under employee stock purchase plan   |                                                     |                                                     | 38      |                  |        |          | 85      |       
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     |                                                                      | Principal payments under capital lease obligations and notes payable |                                                     |                                                     | (89     | )                |        |          | (336    | )     
|                                                    
|                                                     |                                                                      |                                                                      |                                                     | Net cash provided by (used in) financing activities |         |                  | 11     |          |         |        | (213    | )
|                                                    
|Net (decrease) increase in cash and cash equivalents |                                                                      |                                                                      | (1,813                                              | )                                                   |         |                  | 8,051  |         
|                                                    
|                                                    
|                                                    
|                                                    
|Cash and cash equivalents at beginning of period     |                                                                      |                                                                      | 14,929                                              |                                                     |         |                  | 16,396 |         
|                                                    
|Cash and cash equivalents at end of period           |                                                                      | $                                                                    | 13,116                                              |                                                     |         | $                | 24,447 |         
|                                                    

See accompanying notes to the consolidated financial statements.

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##### Table of Contents






NET PERCEPTIONS, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(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. 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, 2001, which are contained in the
Companys Annual Report on Form 10-K (File No. 000-25781). 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.

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 $(389) and $134 for the
second quarter 2002 and 2001 and $314 and $141 for the six months ended June
30, 2002 and 2001, respectively. Comprehensive loss was $4,727 and $5,700 for
the three months ended June 30, 2002 and 2001, respectively, and $7,496 and
$114,487 for the six months ended June 30, 2002 and 2001, respectively.

Note 2. Recently Issued Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board (FASB) approved
Statements of Financial Accounting Standards (SFAS) No. 141, Business
Combinations and No. 142, Goodwill and Other Intangible Assets. The
statements eliminate the pooling-of-interests method of accounting for business
combinations and require that goodwill and certain intangible assets not be
amortized. Instead, the statements provide that these assets should be tested,
at least annually, for impairment with any related losses recognized as
incurred. SFAS No. 141 is generally effective for business combinations
completed after June 30, 2001. SFAS No. 142 was effective for the Company
beginning January 1, 2002 for existing goodwill and intangible assets. See Note
5 to the Consolidated Financial Statements for additional discussion on the
impact of SFAS No. 141 and No. 142.

In October 2001, FASB issued SFAS No. 144, Accounting for the Impairment
or Disposal of Long-Lived Assets. This statement addresses financial
accounting and reporting for the impairment of long-lived assets and for
long-lived assets to be disposed of and supersedes SFAS No. 121 and APB Opinion
No. 30. SFAS No. 144 was effective for the Company beginning January 1, 2002.
The adoption of SFAS No.144 had no impact on the Companys financial position
or results of operations.

In accordance with Emerging Issue Task Force Issue No. 01-14, Income
Statement Characterization of Reimbursements Received for Out-of-Pocket
Expenses Incurred, the Company began to account for such items as revenue and
cost of revenue effective January 1, 2002. Service revenues and cost of
service revenues include $60 and $109 of such amounts for the second quarter of
2002 and the six months ended June 30, 2002, respectively. Additionally,
service revenues and cost of service revenues of $85 and $179 for the second
quarter of 2001 and the six months ended June 30, 2001, respectively, have been
reclassified to conform to current period presentation.

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Note 3. Net Loss Per Share

Net loss per share is computed under SFAS No. 128, Earnings Per Share.
Basic net loss per share is computed using the weighted-average number of
shares of common stock outstanding, excluding shares of common stock subject to
repurchase. Such shares of common stock subject to repurchase aggregated 2 and
24 at June 30, 2002 and 2001, respectively. Diluted net loss per share does
not differ from basic net loss per share since potential shares of common stock
from conversion of stock options and outstanding shares of common stock subject
to repurchase are anti-dilutive for all periods presented. Options to purchase
3,073 and 3,711 shares of the Companys common stock were outstanding as of
June 30, 2002 and 2001, respectively, and could potentially dilute earnings per
share in future periods.

Note 4. Impairment of Goodwill and Other Intangibles

In February 2000, the Company acquired Knowledge Discovery One, Inc.
(KD1), a developer and marketer of advanced data analysis solutions for
retailers. Intangible assets recorded in conjunction with the acquisition
consisted of acquired technology, customer list, workforce and goodwill of
$4,000, $3,000, $1,000 and $110,755, respectively. At March 31, 2001, the
Company performed an impairment assessment of the KD1 goodwill and intangible
assets. As a result of its review, the Company recorded a $75,298 impairment
charge to reduce goodwill and other intangible assets to their estimated fair
values.

Note 5. Goodwill and Other Intangible Assets  Adoption of SFAS No. 141 and No. 142

Effective January 1, 2002, in accordance with SFAS No. 141 and No. 142,
the Company ceased amortizing goodwill and certain other identified intangible
assets that had a net book value of approximately $6,500 as of January 1, 2002,
which is expected to reduce 2002 annual amortization expense by approximately
$3,100. Instead these assets will be reviewed for impairment at least annually.
A transitional impairment review was performed during the quarter ended June
30, 2002 and the Company did not record any impairment charge as a result of
this review.

The adoption of these statements resulted in the Company not recognizing
$771 and $1,541 of amortization expense for the second quarter of 2002 and the
six months ended June 30, 2002, respectively, that would have been recognized
had the old standards been in effect. The Companys net loss for the second
quarter of 2001 and the six months ended June 30, 2001 included $771 and
$7,776, respectively, in amortization expense relating to goodwill and certain
other identified intangible assets that are no longer being amortized.

The following table presents the impact of these statements on net loss
and net loss per share, as if they had been in effect for the three and six
months ended June 30, 2001.

|                   |  |                    |        |                  |  |          |        |          |  |          |        |          |  |   |        |   |  |   |          |   |  |   |          |  
|------------------ |  | ------------------ | ------ | ---------------- |  | -------- | ------ | -------- |  | -------- | ------ | -------- |  | - | ------ | - |  | - | -------- | - |  | - | -------- | -
|                   |  | Three Months Ended |        | Six Months Ended
|                   |  | June 30,           |        | June 30,        
|                   |  |                    |        |                 
|                   |  | 2002               |        | 2001             |  | 2001     |        | 2002     |  | 2001     |        | 2001    
|                   |  | Reported           |        | Adjusted         |  | Reported |        | Reported |  | Adjusted |        | Reported
|                   |  |                    |        |                 
|Net Loss           |  | $                  | (4,338 | )                |  | $        | (5,063 | )        |  | $        | (5,834 | )        |  | $ | (7,810 | ) |  | $ | (106,852 | ) |  | $ | (114,628 | )
|                  
|                  
|                  
|                  
|Net Loss per Share |  | $                  | (0.16  | )                |  | $        | (0.19  | )        |  | $        | (0.22  | )        |  | $ | (0.29  | ) |  | $ | (3.97    | ) |  | $ | (4.26    | )
|                   |  |                    |        |                 

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##### Table of Contents



Intangible assets subject to amortization were as follows:

|                                                      |  |          |        |              |  |   |        |  
|----------------------------------------------------- |  | -------- | ------ | ------------ |  | - | ------ | -
|                                                      |  | June 30, |        | December 31,
|                                                      |  | 2002     |        | 2001        
|                                                      |  |          |        |             
|Existing Technology                                   |  | $        | 1,775  |              |  | $ | 1,775  |  
|                                                     
|                                                     
|                                                     
|                                                     
|Customer List                                         |  |          | 1,331  |              |  |   | 1,331  |  
|                                                      |  |          |        |              |  |   |        |  
|                                                      |  |          | 3,106  |              |  |   | 3,106  |  
|                                                     
|                                                     
|                                                     
|                                                     
|Less: Accumulated Amortization of Existing
Technology |  |          | (1,683 | )            |  |   | (1,610 | )
|                                                     
|                                                     
|                                                     
|                                                     
|Less: Accumulated Amortization of Customer List       |  |          | (1,262 | )            |  |   | (1,207 | )
|                                                      |  |          |        |              |  |   |        |  
|                                                      |  |          | (2,945 | )            |  |   | (2,817 | )
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      |  | $        | 161    |              |  | $ | 289    |  
|                                                      |  |          |        |              |  |   |        |  

Amortization expense related to other intangible assets was $63 and $128
for the second quarter of 2002 and the six months ended June 30, 2002,
respectively, and is expected to be $257 and $32 for the full fiscal year
ending December 31, 2002 and three months ending March 31, 2003, respectively.

Note 6. Restructuring Related Charges

The Company recorded restructuring related charges of $401 in the second
quarter of 2002. $139 related to employee termination costs due
to a reduction in workforce by 18 or 21%, $291 represents the write- down of
certain fixed assets and $(29) represents a reversal of previously recorded
restructuring related charges resulting from revised estimates of other costs.
In 2001, the Company instituted two separate 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 $15,551 in 2001, of which $13,920 was recorded as of
June 30, 2001.

A total of $1,076 was charged against the restructuring reserve during the
second quarter of 2002, bringing the total charges against the restructuring
reserve to $2,667 for the six months ended June 30, 2002, lowering the accrued
restructuring liability to $5,534. Charges against the reserve during the three
months ended June 30, 2002 included $355 of non-cash fixed assets write-offs,
$191 in employee severance payments, $807 in rent payments and $213 in costs
relating to subletting facilities. These charges were partially offset by $393
of sublease income and $97 in proceeds from the sale of fixed assets. For the
six months ended June 30, 2002 the charges included $642 of non-cash fixed
assets write-offs, $500 in employee severance payments, $1,444 in rent payments
and $845 in costs relating to subletting facilities. These charges were
partially offset by $708 of sublease income and $56 in proceeds from the sale
of fixed assets. In conjunction with the restructuring related charges
recorded, the Company made certain estimates regarding future sublease income
that have a significant impact on its anticipated cash obligations and related
restructuring reserves. Although the Company believes that the lease commitment
estimates are appropriate in the current circumstances, future changes in real
estate markets could impact the ultimate amount of cash paid to resolve these
obligations. The Company is actively seeking to sublease its remaining excess
facilities. Specifically, the Company is currently seeking to sublease an
additional portion of its Edina, Minnesota office space, its entire Roseland,
New Jersey office space and a portion of its office space in Austin, Texas.
However, there is a risk that the Company may not be able to sublease these
facilities under favorable terms, if at all, which could negatively impact the
Companys cash flow and future operating results.

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##### Table of Contents



The following table presents a summary of the restructuring related
activities and accrued restructuring charges as of June 30, 2002:

|                                         |          |      |                    |         |               |          |               |              |             |           |        |        |               |   |          |     |       |   |               |   |         |   |       |       | 
|---------------------------------------- | -------- | ---- | ------------------ | ------- | ------------- | -------- | ------------- | ------------ | ----------- | --------- | ------ | ------ | ------------- | - | -------- | --- | ----- | - | ------------- | - | ------- | - | ----- | ----- | 
|                                         |          |      |                    |         |               |          |               |              |             |           |        |        |               |   | Sublease |     |       |   |               |   | Accrued
|                                         |          |      | Accrued            |         |               |          |               |              |             |           |        |        | Income and    |   |          |     |       |   | Restructuring
|                                         |          |      | Restructuring      |         |               |          |               |              |             |           |        |        | Proceeds from |   | Non-Cash |     | as of
|                                         |          |      | as of December 31, |         | Restructuring |          | Restructuring |              | the Sale of |           | Asset  |        | June 30,     
|Description                              |          | 2001 |                    | Charges |               | Payments |               | Fixed Assets |             | Disposals |        | 2002  
|                                         |          |      |                    |         |               |          |               |              |             |           |        |       
|Lease commitments and
related items      |          | $    | 6,896              |         |               | $        |              |              |             | $         | (2,287 | )      |               | $ | 708      |     |       | $ |              |   |         | $ | 5,317 |      
|                                        
|                                        
|                                        
|                                        
|Employee severance and
termination costs |          |      | 111                |         |               |          | 506           |              |             |           | (500   | )      |               |   |         |     |       |   |              |   |         |   | 117   |      
|                                         |          |      |                    |         |               |          |               |              |             |           |        |        |               |   |          |     |       |   |               |   |         |   |       |      
|                                         | Subtotal |      |                    | 7,007   |               |          |               | 506          |             |           |        | (2,787 | )             |   |          | 708 |       |   |               |  |         |   |       | 5,434 | 
|                                        
|                                        
|                                        
|                                        
|Fixed asset disposals and
other costs    |          |      | 426                |         |               |          | 262           |              |             |           | (2     | )      |               |   | 56       |     |       |   | (642          | ) |         |   | 100   |      
|                                         |          |      |                    |         |               |          |               |              |             |           |        |        |               |   |          |     |       |   |               |   |         |   |       |      
|                                         |          | $    | 7,433              |         |               | $        | 768           |              |             | $         | (2,789 | )      |               | $ | 764      |     |       | $ | (642          | ) |         | $ | 5,534 |      
|                                         |          |      |                    |         |               |          |               |              |             |           |        |        |               |   |          |     |       |   |               |   |         |   |       |      




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

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 develop and market software solutions that enable our customers to
interact more intelligently with their customers. Our solutions integrate and
analyze information about customers, products and promotional activity to
generate specific actions our customers can take to improve their marketing,
selling, merchandising and advertising effectiveness, leading to increased
revenue, improved profit, decreased costs and enhanced customer satisfaction.
We combine our software products with industry expertise and professional
services to create highly-focused, industry-specific solutions that are
designed to integrate with and add significant value to existing custom or
purchased CRM systems and processes.

We sell our solutions worldwide primarily through a direct sales force. We
license our products under various pricing plans, such as per user, per CPU,
per site and per enterprise. We generally grant licenses on a perpetual basis.
License fees for our products range from $50,000 to in excess of $1.0 million.
We provide product maintenance pursuant to service agreements, the pricing of
which is typically based on a percentage of the related product license fee and
is generally paid in advance. Professional service fees for business
consulting, implementation support, data processing and educational services
are generally priced on a time and materials basis. In addition, we offer some
of our products on a hosted basis. Charges for hosted product related services
vary across service offerings, but generally include an initial set-up fee and
a recurring monthly charge based on usage.

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 2002 and 2001, 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 and 59 as of June 30,
2002.

We have sustained losses on a quarterly and annual basis since inception.
As of June 30, 2002, we had an accumulated deficit of $208 million. Our net
loss was $4.3 million in the second quarter of 2002 (including $401,000 in
restructuring related charges and $74,000 of amortization of intangible assets
and non-cash stock compensation expense), compared to a net loss of $5.8
million in the second quarter of the prior year (including $897,000 of
amortization of goodwill and other intangibles and non-cash stock compensation
expense). For the six months ended June 30, 2002, our net loss was $7.8 million
(including $768,000 in restructuring related charges and $154,000 of
amortization of intangible assets and non cash stock compensation expense)
compared to a $114.6 million net loss in

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the same period in 2001 (including $13.9 million in restructuring charges,
$8.6 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).These losses resulted from significant costs
incurred in the development and sale of our products and services as well as a
decline in our product revenues since the third quarter of 2000. We anticipate
that our operating expenses will continue to constitute a material use of our
cash resources. We also expect to incur additional losses and continued
negative cash flow from operations for the foreseeable future. We do not expect
to achieve profitability (including restructuring charges, amortization and
impairment of goodwill and other intangibles and stock compensation) in 2002.

Our relatively limited operating history makes the prediction of future
operating results very difficult. We believe that 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 risks, expenses
and difficulties encountered by companies in relatively new and rapidly
evolving markets. We may not be successful in addressing these risks and
difficulties. Prior to the third quarter of 2000, we experienced significant
sequential percentage quarterly growth in revenues. We do not believe that
prior revenue growth rates are indicative of future growth rates.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our discussion and analysis of financial condition and results of
operations are based upon our consolidated financial statements, which have
been prepared in accordance with accounting principles generally accepted in
the United States. The preparation of these financial statements requires 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:

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 and in accordance with the Securities and Exchange Commission Staff
Accounting Bulletin (SAB) No. 101, 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 and
management, implementation and testing, data analysis, user and partner
training, consulting, product hosting 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.

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 our
products and services on a hosted basis, up front set-up fees are deferred and
recognized ratably over the estimated service period.

11



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##### Table of Contents



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.

Sublease income.In conjunction with the restructuring related charges
recorded in 2001 and 2002, we made certain estimates regarding future sublease
income that have a significant impact on our anticipated cash obligations.
Although we believe that our lease commitment estimates are appropriate in the
current circumstances, future changes in real estate markets could impact the
ultimate amount of cash paid to resolve these obligations.

Allowance for doubtful accounts.We maintain allowances for doubtful
accounts for estimated losses resulting from the inability of our customers to
make required payments. If the financial condition of our customers were to
deteriorate, resulting in an impairment of their ability to make payments,
additional allowances may be required.

Litigation.We have not recorded an estimated liability related to the
class action lawsuit 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, we are unable to make a reasonable estimate of the liability that could
result from an unfavorable outcome. As additional information becomes
available, we will assess the potential liability and revise our estimates
accordingly. Revisions in our estimates of the potential liability could
materially impact our results of operations and financial position.

Valuation of long-lived and intangible assets and goodwill.We review
goodwill, identifiable intangibles and other long-lived assets for impairment
annually or sooner if events or changes in circumstances indicate that the
carrying amount may not be recoverable. Events or changes in circumstances that
indicate the carrying amount may not be recoverable include, but are not
limited to, a significant decrease in the market value of business and asset
acquired, a significant adverse change in the extent or manner in which the
business or asset acquired is used or a significant adverse change in the
business climate. If such events or changes in circumstances are present, the
fair value of a reporting unit is compared with its carrying amount, including
goodwill. If the fair value of a reporting unit exceeds its carrying amount,
goodwill of the reporting unit is considered not impaired. If the carrying
amount of a reporting unit exceeds its fair value, the amount of impairment
will be measured in accordance with the guidance of SFAS 142. All of our
goodwill was assigned to a single reporting unit, which is our sole operating
segment.

12



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##### Table of Contents



RESULTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2002 AND JUNE 30, 2001

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:

|                            |                                              |                          |      |                    |     |                  |      |      |     |      |      |     |     |  |        |       |       | 
|--------------------------- | -------------------------------------------- | ------------------------ | ---- | ------------------ | --- | ---------------- | ---- | ---- | --- | ---- | ---- | --- | --- |  | ------ | ----- | ----- | 
|                           
|                           
|                            |                                              |                          |      | Three Months Ended |     | Six Months Ended
|                            |                                              |                          |      | June 30,           |     | June 30,        
|                            |                                              |                          |      | 2002               |     | 2001             |      | 2002 |     | 2001
|                           
|Revenues:                   |                                              |                          |      |                    |     |                  |      |      |     |      |      |     |     |  |        |      
|                           
|                           
|                           
|                           
|                            | Product                                      |                          |      | 56                 | %   |                  |      | 16   | %   |      |      | 35  | %   |  |        | 24    | %    
|                           
|                           
|                           
|                           
|                            | Service and maintenance                      |                          |      | 44                 |     |                  |      | 84   |     |      |      | 65  |     |  |        | 76    |      
|                           
|                            |                                              | Total revenues           |      |                    | 100 |                  |      |      | 100 |      |      |     | 100 |  |        |       | 100   | 
|                           
|                           
|                           
|                           
|Cost of revenues:           |                                              |                          |      |                    |     |                  |      |      |     |      |      |     |     |  |        |      
|                           
|                           
|                           
|                           
|                            | Product                                      |                          |      | 4                  |     |                  |      | 3    |     |      |      | 7   |     |  |        | 9     |      
|                           
|                           
|                           
|                           
|                            | Service and maintenance                      |                          |      | 34                 |     |                  |      | 52   |     |      |      | 48  |     |  |        | 62    |      
|                           
|                            |                                              | Total cost of revenues   |      |                    | 38  |                  |      |      | 55  |      |      |     | 55  |  |        |       | 71    | 
|                           
|                           
|                           
|                           
|Gross Margin                |                                              |                          | 62   |                    |     |                  | 45   |      |     |      | 45   |     |     |  | 29     |      
|                           
|                           
|                           
|                           
|Operating expenses:         |                                              |                          |      |                    |     |                  |      |      |     |      |      |     |     |  |        |      
|                           
|                           
|                           
|                           
|                            | Sales and marketing                          |                          |      | 86                 |     |                  |      | 123  |     |      |      | 104 |     |  |        | 189   |      
|                           
|                           
|                           
|                           
|                            | Research and development                     |                          |      | 101                |     |                  |      | 91   |     |      |      | 131 |     |  |        | 108   |      
|                           
|                           
|                           
|                           
|                            | General and administrative                   |                          |      | 58                 |     |                  |      | 86   |     |      |      | 61  |     |  |        | 76    |      
|                           
|                           
|                           
|                           
|                            | Lease abandonment expense                    |                          |      |                   |     |                  |      |     |     |      |      |    |     |  |        | 4     |      
|                           
|                           
|                           
|                           
|                            | Restructuring related charges                |                          |      | 25                 |     |                  |      |     |     |      |      | 28  |     |  |        | 239   |      
|                           
|                           
|                           
|                           
|                            | Amortization of intangibles                  |                          |      | 2                  |     |                  |      | 32   |     |      |      | 2   |     |  |        | 139   |      
|                           
|                           
|                           
|                           
|                            | Impairment of goodwill and other intangibles |                          |      |                   |     |                  |      |     |     |      |      |    |     |  |        | 1,295 |      
|                           
|                            |                                              | Total operating expenses |      |                    | 272 |                  |      |      | 332 |      |      |     | 326 |  |        |       | 2,050 | 
|                           
|Loss from operations        |                                              |                          | (210 | )                  |     |                  | (287 | )    |     |      | (281 | )   |     |  | (2,021 | )    
|                           
|                           
|                           
|                           
|Other income (expense), net |                                              |                          | (61  | )                  |     |                  | 52   |      |     |      | (4   | )   |     |  | 50     |      
|                           
|Net loss                    |                                              |                          | (271 | )%                 |     |                  | (235 | )%   |     |      | (285 | )%  |     |  | (1,971 | )%   
|                           

REVENUES

Total revenues. Total revenues decreased 36% to $1.6 million in the
quarter ended June 30, 2002, from $2.5 million in the second quarter of 2001.
Revenues decreased 53% to $2.7 million for the six months ended June 30, 2002,
from $5.8 million for the same period in 2001. Revenues from sales in the
United States were $1.5 million or 94% of total revenues in the second quarter
of 2002 compared to $2.0 million or 82% of total revenues in the second quarter
of 2001. Revenues from sales in the United States were $2.5 million or 90% of
total revenues for the six months ended June 30, 2002 compared to $4.3 million
or 74% of total revenues for the six months ended June 30, 2001. Revenues from
international sales in the second quarter of 2002 were $99,000 or 6% of total
revenues compared to $446,000 or 18% of total revenues in the second quarter of
the prior year. Revenues from international sales were $266,000 and $1.5
million, or 10% and 26% of total revenues, for the six months ended June 30,
2002 and 2001, respectively. The majority of international sales were made in
Europe and Asia by our direct sales organizations based in the United States
and the United Kingdom. International sales are generally denominated in United
States dollars.

During the second quarter of 2002 and as part of our strategy to focus our
marketing and development efforts on NetP 7.0, we began to wind-down our
non-strategic product and service offerings, including Advertising Advisor,
which in 2001 accounted for a significant portion of our total
revenues. NetP 7.0 incorporates certain key components from our non-strategic
product offerings.

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Product revenues.Product revenues increased 134% to $902,000 in the
second quarter of 2002 compared to $386,000 for the same period in the prior
year. Product revenues decreased 32% to $945,000 for the six months ended June
30, 2002 from $1.4 million in the same period of 2001. Product revenues
comprised 56% of total revenues for the second quarter of 2002 compared to 16%
for the same period in 2001. Product revenues comprised 35% of total revenues
for the six months ended June 30, 2002 compared to 24% for the same period in
2001. The increase in product revenues in the second quarter of 2002 is the
result of an increase in license transactions. Historical percentage growth
rates of our product revenues have not been sustainable and we do not currently
expect to achieve such historical percentage growth rates in the future.

Service and maintenance revenues.Service and maintenance revenues
consist primarily of professional and maintenance services and, secondarily,
product hosting services. Our professional service revenues include business
consulting, implementation support, data and processing 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 67% to $697,000 in the second quarter of 2002 from $2.1
million in the second quarter of 2001. Service and maintenance revenues
comprised 44% and 84% of total revenues in the second quarter of 2002 and 2001,
respectively. Total service and maintenance revenues decreased 59% to $1.8
million for the six months ended June 30, 2002 from $4.4 million in the same
period of 2001. Service and maintenance revenues comprised 65% and 76% of
total revenues for the six months ended June 30, 2002 and 2001,
respectively. The decrease in service and maintenance revenues in absolute dollars reflects
lower levels of consulting and maintenance services due to the combined effect
of fewer new customer acquisitions, the wind-down, during the second quarter of
2002, of non-strategic product and services offerings, including Advertising
Advisor, that in 2001 accounted for a significant portion of our services revenues, and a decline
in our customer base, particularly Internet retailers. Prior percentage growth
rates of our service and maintenance revenues have not been sustainable and we
do not currently expect to achieve such prior percentage growth rates in the
future.

As stated in Note 2 to the Consolidated Financial Statements, in
accordance with Emerging Issue Task Force Issue No. 01-14, Income Statement
Characterization of Reimbursements Received for Out-of-Pocket Expenses
Incurred, we began to account for such items as revenue and cost of revenue
effective January 1, 2002. Service revenues for the three months ended June
30, 2002 and the six months ended June 30, 2002 include $60,000 and $109,000,
respectively, of such amounts. Additionally, service revenues of $85,000 and
$179,000 for the three months ended June 30, 2001 and the six months ended June
30, 2001, respectively, have been reclassified to conform to current period
presentation.

COST OF REVENUES

Cost of product revenues.Cost of product revenues consists primarily of
the cost of royalties paid to third-party vendors, amortization of acquired
technology costs, product media and duplication, manuals, packaging materials
and shipping expenses. Cost of product revenues decreased 21% to $63,000 in the
second quarter of 2002 from $80,000 in the second quarter of 2001, representing
7% and 21% of the related product revenues, respectively. Cost of product
revenues decreased 64% to $186,000 for the six months ended June 30, 2002 from
$521,000 for the six months ended June 30, 2001, representing 20% and 37% of
the related product revenues, respectively. The decrease in cost of product
revenues in absolute dollars is primarily attributable to a decrease in
amortization of acquired technology cost in connection with our acquisition of
KD1 in February 2000 and to reduced product revenues and royalties payable to
third parties. Since all internal development costs incurred in the research
and development of new software products and enhancements to existing software
products have been expensed as incurred, cost of product revenues includes no
amortization of capitalized software development costs. We currently intend to
decrease our reliance on licensed third-party technology in 2002, which may
result in the cost of product revenues declining as a percentage of product
revenues.

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, educational and hosted product related
services to customers. Cost of service and maintenance revenues decreased 59%
to $539,000 in the second quarter of 2002, from $1.3 million in the second
quarter of the prior year, representing 77% and 62% of the related service and
maintenance revenues, respectively. Cost of service and maintenance revenues
decreased 64% to $1.3 million for the six months ended June 30, 2002 from $3.6
million for the same period in the prior year, representing 73% and 81% of the
related service and maintenance revenues, respectively. The decrease in cost
of services and maintenance revenues in absolute dollars and

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as a percentage of revenues is primarily due to decreased use of
third-party consultants to staff consulting engagements and headcount
reductions in our service organization as a result of our restructuring
efforts. Cost of service and maintenance revenues may vary significantly from
quarter to quarter depending upon the mix of services that we provide and the
utilization rate of our service personnel.

As stated above, and in Note 2 to the Consolidated Financial Statements,
in accordance with Emerging Issue Task Force Issue No. 01-14, Income Statement
Characterization of Reimbursements Received for Out-of-Pocket Expenses
Incurred, we began to account for such items as revenue and cost of revenue
effective January 1, 2002. Cost of service revenues for the three months ended
June 30, 2002 and the six months ended June 30, 2002 include $60,000 and
$109,000, respectively, of such amounts. Additionally, cost of service
revenues of $85,000 and $179,000 for the three months ended June 30, 2001, and
the six months ended June 30, 2001, respectively, have been reclassified to
conform to current period presentation.

OPERATING EXPENSES

Sales and marketing. Sales and marketing expenses consist 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 were $1.4 million in the second quarter
of 2002, a decrease of 55% from the $3.0 million in the second quarter of 2001.
Sales and marketing expenses were 86% and 123% of total revenues in the second
quarter of 2002 and 2001, respectively. Sales and marketing expenses were $2.9
million and $11.0 million, or 104% and 189% of total revenues, for the six
months ended June 30, 2002 and 2001, 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 decreased spending on marketing
programs.

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 were $1.6
million in the second quarter of 2002, a decrease of 28% from the $2.3 million
in the second quarter of 2001. Research and development expenses were 102% and
91% of total revenues in the second quarter of 2002 and 2001, respectively.
Research and development expenses were $3.6 million and $6.3 million, or 131%
and 108% of total revenues, for the six months ended June 30, 2002 and 2001,
respectively. The decrease in research and development expenses in absolute
dollars is primarily due to headcount reductions as a result of our
restructuring efforts.

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
were $935,000 in the second quarter of 2002, a decrease of 56% from the $2.1
million recorded in the second quarter of 2001. General and administrative
expenses were 58% and 86% of total revenue in the second quarter of 2002 and
2001, respectively. General and administrative expenses were $1.7 million and
$4.4 million, or 61% and 76% of total revenues, for the six months ended June
30, 2002 and 2001, respectively. The decrease in general and administrative
expenses in absolute dollars is primarily due to headcount reductions as a
result of our restructuring efforts and reduction in bad debt expense offset by
$213,000 recorded in second quarter of 2002 related to legal and accounting
fees related to M&A work that we do not believe will materialize in a
transaction in the near term.

Lease abandonment expenses.Lease abandonment expenses relate to our
August 2000 abandonment of our previous headquarters facility upon our move to
new corporate headquarters. In October 2001, we entered into an agreement to
sublease the majority of our previous headquarters facility to a third party.
For the six months ended June 30, 2002, no lease abandonment charges were
recorded compared to $225,000 in the same period in 2001. Lease abandonment
charges represented 4% of total revenues for the six months ended June 30,
2001.

Restructuring related charges.We recorded restructuring related charges
of $401,000 in the second quarter of 2002, relating to employee termination
costs due to a reduction in workforce, a write-down of certain fixed assets and
a reversal resulting from revised estimates of other costs. We recorded a
total of $768,000 of restructuring related charges for the six months ended
June 30, 2002. In 2001, we instituted two separate 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 approximately $15.6 million in 2001 ($13.9 million was
recorded through the second quarter of 2001).

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A total of approximately $1.1 million was charged against the
restructuring reserve during the second quarter of
2002, bringing the total charges against the restructuring reserve to $2.7
million for the six months ended June 30, 2002, lowering the accrued
restructuring liability to approximately $5.5 million. Charges against the
reserve during the second quarter of 2002 included $355,000 of non-cash fixed
assets write-offs, $191,000 in employee severance payments, $807,000 in rent
payments and $213,000 in costs relating to subletting facilities. These charges
were partially offset by $393,000 of sublease income and $97,000 in proceeds
from the sale of fixed assets. For the six months ended June 30, 2002 the
charges included $642,000 of non-cash fixed assets write-offs, $500,000 in
employee severance payments, $1.4 million in rent payments and $845,000 in
costs relating to subletting facilities. These charges were partially offset by
$708,000 of sublease income and $56,000 in proceeds from the sale of fixed
assets. In conjunction with the restructuring related charges recorded, we
made certain estimates regarding future sublease income that have a significant
impact on our anticipated cash obligations and related restructuring reserves.
Although we believe that the lease commitment estimates are appropriate in the
current circumstances, future changes in real estate markets could impact the
ultimate amount of cash paid to resolve these obligations.

Amortization of intangibles.Amortization expense related to goodwill and
other intangibles acquired in the February 2000 acquisition of KD1 was $63,000,
(including $36,000 amortization of goodwill and other intangibles included in
cost of product revenues) during the second quarter of 2002. This is compared
to $835,000 (including $37,000 of amortization of goodwill and other
intangibles included in the cost of product revenues) during the second quarter
of 2001. This represented 4% and 34% of 2002 and 2001 second quarter total
revenues, respectively. Amortization expense was $128,000 (including $73,000 of
amortization and goodwill and other intangibles included in cost of product
revenues) for the six months ended June 30, 2002. This is compared to $8.4
million (including $370,000 of amortization of goodwill and other intangibles
included in the cost of product revenues) for the six months ended June 30,
2001. This represented 5% and 145% of total revenues for the six months ended
June 30, 2002 and 2001, respectively. Total amortization of goodwill and other
intangibles is expected to be significantly lower for 2002 and through the
first quarter of 2003 due to the $75.3 million impairment of goodwill and other
intangibles charge recorded in the first quarter of 2001 discussed below and
our adoption of Statements of Financial Accounting Standards (SFAS) No. 142,
Goodwill and Other Intangible Assets on January 1, 2002, under which we are
no longer amortizing goodwill and certain other identified intangible assets.
See also Note 5 to the Consolidated Financial Statements.

Impairment of goodwill and other intangibles. At March 31, 2001, we
performed an impairment assessment of the goodwill and other intangible assets
recorded in connection with the acquisition of KD1. As a result of our review,
we recorded a $75.3 million impairment charge to reduce goodwill and other
intangible assets to their estimated fair values. In accordance with SFAS
No. 142, beginning January 1, 2002, goodwill and certain other intangibles are
no longer being amortized, resulting in a reduction of quarterly amortization
of $771,000 and annual amortization expense of approximately $3.1 million in
2002. Amortization expense related to other intangible assets is expected to
be $257,000 and $32,000 for 2002 and the first quarter of 2003, respectively.
However, as noted above, the remaining unamortized goodwill and intangible
asset balances are subject to periodic impairment analysis, which could require
a write-down of these assets in the future.

Stock compensation expense. Compensation charges related to stock options
were $11,000 in the second quarter of 2002 and $62,000 in the second quarter of
2001, comprising 0.7% and 2% of total revenues in each of the respective
periods. Stock compensation was $26,000 and $158,000, or 0.9% and 3% of total
revenues, for the first half of 2002 and 2001, respectively. Stock compensation
expense represents the amortization of deferred compensation related to stock
options granted in 1999 and 1998. Such compensation is amortized over the
four-year repurchase period of the common stock underlying the related options.
Stock compensation expense was recorded in the functional operating expense
categories as follows:

|                           |  |                    |        |                  |  |      |        |      |  |   |        |  |  |   |         | 
|-------------------------- |  | ------------------ | ------ | ---------------- |  | ---- | ------ | ---- |  | - | ------ |  |  | - | ------- | 
|                           |  | Three Months Ended |        | Six Months Ended
|                           |  | June 30,           |        | June 30,        
|                           |  |                   
|                           |  | 2002               |        | 2001             |  | 2002 |        | 2001
|                           |  |                   
|Sales and marketing        |  | $                  | 8,000  |                  |  | $    | 13,000 |      |  | $ | 16,000 |  |  | $ | 25,000  | 
|                          
|                          
|                          
|                          
|Research and development   |  |                    |       |                  |  |      | 40,000 |      |  |   | 3,000  |  |  |   | 109,000 | 
|                          
|                          
|                          
|                          
|General and administrative |  |                    | 3,000  |                  |  |      | 9,000  |      |  |   | 7,000  |  |  |   | 24,000  | 
|                           |  |                   
|                           |  | $                  | 11,000 |                  |  | $    | 62,000 |      |  | $ | 26,000 |  |  | $ | 158,000 | 
|                           |  |                   

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Other income (expense), net. Other income (expense), net, consists of
interest income, interest expense, foreign currency transaction losses or gains
and other expense. Net other expense was $972,000 in the second quarter of 2002
compared to net other income of $1.3 million in the same period in 2001. Net
other expense was $113,000 compared to net other income of $2.9 million for the
six months ended June 30, 2002 and 2001, respectively. The decrease in net
other income for the three months ended June 30, 2002 compared to the same
period in 2001 was largely attributable to the $1.6 million loss on investment
resulting from our sale of $2.1 million in WorldCom bonds upon announcement of
accounting issues by WorldCom.

PROVISION FOR INCOME TAXES

We have incurred significant operating losses for all periods from
inception through June 30, 2002. As of December 31, 2001, we had net operating
loss carry-forwards of approximately $91.6 million available to reduce future
taxable income expiring at various dates beginning in 2011. In addition, as of
December 31, 2001, we had $195,000 of tax credit carry-forwards expiring at
various dates beginning in 2011. Under the provisions of the Internal Revenue
Code of 1986, as amended, if certain substantial changes in our ownership were
to occur, we could be limited in the future in the amount of net operating loss
and tax credit carry-forwards that could be utilized annually to offset future
taxable income.

We have recorded a valuation allowance for the full amount of our net
deferred tax assets, as the realization of the future tax benefit is presently
not likely.

LIQUIDITY AND CAPITAL RESOURCES

Since inception, we have financed our operations primarily through the
sale of equity securities. At June 30, 2002, we had $64.6 million of cash, cash
equivalents and short-term investments, compared to $81.0 million at June 30,
2001.

Cash used in operations was $8.5 million for the six months ended June 30,
2002, compared to $14.9 million for the same period in 2001. Cash used in
operations in both periods resulted primarily from net losses, as adjusted for
non-cash expenses. In April 2000, we signed a ten-year lease for a new
corporate facility in Edina, Minnesota, with annual total rent payments
beginning at $1.4 million per year, excluding operating expenses.

A total of $6.7 million in net cash was provided from investing activities
for the six months ended June 30, 2002, compared to $23.2 million of cash
provided in the same period for 2001. Our investing activities consisted
primarily of net sales of short-term investments and marketable securities
offset, in 2001, by purchases of property and equipment. Our investment portfolio as a
percentage of total cash and investment as of July 29, 2002 was comprised of
40% in money market accounts, 26% in corporate bonds and papers, 15% in
municipal bonds and 19% in federal agency securities. We will continue to
invest cash in excess of current requirements in investment grade,
interest-bearing securities.

Capital expenditures were $0 for the six months ended June 30, 2002 as
compared to $148,000 in the same period for 2001. Capital expenditures were
even higher in years prior to 2001 and reflected our rapidly growing employee
base and expanded operations infrastructure.

Net cash provided from financing activities was $11,000 for the six months
ended June 30, 2002 and net cash used for financing activities was $ 213,000
for the same period in 2001.

Restructuring related charges of $401,000 were recorded in the second
quarter of 2002, relating to employee termination costs due to a reduction in
workforce, write-down of certain fixed assets and a reversal resulting from
revised estimates of other costs. We recorded a total of $768,000 of
restructuring related charges for the six months ended June 30,
2002. During 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
approximately $15.6 million in 2001 ($13.9 million was recorded through the
second quarter of 2001). A total of approximately $1.1 million was charged
against the restructuring reserve during the second quarter of 2002, and a
total of approximately $2.7 million was charged against the restructuring
reserve for the first half of 2002, lowering the accrued restructuring
liability to approximately $5.5 million.

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Of the $5.5 million restructuring reserve remaining as of June 30, 2002,
management estimates that approximately $5.4 million will be a use of cash in
future periods for remaining rent commitments and other carrying costs, less
estimated sublease income, related to facilities we have vacated. Cash payments
related to the restructuring are expected to total up to $3.0 million in 2002,
less any benefit from incremental real estate subleasing activities. The
remaining $100,000 of accrued restructuring costs relates to other
miscellaneous restructuring related costs. Although we believe that our lease
commitment estimates are appropriate in the current circumstances, future
changes in real estate markets could impact the ultimate amount of cash paid to
resolve these obligations.

As
of June 30, 2002, we had no material long-term commitments for
capital expenditures.

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. At June 30, 2002, we had $551,000 in short and
long-term liabilities, of which approximately $543,000 comprised of deferred
rent credits. Approximately $8,000 of the short and long-term liabilities
represents loans, consisting primarily of capital lease obligation. This
obligation includes installment loan with third-party financing source that is
secured by the equipment financed by the third party. The loan bears an
interest rate of 14.4% and matures in August 2002.

The following summarizes our contractual obligations at December 31, 2001,
and the effect such obligations are expected to have on our liquidity and cash
flow in future periods (in thousands). This data does not include the effect of
sublease payments expected to be received by us under the terms of sublease
agreements currently in effect. See the discussion below regarding our
operating lease obligations and related sublease agreements.

|                                   |  |      |       |      |  |      |       |      |  |            |       |  |  |   |       |  |  |   |        | 
|---------------------------------- |  | ---- | ----- | ---- |  | ---- | ----- | ---- |  | ---------- | ----- |  |  | - | ----- |  |  | - | ------ | 
|                                   |  | 2002 |       | 2003 |  | 2004 |       | 2005 |  | Thereafter
|                                   |  |     
|Capital leases                     |  | $    | 97    |      |  | $    |      |      |  | $          |      |  |  | $ |      |  |  | $ |       | 
|                                  
|                                  
|                                  
|                                  
|Operating leases                   |  |      | 4,001 |      |  |      | 4,056 |      |  |            | 3,294 |  |  |   | 3,240 |  |  |   | 14,789 | 
|                                   |  |     
|Total contractual cash obligations |  | $    | 4,098 |      |  | $    | 4,056 |      |  | $          | 3,294 |  |  | $ | 3,240 |  |  | $ | 14,789 | 
|                                   |  |     

Operating
lease obligations relate to our existing facilities. As of June 30,
2002, we have signed agreements to sublease approximately 114,000
square feet of our existing facilities. These subleases provide for
sublease payments to us of $1,729,000, $2,240,000, $1,792,000, $1,645,000 and
$7,551,000 in 2002, 2003, 2004, 2005 and thereafter, respectively, or
a total of approximately $15.1 million over the respective terms of
the subleases.

We
are actively seeking to sublease our remaining excess facilities.
Specifically, we are currently seeking to sublease an additional
portion of our Edina, Minnesota office space, our entire Roseland,
New Jersey office space and a portion of our office space in Austin,
Texas. However, there is a risk that we may not be able to sublease
these facilities under favorable terms, if at all, which could
negatively impact our cash flow and future operating results.

We believe that existing cash and investments will be sufficient to meet
our working capital and capital expenditure needs for at least the next 12
months. If we need to raise additional funds, we may not be able to do so on
favorable terms or at all. If we raise additional funds through the issuance of
equity securities, the percentage ownership of our current stockholders will be
reduced.

RISKS THAT MAY AFFECT 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 business, financial condition
and results of operations. If any of these risks actually occur, our business,
financial condition and results of operations could be materially adversely
affected.

We are an early-stage company and we expect to encounter risks and difficulties
frequently encountered by early-stage companies in new and rapidly evolving
markets.

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We were founded in July 1996. We began shipping products in the first
quarter of 1997. The market for our products is unproven and our limited
operating history makes an evaluation of our future prospects very difficult.
We will encounter risks and difficulties frequently encountered by early-stage
companies in new and rapidly evolving markets. We may not successfully address
any of these risks. If we do not successfully address these risks, we may not
achieve profitability and we could suffer increased operating losses.

Our quarterly operating results are volatile and difficult to predict. If we
fail to meet the expectations of public market analysts and investors, the
market price of our common stock may decrease significantly.

Our quarterly operating results have varied in the past and may vary
significantly in the future. Because our operating results are volatile and
difficult to predict, we believe that period-to-period comparisons of our
results of operations are not a good indication of our future performance.
Historically, our operating results have been below the expectations of public
market analysts and investors and it is likely that in some future quarter or
quarters our operating results will again be below the expectations of public
market analysts and investors. In this event, the market price of our common
stock may decrease significantly.

We cannot predict our future quarterly revenues with any degree of
certainty for a variety of reasons, because:



| |  |  | we operate with a limited order backlog, and revenues in any quarter
are substantially dependent on orders booked and shipped in that
quarter;                                                                          
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | the market in which we compete is relatively new and rapidly evolving
and has many new entrants;                                                                                                                        
|
| |  |  | we expect that, for the foreseeable future, revenues will come from
licenses to a small number of customers, so delays or cancellations of
orders by a few customers can significantly impact revenues within a
quarter;
|
| |  |  | our sales cycle varies substantially from customer to customer; and                                                                                                                                                     
|
| |  |  | the timing of large orders can significantly affect revenues within a quarter.                                                                                                                                          

Historically, we have recognized a substantial portion of our revenues in
the last month of a quarter, with these revenues frequently concentrated in the
last two weeks of the quarter. Accordingly, we cannot predict our financial
results for any quarter until very late in the quarter. A delay in an
anticipated sale or revenue recognition near the end of a quarter can seriously
harm our operating results for that quarter.

Our expense levels are relatively fixed in the short term and are based,
in part, on our expectations as to our future revenues. As a result, any delay
in generating or recognizing revenues could cause significant variations in our
operating results from quarter to quarter and could result in increased
operating losses.

Our business could be materially adversely affected as a result of general
economic and market conditions.

We are subject to the effects of general global economic and market
conditions. A sustained general economic slowdown could have serious negative
consequences for our business and operating results. For example, an economic
slowdown may cause some current or potential customers to defer purchases, to
go out of business or to have insufficient capital to buy our products. An
economic slowdown could also cause a significant reduction in the value of our
investments. If economic and market conditions do not improve, our business,
results of operations or financial condition could be materially adversely
affected.

We have a history of losses and expect to incur losses in the future.

We had net losses of $4.7 million in 1997, $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 (including $15.6
million in 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
related to the acquisition of KD1) for the year ended December 31, 2001. As of
June 30, 2002, we had an accumulated deficit of $207.9 million. We have

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not had a profitable quarter and do not expect to have a profitable
quarter in 2002. We expect to continue to incur significant sales and
marketing, research and development and general and administrative expenses. We
will need to generate significant additional revenues to achieve profitability.
We may never achieve profitability.

A decline in the price of, demand for, or market acceptance of NetP 7.0 would
seriously harm our business.

We
currently derive a substantial portion of our revenues from one product  NetP
7.0. As part of our strategy to focus our marketing and development efforts on
NetP 7.0, we have begun to wind-down our non-strategic product and service
offerings, including Advertising Advisor, which in 2001 accounted for
a significant portion of our revenues.

We anticipate that NetP 7.0 will account for a substantial
majority of our revenues for the foreseeable future. Consequently, a decline in
the price of or demand for NetP 7.0, or failure to achieve broad market
acceptance for NetP 7.0, would materially adversely affect our
business and results of operations.

The market price of our common stock may be volatile, which could result in
substantial losses for individual stockholders.

The market price for our common stock has been and is likely to continue
to be highly volatile and subject to wide fluctuations in response to factors
including the following, some of which are beyond our control:



| |  |  | actual or anticipated variations in our quarterly operating results;                                                                                            
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | announcements of new technological innovations, increased cost of
operations or new products or services by us or our competitors;                              
|
| |  |  | changes in financial estimates by securities analysts;                                                                                                          
|
| |  |  | conditions or trends in the industries into which we sell our products and services;                                                                            
|
| |  |  | changes in the economic performance and/or market valuations of other comparable companies;                                                                     
|
| |  |  | volatility in the stock markets, particularly with respect to
technology stocks, and decreases in the availability of capital for
technology-related businesses;
|
| |  |  | announcements by us or our competitors of significant acquisitions,
strategic partnerships, joint ventures or capital commitments;                              
|
| |  |  | additions or departures of key personnel;                                                                                                                       
|
| |  |  | sales of additional shares of common stock; and                                                                                                                 
|
| |  |  | potential litigation.                                                                                                                                           

From April 23, 1999 (the first day of public trading of our common stock),
through June 30, 2002, the high and low sales prices for our common stock
fluctuated between $66.50 and $0.85. On July 31, 2002, the last reported sale
price of our common stock on the Nasdaq National Market was $1.01. In the past,
securities class action litigation has often been brought against a company
following periods of volatility in the market price of its securities.

On November 2, 2001, Timothy J. Fox filed a purported class action lawsuit
against us, FleetBoston Robertson Stephens, Inc., the lead underwriter of our
initial public offering in April 1999, 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 and chief operating officer. For a discussion of this matter,
see the section of this report entitled Legal Proceedings. We may in the
future be the target of other similar litigation. Securities litigation could
result in substantial costs and divert managements attention and resources.

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Our common stock may be delisted from Nasdaq.

We may fail to maintain the minimum closing bid price of $1.00 for 30
consecutive business days as required by the Nasdaq National Market. If we are
unable to demonstrate compliance with this or any other Nasdaq requirement,
Nasdaq may take further action with respect to a potential delisting of our
common stock. We may appeal any such decision by Nasdaq to the Nasdaq Listing
Qualifications Panel. If our common stock were delisted from Nasdaq this could
result, among other things, in a number of negative implications, including
reduced liquidity in our common stock as a result of the loss of market
efficiencies associated with Nasdaq, as well as the potential loss of
confidence by suppliers, customers and employees, the loss of analyst coverage
and institutional investor interest, fewer business development opportunities
and greater difficulty in obtaining financing.

We face intense competition and, if we are unable to compete successfully, we
may be unable to increase our product sales and market share.

The market for our products is intensely competitive, evolving and subject
to rapid technological change. We expect the intensity of competition to
increase in the future. Competitors vary in size and in the scope and breadth
of the products and services offered.

We believe that the principal competitive factors affecting our market
include core technology, product features, product quality and performance,
customer service and price. Although we believe that our products currently
compete favorably with respect to such factors, our market is relatively new
and is rapidly evolving. We may not be able to maintain our competitive
position against current and potential competitors, especially those with
significantly greater financial, marketing, service, support, technical and
other resources.

Many of our competitors have longer operating histories, significantly
greater financial, technical, marketing and other resources, significantly
greater name recognition and a larger installed base of customers than we have.
In addition, many of our competitors have well-established relationships with
current and potential customers of ours, have extensive knowledge of our
industry and are capable of offering a single-vendor solution. As a result, our
competitors may be able to respond more quickly to new or emerging technologies
and changes in customer requirements, or to devote greater resources to the
development, promotion and sale of their products than we can. In addition,
current and potential competitors have established or may establish cooperative
relationships among themselves or with third parties to increase the ability of
their products to address customer needs. Also, relationships with large
systems integrators such as Accenture, large consulting firms and others are an
important factor in successfully achieving widespread deployment of these
solutions. Many of our competitors have such relationships in place today, and
this may hinder our ability to gain equivalent access to systems integration
resources. Accordingly, it is possible that new competitors or alliances among
competitors may emerge and rapidly acquire significant market share. We also
expect that competition will increase as a result of software industry
consolidations. Increased competition is likely to result in price reductions,
reduced gross margins and loss of market share. We may not be able to compete
successfully against current and future competitors.

We may need to make acquisitions to remain competitive.

A component of our business strategy is to seek to buy businesses,
products and technologies that complement or augment our existing businesses,
products and technologies. Acquisitions are difficult to identify and complete
for a number of reasons, including the cost of potential transactions,
competition among prospective buyers and the need for regulatory approvals. We
may not be able to complete any given acquisition. Furthermore, in order to
finance a potential acquisition, we may need to raise additional funds by
selling our stock or borrowing money. We may not be able to find financing on
favorable terms, and the sale of our stock may result in the dilution of our
existing stockholders. If we do undertake any transaction of this sort, the
process of integrating an acquired business, product or technology may result
in unforeseen operating difficulties and expenditures and may absorb
significant management attention that would otherwise be available for ongoing
development of our business. Moreover, we may fail to realize the anticipated
benefits of any acquisition.

Our products have a lengthy sales cycle. As a result, it is difficult to
predict the quarter in which a sale may occur.

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Our solutions are relatively new to the marketplace. As a result, we must
use significant resources to educate
potential customers on the use and benefits of our products. In addition,
we believe that the purchase of our products is relatively discretionary and
involves a significant commitment of capital and other resources by a customer.
As a result, it usually takes our sales organization several months to finalize
a sale. This makes it difficult to predict the quarter in which a sale may
occur.

Our products have a lengthy implementation cycle. In addition, only a limited
number of our customers have a deployed and operating application that utilizes
our products. As a result, we cannot be certain that our products will perform
and be received as expected.

The implementation, including application design and deployment, of our
products requires a commitment of resources by our customers. The time required
for implementation of our products has varied depending on the customers
application of the product.

We have licensed one or more of our products to more than 200 customers.
However, only a limited number of these customers have a fully deployed
operating application that utilizes our products. In addition, a significant
number of Internet retailer customers have gone out of business, and are no
longer utilizing our products. Because many of our customers have not yet fully
implemented and deployed our products, we cannot be certain that our products
will:



| |  |  | perform as designed;                                                                
| | - |  | ------------------------------------------------------------------------------------
|
| |  |  | deliver the desired level of economic benefit to our customers;                     
|
| |  |  | meet the other expectations and needs of our customers;                             
|
| |  |  | achieve any significant degree of market acceptance; or                             
|
| |  |  | perform to the level necessary to generate repeat customers and customer references.

If implementation services performed by us constitute a significant part
of a product sales transaction, we recognize a substantial portion of our
revenues from the sales transaction upon the delivery of the implementation
services. As a result, delays in service delivery could cause significant
reduction in our license revenues and operating results for any particular
period.

We have a new product that may not achieve market acceptance.

In June 2002, we announced the commercial launch of NetP 7.0. In addition,
we expect to introduce new and enhanced product features during 2002 and
thereafter.

Our products have not received a significant degree of market acceptance.
There are significant risks inherent in product introductions such as these.
These products may not address some or all of the needs of customers and may
contain undetected errors or failures. A lack of necessary features or errors
or failures in the products will likely result in loss or delay of market
acceptance. We expect that our future financial performance will depend
significantly on the successful sales, implementation and market acceptance of
these new or enhanced products which may not occur on a timely basis or at all.

Our new products are subject to significant technical risks. We may fail
to introduce or deploy new products on a timely basis, or at all. In the past,
we have experienced some delays in the commencement of commercial shipments of
our new releases and new products. These delays caused customer frustrations
and delay or loss of product revenues. Some of our competitors currently offer
products with features and functionality similar to those of some of our new
products. In the past, we have also experienced delays in purchases of our
products by customers anticipating our launch of new releases or new products.
We could experience increased expenses or lost revenues if customers defer
material orders in anticipation of new releases or new product introductions.

The software products we offer are complex and may contain undetected
errors or failures when first introduced, or as new versions are released. We
have in the past discovered software errors in our new releases and new
products after their introduction. We experienced delays in release and lost
revenues during the period

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required to correct these errors. We may discover errors in new releases
or new products after the commencement of commercial shipments, despite testing
by our personnel and our current and potential customers. This may result in
loss of or delay in market acceptance of our products, which could seriously
impair our ability to achieve profitability.

Acts of terrorism or war may hurt global economic conditions, which could harm
our business.

Our business is subject to and affected by forces, pressures and events
affecting global economic conditions. The September 11, 2001 terrorist attacks
exacerbated global economic conditions and adversely impacted many businesses,
including that of Net Perceptions. Future terrorist acts or acts of war may
cause damage or disruption to our employees, facilities, customers and
suppliers, which could have a material adverse effect on our business, results
of operations and financial condition.

If we fail to generate repeat or expanded business from our current and future
customers, we may be unable to build a critical mass of customers necessary to
achieve increased sales and market share.

Our success is dependent on the continued growth of our customer base and
the retention of our customers. We currently depend on a limited number of key,
high-profile customers. Our ability to attract new customers will depend on a
variety of factors, including the accuracy, scalability, reliability and
cost-effectiveness of our products and services and our ability to effectively
market such products and services. In the past, we have lost potential
customers to competitors for various reasons, including lower prices and other
incentives not matched by us. Many of our customers initially purchase a
limited license for our products and services for evaluation. If such
evaluation is successful, the customer may purchase a license to expand the use
of our products in its organization or license additional products and
services. If we fail to generate repeat and expanded business from our current
and future customers, we may be unable to build a critical mass of customers
necessary to achieve increased sales and market share.

If we fail to attract or retain skilled salespeople as needed, we may be unable
to increase market awareness and sales of our products and services.

Our products and services require a sophisticated sales effort targeted at
the senior management of our prospective customers. As of June 30, 2002, our
direct sales organization consisted of 12 employees. We may need to hire
additional direct sales personnel in the future. Competition for qualified
sales personnel is intense, and we might not be able to attract or retain the
kind and number of sales personnel we need. New hires require extensive
training, typically take several months to achieve productivity and may not be
as productive as necessary. If we are unable to attract or retain additional
skilled sales personnel as needed, we may not be able to capture increased
market share for our products and services.

If we cannot expand our indirect sales channel, we may be unable to increase
our customer base and achieve profitability.

We intend to increase the proportion of our customers licensed through our
indirect channel, which includes resellers, systems integrators and original
equipment manufacturers. Our agreements with resellers are generally not
exclusive and in many cases may be terminated by either party without cause.
Many of these resellers do not have minimum purchase or resale requirements. In
addition, many of these resellers carry product lines that are competitive with
our product lines. These resellers may not give a high priority to the
marketing of our products or may not continue to carry our products. They may
give a higher priority to other products, including the products of
competitors. We may not retain any of our current resellers or successfully
recruit additional resellers. Events or occurrences of this nature could
seriously impair our ability to increase our sales and market share. In
addition, any sales through resellers will have lower gross margins than direct
sales.

We have established an effort dedicated to the development of the indirect
sales channel for our products. Competition for the qualified sales personnel
necessary to develop such relationships is intense, and we might not be able to
retain our existing personnel. We cannot be certain that our recent hires will
be as productive as necessary.

If we are unsuccessful in attracting and retaining qualified service personnel,
we may lose current customers
or be unable to attract new customers.

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Customers that license our software typically engage our professional
services organization to assist with support, training, consulting and
implementation. We believe that growth in our product sales depends on our
ability to provide our customers with these services and to educate resellers
on how to use our products. From time to time, we receive customer complaints
about the timeliness and accuracy of our customer support. As of June 30, 2002,
our professional services and customer support organization consisted of 10
employees. There are a limited number of people who have the skills needed to
provide the services that our customers demand. Competition for qualified
service personnel is intense. We cannot be certain that we can attract or
retain a sufficient number of the highly qualified service personnel that our
business needs.

We derive revenues from international sales and, therefore, our business is
susceptible to numerous risks associated with international operations.

Licenses and services sold to customers outside of the United States
accounted for approximately 22% of our total revenues in 2000, 20% in 2001 and
10% for six months ended June 30, 2002. We expect to derive additional
international revenues in the future, and we believe that we must retool and
expand our international sales and marketing activities in order to be
successful.

We have limited experience in marketing, selling, distributing and
supporting our products and services internationally.

International operations are generally subject to a number of risks,
including:



| |  |  | expenses associated with customizing products and services for foreign countries;
| | - |  | ---------------------------------------------------------------------------------
|
| |  |  | protectionist laws and business practices that favor local competition;          
|
| |  |  | conflicting and changing governmental laws and regulations;                      
|
| |  |  | longer sales cycles;                                                             
|
| |  |  | difficulties in collecting accounts receivable;                                  
|
| |  |  | foreign currency exchange rate fluctuations; and                                 
|
| |  |  | political and economic instability.                                              

In 1999, we established operations in the United Kingdom and established
operations in Japan through a joint venture that created Net Perceptions Japan.
In the second quarter of 2002, we terminated our Japanese joint venture.
However, as part of such termination, we were assigned certain of the
agreements of Net Perceptions Japan under which we are obligated to provide
secondary levels of technical support.

As of June 30, 2002, we had two employees located in the United Kingdom.
All other employees were located in the United States.

We may be unable to sublease or find suitable
sub-tenants for a portion of our
principal executive offices and some of our other offices, and
tenants may fail to make sublease payments.

In April 2000, we executed a ten-year lease for a new facility for our
principal executive offices in Edina, Minnesota. We have sublet a significant
portion of this facility to third parties and are currently seeking to sublease
an additional portion of this facility. We have also sublet all of the space at
our Berkshire, United Kingdom facility and a portion of the space at our San
Francisco, California facility. We are also currently seeking to sublease our
Roseland, New Jersey office space and a portion of our office space in Austin,
Texas. We may not be able to find suitable sub-tenants for these properties in
a timely manner, if at all. If we are unable to find suitable sub-tenants in a
timely manner, or if our existing sub-tenants fail to make the
sublease payments required under their respective sublease agreements, we may experience greater than anticipated operating expenses in
the future.

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If our intellectual property is not protected adequately, we may lose our
competitive advantage in the market.

We are a technology company. Our success depends in large part on
protecting our intellectual property, which is our most important asset. We
rely upon a combination of trademark, copyright, patent and trade secret laws
to protect our rights in our technology. We license our software and require
our customers to enter into license agreements, which impose restrictions on
our customers ability to utilize the software. In addition, we seek to avoid
disclosure of our trade secrets, including but not limited to requiring those
persons with access to our proprietary information to execute confidentiality
agreements with us and restricting access to the source code for our software.

We have 17 pending United States patent applications and four issued
United States patents. We also have license rights to three issued United
States patents from the University of Minnesota. It is possible that no patents
will issue from the currently pending patent applications. It is also possible
that our current patents and potential future patents may be invalid or
unenforceable. It is also possible that any patent issued to us may not provide
us with any competitive advantages. Moreover, we may not develop future
proprietary products or technologies that are patentable, and the patents of
others may seriously limit our ability to conduct our business. In this regard,
we have not performed any comprehensive analysis of patents of others that may
limit our ability to conduct our business.

Our efforts to protect our proprietary rights may not succeed. Copyright
and trade secret laws afford only limited protection for our proprietary rights
in our software, documentation and other written materials. Unauthorized
parties may be able to copy aspects of our products or to obtain and use
information that we regard as confidential and proprietary. Policing
unauthorized use of our products is difficult, and while we are unable to
determine the extent to which piracy of our software products exists, software
piracy can be expected to be a persistent problem. In addition, the laws of
some foreign countries do not protect our proprietary rights to as great an
extent as the laws of the United States. Our means of protecting our
proprietary rights may not be adequate and our competitors may independently
develop similar technology, duplicate our products or design around patents
issued to us or our other intellectual property. We may not be able to detect
infringement or enforce our patent or other rights and, as a result, our
competitive position in the market may suffer.

Third-party infringement claims against us or our technology suppliers could
result in delays in product development, the loss of customers, or costly and
time-consuming litigation.

There has been a substantial amount of litigation in the software industry
regarding intellectual property rights. We have from time to time received
claims that we are infringing third parties intellectual property rights. It
is possible that in the future third parties may claim that our current or
potential future products infringe their intellectual property rights,
including under issued patents. We expect that software companies such as Net
Perceptions will increasingly be subject to infringement claims as the number
of products and competitors in our industry segment grows and the functionality
of products in different industry segments overlaps. Any such claims, with or
without merit, could be time-consuming, result in costly litigation, cause
product shipment delays or require us to enter into royalty or licensing
agreements in order to secure continued access to required technology. Royalty
or licensing agreements, if required, may not be available on terms acceptable
to us or at all. Claims of intellectual property infringement may also require
us to pay significant damages or subject us to an injunction against the use of
our products. Any successful claim of intellectual property infringement
against us could have an immediate and significant impact on our ability to
carry on our business and market our products.

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 we are unable to continue to utilize technology licensed from third parties,
we may be unable to conduct our business.

We license technology from various third parties for integration into our
products. Licenses to such third-party technology may not continue to be
available to us on commercially reasonable terms. We may not be able to renew

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existing agreements or to license or develop alternative technology. If we
cannot maintain license rights to key third-party software, develop similar
technology or license similar technology from another source on a timely or
commercially feasible basis, we may be unable to market our current products or
develop new products in a timely manner.

Our ability to increase our customer base and our sales depends on the
continuing contribution of our key personnel and our ability to attract,
assimilate and retain other highly qualified personnel.

Our future success depends on the continued service of our key personnel.
The loss of the services of one or more of our key employees could seriously
harm our ability to increase our customer base and sales. As of June 30, 2002,
we had 59 employees. We do not carry any key person life insurance policies.

Our future success also depends on our continuing ability to attract and
retain an adequate number of highly skilled managerial, technical, sales,
marketing and customer support personnel. Competition for skilled personnel is
intense, and we may fail to retain our key employees, or attract, assimilate or
retain other highly qualified personnel in the future. If so, we may be unable
to service our current customers, attract new customers and increase our sales.

The market price of our common stock has been volatile and has fluctuated
significantly in the past. To the extent this volatility and fluctuation
continues, equity-based compensation policies and plans, which have
historically been significant in our attracting, hiring and retaining highly
skilled personnel, may not be as effective as in the past.

We may need to raise additional capital that may not be available on reasonable
terms, or at all.

We believe we have sufficient cash and investments to meet our working
capital and capital expenditure needs for at least the next 12 months. After
that, we may need to raise additional funds and we cannot be certain that we
will be able to obtain additional financing on favorable terms, or at all. If
we raise additional funds through the issuance of equity or convertible debt,
the percentage ownership of our stockholders will be reduced, and these newly
issued securities may have rights, preferences or privileges senior to those of
our existing stockholders. If we cannot raise funds as needed on acceptable
terms, we may not be able to develop or enhance our products, take advantage of
future opportunities or respond to competitive pressures or unanticipated
requirements.

Future sales of our common stock could depress its market price.

If our stockholders sell substantial amounts of our common stock, or there
is a belief that such sales could occur, the market price of our common stock
could fall. These factors could also make it more difficult for us to raise
funds through future offerings of common stock. As of June 30, 2002, we had
outstanding 27,299,333 shares of common stock and options to acquire an
aggregate of 3,072,879 shares of common stock, of which 1,291,964 were
exercisable. Substantially all of our outstanding shares are freely tradeable
and all shares acquired upon exercise of options will be freely tradeable.
Those shares which are not freely tradeable may be resold publicly at any time,
subject to the volume and other restrictions of Rule 144 under the Securities
Act. If large numbers of these shares are sold over a short period of time, the
price of our common stock could be adversely affected.

We may be subject to potential product liability claims that could result in
costly and time-consuming litigation.

Because our customers 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 damages
for losses from us. 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, and potential
liabilities could exceed our available insurance coverage.

Our current revenue recognition practices may need to change, which could
seriously harm our business.

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The American Institute of Certified Public Accountants issued Statement of
Position 97-2, Software Revenue Recognition, in October 1997 and amended it
by Statements of Position 98-4 and 98-9. There may be additional pronouncements
issued in the future. Our current revenue accounting practices may need to
change and such changes could seriously harm our future revenues and earnings.

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
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, by-laws 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.

Our business could be seriously impacted by privacy and security concerns.

In some cases, our customers capture user preference and profile
information each time a user interacts with the application utilizing our
products or volunteers information in response to survey questions. Our
customers generally have implemented security measures to protect such customer
data from unauthorized disclosure or interception by third parties. However,
the security measures may not be effective against all potential security
threats. If a breach of customer data security were to be publicized, our
products may be perceived as less desirable, and our future sales could be
negatively impacted. More importantly, even the perception of privacy and
security concerns, whether or not valid, may indirectly inhibit market
acceptance of our products. In addition, legislative or regulatory requirements
may heighten such concerns if, for example, our customers were required to
notify users that the data captured after these interactions may be used by
marketing entities to direct product promotion and advertising to that user.
Legislation has been proposed at the federal and state levels that address some
aspect of the Internet, including a number of bills that specifically address
Internet privacy matters. Such proposed legislation indicates that some federal
and state legislators believe that certain aspects of the Internet and
e-commerce, including data privacy, are appropriate matters for regulation and
review. Various other countries and political entities, such as the European
Union, have adopted legislation or regulatory requirements addressing issues,
such as data privacy, that may directly impact some of our customers. If user
privacy concerns are not adequately addressed or if restrictive legislation is
adopted in the United States, our business could be seriously harmed and we
could experience increased operating losses.

If we do not respond to rapid technological changes, our products could become
obsolete and we could lose our competitive advantage in the market.

The life cycles of our products are difficult to predict because the
markets for our products are characterized by rapid technological change,
changing customer needs, frequent new software product introductions and
evolving industry standards.

The introduction of products embodying new technologies and the emergence
of new industry standards could render our existing products obsolete and
unmarketable. To be successful, we need to develop and introduce new software
products and enhancements to existing products on a timely basis that:



| |  |  | keep pace with technological developments and emerging industry standards; and
| | - |  | ------------------------------------------------------------------------------
|
| |  |  | address the increasingly sophisticated needs of our customers.                

In addition, we may:



| |  |  | fail to develop and market new products and enhancements to existing
products that respond to technological changes or evolving industry
standards;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | experience difficulties that could delay or prevent the successful
development, introduction and marketing                                         

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| |   |  | of these new products and enhancements to existing products; and                                                                                         
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | fail to develop new products and enhancements to existing products
that adequately meet the requirements of the marketplace or achieve
market acceptance.

If any of these events occur, we may be unable to compete successfully in
the market for our products and services, and as a result, our business could
fail.

The growth of the market for our products and services would be impaired if the
use of the Internet and electronic commerce do not grow as anticipated, and
third parties do not continue to develop and improve the Internet
infrastructure.

Our future revenues depend, in part, upon the increased acceptance and use
of the Internet and other on-line services as a medium of commerce. Rapid
growth in the use of the Internet, the Web and on-line services is a recent
phenomenon. Acceptance and use may not continue to develop at historical rates
and a sufficiently broad base of customers may not adopt or continue to use the
Internet and other on-line services as a medium of commerce. Demand and market
acceptance for recently-introduced services and products over the Internet are
subject to a high level of uncertainty and few proven services and products
exist.

In addition, the Internet may not be accepted as a viable long-term
commercial marketplace for a number of reasons, including potentially
inadequate development of the necessary network infrastructure or delayed
development of enabling technologies and performance improvements. To the
extent that the Internet continues to experience significant expansion in the
number of users, frequency of use or bandwidth requirements, the infrastructure
for the Internet may be unable to support the demands placed upon it. In
addition, the Internet could lose its viability as a commercial medium due to
delays in the development or adoption of new standards and protocols required
to handle increased levels of Internet activity, or due to increased
governmental regulation. Changes in, or insufficient availability of,
telecommunications services to support the Internet also could result in slower
response times and adversely affect usage of the Internet generally.

The growth of the market for our products and services would be impaired
if:



| |  |  | use of the Internet, the Web and other on-line services does not
continue to increase or increases more slowly than expected;                              
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | the infrastructure for the Internet, the Web and other on-line
services does not effectively support expansion that may occur; or                          
|
| |  |  | the Internet, the Web and other on-line services do not become a
viable commercial marketplace, which would inhibit the development of
electronic commerce.

Increasing government regulation could limit the market for our products and
services, which could seriously impair the growth of our business or expose us
to unanticipated liabilities.

As Internet commerce evolves, we expect that federal, state or foreign
governmental authorities will enact laws or adopt regulations covering issues
such as user privacy, pricing, content and quality of products and services. If
enacted, such laws, rules or regulations could limit the market for our
products and services. Although many of these regulations may not apply to our
business directly, we expect that laws regulating the solicitation, collection
or processing of personal/customer information could indirectly affect our
business.

28



---



##### Table of Contents






Item 3. Quantitative and Qualitative Disclosures about Market Risk

Through June 30, 2002, 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. We expect, however, that future product license and service
revenues may increasingly be derived from international markets and may be
denominated in the currency of the applicable market. As a result, our
operating results may become subject to significant fluctuations based upon
changes in the exchange rates of certain currencies in relation to the United
States dollar. Furthermore, to the extent that we engage in international sales
denominated in United States dollars, an increase in the value of the United
States dollar relative to foreign currencies could make our products less
competitive in international markets. Although we will continue to monitor our
exposure to currency fluctuations, and, when appropriate, may use financial
hedging techniques in the future to minimize the effect of these fluctuations,
exchange rate fluctuations may adversely affect our financial results in the
future.

Our exposure to market risk is 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 are in
debt securities issued by corporations and the United States government. A
hypothetical 100 basis point increase in interest rates would result in an
approximate $ 243,000 decrease in the fair value of our investments as of June
30, 2002. The same hypothetical increase in interest rates as of
December 31, 2001 would have resulted in a decrease in the fair value
of our investments of approximately $496,000.
Our objective in managing our exposure to interest rate risk is to
preserve principal while at the same time maximizing the income we receive from
our investments. To minimize this risk, we maintain our portfolio of cash
equivalents and short-term investments in a variety of securities in addition
to debt and have adopted practices and policies to ensure that our portfolio
remains adequately diversified. Due to the conservative nature of our
investments and relatively short duration, interest risk is mitigated.
Furthermore, we place our investments with high-quality issuers and limit the
amount of credit exposure to any one issuer. We do not have any derivative
financial instruments and do not hold any instruments for trading purposes.

29



---



##### Table of Contents






PART II. OTHER INFORMATION




Item 1. Legal Proceedings

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 operating officer and
chief financial officer. The lawsuit, Fox v. Net Perceptions, Inc., et al.,
Civil Action No. 01-CV-9675, 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 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 through December
6, 2000.

We believe that the allegations are without merit, and we intend to
vigorously defend against the plaintiffs claims. As this litigation is in an
initial stage, we are unable to predict its outcome or its ultimate effect, if
any, on our financial condition.




Item 2. Changes in Securities and Use of Proceeds



| |  |  | None.
| |  |  | -----




Item 3. Defaults Upon Senior Securities



| |  |  | None.
| |  |  | -----




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



| |  |  | The Companys Annual Meeting of Stockholders was held on May 30, 2002.
The number of votes cast by the Companys stockholders for the
election of each director and the number of votes withheld were as
follows:
| |  |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                   |  |     |            |          |  |  |         | 
|------------------ |  | --- | ---------- | -------- |  |  | ------- | 
|Nominee            |  | For |            | Withheld
|                   |  |     |            |         
|John F. Kennedy    |  |     | 20,872,563 |          |  |  | 281,040 | 
|                  
|                  
|                  
|                  
|William Lansing    |  |     | 20,851,729 |          |  |  | 301,874 | 
|                  
|                  
|                  
|                  
|Donald C. Peterson |  |     | 20,875,928 |          |  |  | 277,675 | 
|                  
|                  
|                  
|                  
|John T. Riedl      |  |     | 20,896,479 |          |  |  | 257,124 | 
|                  
|                  
|                  
|                  
|Ann L. Winblad     |  |     | 20,882,755 |          |  |  | 270,848 | 



| |                                                                                                                                                                                                       
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Each director will hold office until the next Annual Meeting of
Stockholders and until the directors successor is duly elected and
qualified, or until the directors earlier resignation or removal.

30



---



##### Table of Contents





| |                                                                                                                                                                                          
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Also, at the same Annual Meeting, the stockholders ratified
the appointment of PricewaterhouseCoopers LLP as the Companys
independent public accountants for 2002 by the following vote:

|           |  |         |        |             |  |  |           | 
|---------- |  | ------- | ------ | ----------- |  |  | --------- | 
|For        |  | Against |        | Abstentions
|           |  |         |        |            
|19,089,202 |  |         | 79,006 |             |  |  | 1,985,395 | 




Item 5. Other Information



| |  |  | None.
| |  |  | -----




Item 6. Exhibits and Reports on Form 8-K



| | (a) |  | Exhibits
| | --- |  | --------

|        |  |                                                                                                                                                                   
|------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |  |                                                                                                                                                                   
|Number  |  | Description                                                                                                                                                       
|        |  |                                                                                                                                                                   
|3.1(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 April 18,
2001(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     |  | 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)
|       
|       
|       
|       
|        |  |                                                                                                                                                                   
|       
|       
|       
|       
|4.6     |  | Form of Rights Certificate (attached as Exhibit B to the
Rights Agreement filed as Exhibit 4.4 hereto)(5)                                                         
|       
|       
|       
|       
|        |  |                                                                                                                                                                   
|       
|       
|       
|       
|99.1    |  | Certification of the Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.            
|       
|       
|       
|       
|        |  |                                                                                                                                                                   
|       
|       
|       
|       
|99.2    |  | Certification of the Chief Financial 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 Quarterly Report on Form
10-Q for the Quarter Ended June 30, 2000 (File No. 000-25781) 
|   
|   
|   
|   
|(3) |  | Incorporated by reference to Net Perceptions Quarterly Report on Form
10-Q for the Quarter Ended March 31, 2001 (File No. 000-25781)
|   
|   
|   
|   
|(4) |  | Incorporated by reference to Net Perceptions Quarterly Report on Form
10-Q for the Quarter Ended June 30, 2001 (File No. 000-25781) 
|   
|   
|   
|   
|(5) |  | Incorporated by reference to Net Perceptions Registration Statement on
Form 8-A filed June 6, 2001 (File No. 000-25781)             



| | (b) |  | Reports on Form 8-K
| | --- |  | -------------------

During the second quarter of 2002 the Company did not file any Current
Reports on Form 8-K.

31



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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: August 14, 2002 |  | By:                   |  | /s/ Thomas M. Donnelly                                    
|                      |  |                       |  |                                                           
|                      |  |                       |  | Thomas M. DonnellyChief Financial Officer                 
|                     
|                     
|                     
|                     
|                     
|                     
|                     
|                     
|                     
|                     
|                     
|                     
|                     
|                     
|                     
|                     
|                      |  |                       |  | (Duly authorized officer and 
principal financial officer)

32



---



##### Table of Contents






NET PERCEPTIONS, INC.
FORM 10-Q
For the Quarter Ended June 30, 2002

EXHIBIT INDEX

|        |  |                                                                                                                                                                    |  |  |  | 
|------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  |  |  | 
|Exhibit |  |                                                                                                                                                                    |  |  |  | 
|Number  |  | Description                                                                                                                                                        |  |  |  | 
|        |  |                                                                                                                                                                    |  |  |  | 
|3.1(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 April 18,
2001(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     |  | 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)
|       
|       
|       
|       
|        |  |                                                                                                                                                                   
|       
|       
|       
|       
|4.6     |  | Form of Rights Certificate (attached as Exhibit B to the
Rights Agreement filed as Exhibit 4.4 hereto)(5)                                                         
|       
|       
|       
|       
|        |  |                                                                                                                                                                   
|       
|       
|       
|       
|99.1    |  | Certification of the Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.            
|       
|       
|       
|       
|        |  |                                                                                                                                                                   
|       
|       
|       
|       
|99.2    |  | Certification of the Chief Financial 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 Quarterly Report on Form
10-Q for the Quarter Ended June 30, 2000 (File No. 000-25781) 
|   
|   
|   
|   
|(3) |  | Incorporated by reference to Net Perceptions Quarterly Report on Form
10-Q for the Quarter Ended March 31, 2001 (File No. 000-25781)
|   
|   
|   
|   
|(4) |  | Incorporated by reference to Net Perceptions Quarterly Report on Form
10-Q for the Quarter Ended June 30, 2001 (File No. 000-25781) 
|   
|   
|   
|   
|(5) |  | Incorporated by reference to Net Perceptions Registration Statement on
Form 8-A filed June 6, 2001 (File No. 000-25781)             

33