##### Table of Contents









UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington, D.C. 20549




---




Form 10-K/A




|           |  |                                                                                                                  
|---------- |  | -----------------------------------------------------------------------------------------------------------------
|(Mark One) |  |                                                                                                                  
|þ          |  | FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO
    SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
    1934
|          
|           |  | For the fiscal year ended December 31,
    2003                                                                  
|          
|or        
|          
|o          |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR
    15(d) OF THE SECURITIES EXCHANGE ACT OF 1934                         
|          
|           |  | For the transition period
    from           to                                                                  

Commission file number 000-27913



---

FreeMarkets, Inc.

(Exact Name of Registrant as Specified in its
Charter)


|                                                                                                       |  |                                         
|------------------------------------------------------------------------------------------------------ |  | ----------------------------------------
|Delaware                                                                                               |  | 04-3265483                              
|(State or Other jurisdiction of
    incorporation or organization)                                     |  | (I.R.S. Employer
    Identification No.)
|                                                                                                      
|FreeMarkets Center
    210 Sixth Avenue
    Pittsburgh, PA(Address of principal executive
    offices) |  | 15222(Zip Code)                         

Registrants telephone number, including
area code:

(412) 434-0500


Registrants URL:
http://www.freemarkets.com

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

|                    |  |                                          
|------------------- |  | -----------------------------------------
|Title of Each Class |  | Name of Each Exchange on Which Registered
|                    |  |                                          
|None                |  | Not applicable                           

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

Common Stock, par value $.01 per
share

(Title of Class)


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 þ          No o

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

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

|                                                                                                               |  |   |             | 
|-------------------------------------------------------------------------------------------------------------- |  | - | ----------- | 
|Aggregate market value of voting common stock
    held by non-affiliates of the registrant as of June 30, 2003 |  | $ | 292,115,297 | 
|Number of shares of the registrants common
    stock outstanding as of February 1, 2004                       |  |   | 42,583,297  | 




DOCUMENTS INCORPORATED BY REFERENCE







|         |  |                  
|-------- |  | -----------------
|Document |  | Part of Form 10-K
|         |  |                  
|None     |  | 1A               






---






---










FREEMARKETS, INC.




FORM 10-K/A




INDEX




|           |  |                                                                                                        |    |      |    | 
|---------- |  | ------------------------------------------------------------------------------------------------------ | -- | ---- | -- | 
|           |  |                                                                                                        |    | Page
|           |  |                                                                                                        |    |     
|PART I    
|Item 1.    |  | Business                                                                                               |    |      | 1  | 
|Item 2.    |  | Properties                                                                                             |    |      | 16 | 
|Item 3.    |  | Legal Proceedings                                                                                      |    |      | 16 | 
|Item 4.    |  | Submission of Matters to a
    Vote of Security Holders                                                |    |      | 17 | 
|          
|PART II   
|Item 5.    |  | Market for Registrants
    Common Equity and Related Stockholder Matters                              |    |      | 17 | 
|Item 6.    |  | Selected Financial Data                                                                                |    |      | 18 | 
|Item 7.    |  | Managements Discussion
    and Analysis of Financial Condition and Results of Operations              |    |      | 19 | 
|Item 7A.   |  | Quantitative and Qualitative
    Disclosures About Market Risk                                         |    |      | 34 | 
|Item 8.    |  | Financial Statements and
    Supplementary Data                                                        |    |      | 36 | 
|Item 9.    |  | Changes in and Disagreements
    with Accountants on Accounting and Financial Disclosure               |    |      | 62 | 
|Item 9A.   |  | Controls and Procedures                                                                                |    |      | 62 | 
|          
|PART III  
|Item 10.   |  | Directors and Executive
    Officers of the Registrant                                                 |    |      | 62 | 
|Item 11.   |  | Executive Compensation                                                                                 |    |      | 64 | 
|Item 12.   |  | Security Ownership of
    Certain Beneficial Owners and Management and Related Stockholder
    Matters |    |      | 67 | 
|Item 13.   |  | Certain Relationships and
    Related Transactions                                                     |    |      | 68 | 
|Item 14.   |  | Principal Accountant Fees
    and Services                                                             |    |      | 69 | 
|          
|PART IV   
|Item 15.   |  | Exhibits, Financial
    Statement Schedules and Reports on Form 8-K                                    |    |      | 69 | 
|Signatures |  |                                                                                                        | 72 |     
|EX-10.14  
|EX-23.1   
|EX-31.1   
|EX-31.2   
|EX-32     






i



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Explanatory Note







On March 1, 2004, FreeMarkets filed its
Annual Report on Form 10-K for the year ended December 31,
2003 (the 2003 10-K) with the Securities and
Exchange Commission. In that filing, the information required by
Part III was incorporated by reference to FreeMarkets
2004 Proxy Statement. In light of the proposed merger of
FreeMarkets with Ariba, Inc. (see Recent
Developments below), FreeMarkets expects to delay its
annual meeting to elect directors until after the special
meeting of FreeMarkets stockholders to consider the
proposed merger. In the event the proposed merger is
consummated, FreeMarkets will not hold its annual meeting and
will not file a proxy statement for such meeting. As a result,
FreeMarkets is filing this Amended 2003 10-K
(10-K/A) to include herein the information required
by Part III. This amendment does not reflect events
occurring after the original filing of our 2003 10-K or modify
or update those disclosures, except to reflect certain revisions
and clarifications in Items 1, 6, 7 and 8 of this 10-K/A.







Recent Developments







In connection with the proposed merger between
FreeMarkets and Ariba, Inc., Ariba and FreeMarkets have filed
relevant materials with the Securities and Exchange Commission,
including a registration statement and joint preliminary proxy
statement, which was originally filed on February 12, 2004.
The definitive proxy statement will be sent to holders of
FreeMarkets common stock if and when it becomes available.
Holders of FreeMarkets common stock are urged to read the
preliminary proxy statement on file with the Securities and
Exchange Commission, the definitive proxy statement if and when
it becomes available and any other relevant materials filed by
FreeMarkets or Ariba with the Securities and Exchange Commission
because they contain, or will contain, important information
about FreeMarkets, Ariba and the transaction. The preliminary
proxy statement is available, and the definitive proxy statement
will be available if and when it is filed, for free (along with
any other documents and reports filed by FreeMarkets and Ariba
with the Securities and Exchange Commission) at the Securities
and Exchange Commissions website, www.sec.gov. In
addition, you may obtain documents filed with the Securities and
Exchange Commission by FreeMarkets free of charge by requesting
them in writing from FreeMarkets, Inc., 210 Sixth Avenue,
Pittsburgh, Pennsylvania, 15222, Attention: Investor Relations,
or by telephone at (412) 434-0500.







PART I






|        |         
|------- | --------
|Item 1. | Business




Certain statements contained in this Annual
Report on Form 10-K/A (Form 10-K/A)
constitute forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995.
These statements involve known and unknown risks, uncertainties
and other factors that may cause our actual results, levels of
activity, performance or achievements to be materially different
than any expressed or implied by these forward-looking
statements. In some cases, you can identify forward-looking
statements by terminology such as may,
will, should, expects,
plans, anticipates,
believes, estimates,
predicts, potential,
continue, or the negative of these terms or other
comparable terminology. Please refer to the risk factors set
forth in the section entitled Additional Factors that May
Affect Future Results for a description of some of the
risk factors that could cause our results to differ materially
from our forward-looking statements.




Overview

FreeMarkets provides software, services and
solutions to help companies improve their sourcing and supply
management processes and enhance the capabilities of their
supply management organization. Our customers are buyers of
industrial parts, raw materials, commodities and services. As of
December 31, 2003, we serve our customers from 17 locations
in 13 countries on five continents. Our team members

1



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##### Table of Contents



provide services to customers in more than 35
languages through operations centers in Pittsburgh and Singapore.


Since our inception, FreeMarkets has provided
software and services to help companies identify savings,
enhance their sourcing efficiency and achieve their strategic
sourcing goals by enabling them to source goods and services in
our online markets. In providing these services, we work with
our customers to identify and screen suppliers and to assemble a
request for quotation that provides detailed, clear and
consistent information for suppliers to use in our online
markets. Our web-based technology enables suppliers from around
the world to submit bids for our customers purchase orders
in real-time interactive competition featuring downward
price dynamic bidding. While we have provided this
technology-enhanced service to buyers since 1995, we began to
describe it using the FullSource name in 2001. In
2001, we also introduced our QS solution, which enables
customers to conduct their own sourcing projects, including
running their own online markets. During the second half of 2002
and beginning of 2003, we introduced a number of new product
offerings to expand our solutions beyond sourcing to address a
broader set of supply management activities. Our development of
a broader set of solutions in 2002 and 2003 is part of a
strategic transition from a company that offers a single
technology-enhanced service to one with multiple software and
service solutions. These activities include supply analysis and
strategy, spend requirements management, sourcing, supplier
development and supplier relationship management. We refer to
these activities as Global Supply Management, or GSM.

Our solutions combine software, services and
information to address the GSM market. These solutions are
ultimately designed to help companies lower costs and reduce
their supply risks.




The following is a breakdown of revenues by
offering (in thousands):







|               |  |                   |         |                   |  |                   |     |            |  |   |         |            |  |  |     |   |  |   |         |  |  |  |     |  
|-------------- |  | ----------------- | ------- | ----------------- |  | ----------------- | --- | ---------- |  | - | ------- | ---------- |  |  | --- | - |  | - | ------- |  |  |  | --- | -
|               |  |                   |         |                   |  |                  
|               |  | Year Ended        |         | Year Ended        |  | Year Ended       
|               |  | December 31, 2003 |         | December 31, 2002 |  | December 31, 2001
|               |  |                   |         |                   |  |                  
|               |  | $                 |         | % of Total        |  | $                 |     | % of Total |  | $ |         | % of Total
|               |  |                   |         |                   |  |                   |     |            |  |   |         |           
|FullSource     |  | $                 | 92,093  |                   |  |                   | 66  | %          |  | $ | 138,420 |            |  |  | 81  | % |  | $ | 143,336 |  |  |  | 92  | %
|All other      |  |                   | 46,623  |                   |  |                   | 34  |            |  |   | 32,021  |            |  |  | 19  |   |  |   | 12,006  |  |  |  | 8   |  
|               |  |                   |         |                   |  |                   |     |            |  |   |         |            |  |  |     |   |  |   |         |  |  |  |     |  
|Total revenues |  | $                 | 138,716 |                   |  |                   | 100 | %          |  | $ | 170,441 |            |  |  | 100 | % |  | $ | 155,342 |  |  |  | 100 | %
|               |  |                   |         |                   |  |                   |     |            |  |   |         |            |  |  |     |   |  |   |         |  |  |  |     |  




Recent Events

In January 2004, we announced a definitive
agreement to merge with Ariba, Inc. (Ariba), a
provider of Enterprise Spend Management products and services.
Under terms of the agreement, shareholders of our common stock
will receive 2.25 Ariba common shares and $2.00 in cash for each
outstanding share of FreeMarkets. The transaction is subject to
customary closing conditions, including regulatory review and
approval by the stockholders of each company, and is expected to
close in the latter part of the second quarter. Because the
merger is subject to factors beyond the parties control,
however, we cannot predict whether or when the merger will be
completed.




Also in January 2004, we acquired the auction and
services business of Covisint, an independent e-business service
provider for the global automotive industry, for
$16.3 million.







Also in January 2004, we executed a restructuring
plan resulting in the elimination of 65 positions in our global
workforce. Additionally, in February 2004, we evaluated our
office space in Pittsburgh, Pennsylvania, and determined that we
will cease using one of the floors we currently lease in our
global headquarters, as well as close two domestic offices. In
accordance with SFAS No. 146, we will record a
restructuring charge of approximately $4.4 million in the
first quarter of 2004 covering these severance and lease costs.




Industry Background



| |                         
| | ------------------------
| | Global Supply Management

Global Supply Management is the set of activities
that links a buyer of goods and services with its suppliers, as
well as helps a buyer to manage and streamline the process
through which it sources the

2



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goods and services it purchases. We believe that
a number of factors are driving the development of GSM as a
strategic tool in a companys procurement process.




| |              
| | -------------
| | Globalization

Market economies are expanding demand around the
world, while technology is accelerating suppliers
abilities to provide lower cost, higher quality goods and
services.



| |              
| | -------------
| | Consolidation

Industries around the world are consolidating.
Supply management is key to realizing acquisition integration
synergies.



| |         
| | --------
| | Velocity

Global competition and improved technology are
shrinking new product introduction and order-to-delivery times.
These factors in turn require companies to select the best
suppliers and integrate them into their core enterprise
activities.



| |            
| | -----------
| | Outsourcing

Increasingly, companies are narrowing their focus
on core activities and outsourcing non-core activities to
outside suppliers. As a result, a larger portion of the final
good or service is produced by someone other than the original
manufacturer.



| |              
| | -------------
| | Profitability

Total cost savings driven by supply management
can be dramatic. As margins decrease, either due to higher costs
or lower revenues, it becomes more critical to achieve savings
on supply management costs. Importantly, in a weak economy,
savings realized as a result of effective supply management can
exceed revenue growth.



| |     
| | ----
| | Risk

As supply chains become more complex through
globalization, consolidation and outsourcing, the probability of
supply failures increases, creating higher levels of risks for
companies in terms of product innovation, order-to-delivery
times and customer satisfaction.

As a result of these factors, effective supply
management can have a dramatic impact on profitability and has
become an increasingly important enterprise function.



| |                                         
| | ----------------------------------------
| | The Global Supply Management
    Process

GSM enables the enterprise to enhance the
capabilities of its supply management organization through
effective management of its supply of goods and services:

(SUPPLY MANAGEMENT GRAPHIC)



| |                             
| | ----------------------------
| | Supply Analysis and Strategy

An enterprise must first determine what goods and
services it needs, as well as the strategies for how, when and
from whom it should buy them. To accomplish this, a company must
analyze its spend, the

3



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performance and abilities of its current
suppliers and the trends in global supply markets. Supply
managers collaborate with engineering, manufacturing and other
enterprise functions to develop supply strategies in-line with
future product plans and enterprise strategy.




| |                              
| | -----------------------------
| | Spend Requirements Management

Once the supply strategy is determined, supply
managers gather detailed spend requirements from in-house
users. These requirements can include technical
drawings and specifications, packaging, logistics, etc. Over
time, supply managers must analyze these spend requirements to
decrease the total cost of their supplies. Accurately gathering
and maintaining these supplies over time is a critical supply
management activity.



| |         
| | --------
| | Sourcing

The next step is for supply managers to evaluate
and select suppliers. The sourcing process includes gathering
and evaluating supplier capabilities, communicating the
necessary requirements and negotiating with suppliers through
various techniques. The sourcing process requires close
collaboration between supply managers in multiple locations and
divisions to ensure maximum bargaining power and process
efficiency. We believe that supply managers ultimately select
suppliers based upon a total cost and risk evaluation.



| |                     
| | --------------------
| | Supplier Development

After sourcing, an entity must formally qualify
suppliers in terms of their production, quality and management
practices. If approved, the supply manager works with the
supplier as well as the internal users to transition the supply
of goods or services to them. Supply managers collaborate with
internal users and suppliers to guide and improve their
capabilities over time.



| |                                 
| | --------------------------------
| | Supplier Relationship Management

As part of the ongoing relationship, supply
managers monitor supplier performance and activity to ensure
contract compliance, acceptable quality, delivery, etc.
Monitoring contract expirations helps supply managers
proactively manage their sourcing and supplier relationships.

FreeMarkets®GSM Solutions

Our solutions combine software, services and
information, and are designed to address the full range of
supply management activities. These solutions are designed to
help companies lower costs and reduce their supply risks. Our
portfolio of GSM solutions includes:



| |                         
| | ------------------------
| | FreeMarkets®FullSourceTM

FreeMarkets FullSource is a program of
technology-enhanced services designed to help companies generate
savings from their sourcing activities and lower their supply
risks. FreeMarkets FullSource combines online bidding technology
with services in hundreds of spend categories, industry-specific
program management, around-the-clock global market operations
services, knowledge about specific commodities and supply market
dynamics. Through FullSource, we help our customers identify and
screen global suppliers and assemble a request for quotation
that provides detailed, clear and consistent information for
suppliers to use as a basis for their competitive bids. Since
1995, our customers have sourced over $70 billion of goods
and services through our FullSource offering. FullSource
represented 66% of our 2003 revenues, and is expected to account
for a majority of revenues in 2004.



| |                 
| | ----------------
| | FreeMarkets®QSTM

FreeMarkets QS is a hosted software application
that enables companies to create and run their own sourcing
projects. We offer optional add-on services designed to enhance
the use of QS, and provide our customers with additional
capabilities that they may need to create effective online
markets and achieve

4



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their strategic sourcing objectives. Our QS
software is available in English, French, German, Italian,
Spanish, Portuguese, Japanese and Chinese.




| |                 
| | ----------------
| | FreeMarkets®ESTM

FreeMarkets ES enables companies to perform
global supply management activities effectively and efficiently
to reduce their total supply costs and supplier risk.
FreeMarkets ES contains software modules that facilitate
increased communication between purchasers and the users of
goods and services, enable purchasers to re-use information,
standardize sourcing processes and evaluation criteria and
facilitate the effective management of contract compliance.



| |                                           
| | ------------------------------------------
| | FreeMarkets® Spend Visibility
    Solution

FreeMarkets Spend Visibility Solution is an
integrated offering that combines analysis software with data
collection, cleansing and enhancement services, and provides
companies visibility into what they spend globally on goods and
services.



| |                                                  
| | -------------------------------------------------
| | FreeMarkets® Supplier Implementation
    Solution

FreeMarkets Supplier Implementation Solution
combines software and services to help companies improve the
speed and quality with which they engage and interact with new
suppliers to serve their operations.



| |                                          
| | -----------------------------------------
| | FreeMarkets® Global Service
    Solutions

FreeMarkets offers a range of services to support
its GSM solutions. These solutions include support, consulting,
sourcing and global education services.

Competition

A number of companies provide GSM software and/or
services. Competition in this market is rapidly evolving, and we
expect competition to intensify in the future, which could lead
to price reductions, reduced gross margins and loss of market
share. We currently or potentially will compete with a number of
other companies, including:



| |   |                                                                                                                                                                                               
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | providers of enterprise software (such as SAP,
    Oracle and PeopleSoft), extending their offerings to include
    services or technology similar to ours;                                   
|
|
|
| |  | professional service and consulting firms (such
    as McKinsey, A.T. Kearney and Accenture), and others offering
    managed sourcing and supply management services similar to ours;
    and
|
|
|
| |  | providers of stand-alone, self-service software
    products (such as Emptoris, Frictionless and B2eMarkets) that
    make available to buyers point-solution GSM technology.                 
|




Sales and Marketing







We sell our services and software solutions
through our direct sales organization. As of December 31,
2003, our direct sales force was organized by geographic region.







We typically target our sales efforts at senior
purchasing executives, chief technology officers and other
senior executives within a buying organization. When a
prospective customer is interested in working with us, we
analyze which portions of its sourcing needs are best suited for
our GSM solutions. Throughout this analysis, we work with the
prospective customer to negotiate terms of an agreement.







New customers often enter into short-term
agreements with us before making a longer-term commitment.
Because our technology does not have to be integrated with the
customers existing information technology infrastructure,
short-term agreements can quickly result in savings for our
customer.




5



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Our marketing efforts focus on general
communications and on obtaining referrals from our existing
customers. We participate in trade conferences and purchasing
industry forums. We intend to continue to make advertising and
marketing expenditures in an effort to become better known in
our target markets.







Technology







We have tailored our proprietary technology to
the needs of purchasing professionals. Our technology consists
of a suite of sourcing tools that enable our customers, in a
secure, password-protected environment, to create complex RFQs,
publish specifications, select and collaborate with global
suppliers, configure a market, negotiate dynamically in real
time with suppliers, and award business to suppliers.







We spent $20.1 million on research and
development in 2001, $27.0 million in 2002 and
$24.6 million in 2003. We plan to continue to invest in our
research and development efforts to develop new technology and
add features to our existing technology.







Intellectual Property







We regard the protection of our intellectual
property rights to be important to our success. We rely on a
combination of patent, copyright, trademark, service mark and
trade secret restrictions and contractual provisions to protect
our intellectual property rights. We require employees to enter
into confidentiality and invention assignment agreements, and
require some of our key employees to enter into non-competition
agreements. The contractual provisions and the other steps we
have taken to protect our intellectual property may prevent
misappropriation of our technology or deter third parties from
developing similar or competing technologies.







We have obtained eight patents on aspects of our
technology and business processes and have filed applications
for additional patents. We cannot assure you that our existing
patents or any patent that may be issued in the future will not
be successfully challenged by others or invalidated, or will
adequately protect our technology or processes or otherwise
result in commercial advantages to us. We have also obtained and
applied for United States and foreign registrations for certain
trademarks, domain names and logos, and some of our software,
documentation and other written materials are copyrighted, but
these protections may not be adequate.







We cannot be certain that the steps that we have
taken to protect our intellectual property will be adequate,
that third parties will not infringe or misappropriate our
proprietary rights or that third parties will not independently
develop similar proprietary information. Any such infringement,
misappropriation or independent development could harm our
future financial results. Additionally, effective patent,
trademark, copyright and trade secret protection may not be
available in every country where we do business. We may, at
times, have to incur significant legal costs and spend time
defending our trademarks, copyrights and patents. Any defense
efforts, whether successful or not, would divert both time and
resources from the operations and growth of our business.




Employees

As of December 31, 2003, we had 967
employees worldwide, including 515 in account management, global
sourcing services and market operations, 145 in research and
development, 144 in sales and marketing, 72 in technical
operations and 91 in executive leadership, administration, human
resources, legal, finance and facilities management. Our global
workforce consists of 702 team members in North America, 65 in
Europe, 190 in Asia and Australia and 10 in South America. In
January 2004, we eliminated 65 positions, or 7% of our workforce
to better align our cost structure with our anticipated future
revenues. None of our employees is represented by a collective
bargaining agreement, and we believe that we have good relations
with our employees.

6



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##### Table of Contents



Corporate History

We were originally incorporated in 1995 as
Online Markets Corporation. We changed our name to
FreeMarkets OnLine, Inc. shortly after our
formation, and then changed our name again in September 1999 to
FreeMarkets, Inc.

Available Information

Our Internet address is www.freemarkets.com. We
make available free of charge through our website our annual
report on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K and amendments to those reports
filed or furnished pursuant to Section 13(a) or 15(d) of
the Securities Exchange Act of 1934 as soon as reasonably
practicable after we electronically file such material with, or
furnish it to, the Securities and Exchange Commission.

Additional Factors that May Affect Future
Results



| |                                                                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | In January 2004, we announced a definitive
    agreement to enter into a merger agreement with Ariba, Inc.; if
    we fail to complete the merger, our stock price and future
    business operations could be harmed

If the merger is not completed for any reason,
the price of our common stock may decline insofar as the current
price of our common stock reflects a positive market assumption
that the merger will be completed. In addition, if the merger is
not completed, we may be subject to a number of material risks,
including:



| |   |                                                                                                                                                                    
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | payment of a $17 million termination fee
    under certain circumstances; and                                                                                      
|
| |  | costs related to the merger, such as financial
    advisory, legal and accounting fees, the majority of which must
    be paid even if the merger is not completed.

If the merger agreement is terminated, we may be
unable to find a partner willing to engage in a similar
transaction on terms as favorable as those set forth in the
merger agreement, or at all. This could limit our ability to
pursue our strategic goals. In addition, while the merger
agreement is in effect, we are prohibited from soliciting,
initiating or taking any other action with respect to competing
transactions, such as a merger, sale of assets or other business
combination, with any party other than unsolicited, written,
bona fide proposals or offers under specified terms and
conditions.

Our customers may, in response to the
announcement of the merger, delay or defer decisions concerning
our products. Any delay or deferral in those decisions by our
customers could have a material adverse effect on our business,
regardless of whether the merger is ultimately completed.
Similarly, current and prospective employees may experience
uncertainty about their future roles with the combined company
until the combined companys strategies with regard to all
employees are announced or executed. This may adversely affect
our ability to attract and retain key management, sales,
marketing and technical personnel.

If the merger is terminated and our board of
directors determines to seek another partner or business
combination, there can be no assurance that we will be able to
find a partner willing to pay an equivalent or more attractive
price than the price offered in the merger.



| |                                                                                                                 
| | ----------------------------------------------------------------------------------------------------------------
| | We cannot be certain that our new global
    supply management solutions will be accepted in the
    marketplace

We are currently in the midst of a strategic
transition from a company that offers a single
technology-enhanced service to a provider of a broader range of
software, services and information solutions. There are
significant risks associated with this strategy. The market for
supply management products is still evolving, and there can be
no guarantee that our new products will gain the market
acceptance we anticipate. The technology is complex and may
contain undetected errors or defects that we may not be able to
fix. Reduced market acceptance of our services or software due
to errors or defects in our technology would reduce revenues and
could damage our reputation in the marketplace. In addition, our
management has

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limited experience in managing a multi-product
company. The management challenges will be exacerbated by the
current weak economic environment and continued relatively low
levels of technology spending.







| |                                                                                                                                                                               
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our customers may buy self-service products
    instead of more costly technology-enhanced services, which could
    adversely affect revenue from our FullSource
    solution







We offer our customers a technology-enhanced
service, which we call the FullSource solution.
Since 2001, we have also offered our QS solution, which enables
customers to conduct their own sourcing projects, and since the
second half of 2002, we have been introducing additional new
product offerings to address a broader set of supply management
activities. Our QS solution and our newer software products are
less costly than our FullSource solution. In 2003, many of our
customers expanded their use of our QS solution and newer
products, and decreased the amounts they were spending on our
FullSource solution. Because the increased sales attributable to
our QS solution and newer products did not make up for the
decreased sales attributable to our FullSource solution, our
revenues declined 19% in 2003 compared with 2002, and could
decline further in the future if this trend continues. Any
future revenue decline would have an adverse effect on our
business.






| |                                                                                                                                                                                                                 
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our operating results are volatile and
    trends are difficult to predict; if we fail to meet the
    expectations of public market analysts or investors, the market
    price of our common stock may decline

Our quarterly operating results have varied
significantly in the past and will likely vary significantly in
the future. For example, over the past four quarters ending
December 31, 2003, our net loss has ranged from as high as
$11.8 million to as low as $4.6 million. Based on our
transition to a new business model and the continued weak state
of the economy, you should not rely upon our past quarterly
operating results as indicators of future performance. In
addition, our operating results could fall below the
expectations of securities analysts or investors in some future
quarter or quarters. As a result, the price of our common stock
may fall.

Our industry is highly competitive, and we
cannot assure you that we will be able to compete
effectively

The Global Supply Management, or GSM, software
and service solutions industry is intensely competitive. If we
cannot successfully compete, our business will suffer reduced
revenues and operating results. As one of a number of companies
providing GSM solutions to market, we face the risk that
existing and potential customers may choose to purchase
competitors services or products. If they do, then our
revenues and operating results will be reduced. Given that
barriers to entry are relatively low, we expect competition to
intensify as new competitors enter the market.






| |                                                                                                                                                                                        
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We have experienced revenue concentration
    in the past; the loss of our largest customers would reduce our
    revenues and operating results, and could cause our stock to
    fall







In 2002 and 2003, our top five customers and four
customers, respectively, comprised over 20% of our revenues.
Although no customer in 2002 or 2003 accounted for 10% or more
of revenues, the loss of any one of these significant customers
would reduce our revenues and operating results, and may cause a
decrease in our stock price. In addition, as of
December 31, 2003, amounts due from one customer, and as of
December 31, 2002, amounts due from two customers, each
exceeded 10% of our total accounts receivable. The failure of
these customers to pay these accounts receivable would have an
adverse effect on our cash flows and operating results.






| |                                                                                                 
| | ------------------------------------------------------------------------------------------------
| | General economic conditions may adversely
    affect our future operations and operating results

The continued uncertainty in the global economy
had an effect on our operations in 2003, which resulted in a
reduction in our FullSource online market volume and contributed
to a slowdown in the growth of our total customers during the
year. If the uncertainty surrounding the global economy
continues, customers may continue to defer or postpone their
purchasing decisions. The uncertainty may have the effect of
increasing the length of sales cycles for our products and
services. In addition, the

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amount of fixed monthly fees that we are able to
negotiate for new customers may be adversely affected based on
lower anticipated market volume from our customers. The amount
of revenue we earn from variable fees, such as performance
incentive payments based on volume and/or savings, may also
decline as a result of lower volumes.




| |                                                                                                                                                                                                                                                      
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We have acquired in the past and may in the
    future acquire complementary businesses or technologies;
    acquisitions may dilute our existing stockholders and we may not
    achieve any of the benefits we would expect from an
    acquisition

If appropriate opportunities present themselves,
we may acquire additional businesses, technologies, services or
products that we believe are strategic, and any such
acquisitions may be material in size. We may not be able to
successfully identify, negotiate or finance any future
acquisition. Even if we do succeed in acquiring a business,
technology, service or product, we have limited experience in
integrating an acquisition into our business. The process of
integrating any acquired company may produce unforeseen
operating difficulties and expenditures, and may absorb
significant attention of our management that would otherwise be
available for the ongoing development of our business. Moreover,
we may not achieve any of the benefits that we might anticipate
from an acquisition. If we make acquisitions, we may issue
shares of stock that dilute other stockholders, incur debt or
assume contingent liabilities. Any financing that we might need
for acquisitions may only be available to us on terms that
restrict our business or that impose additional costs that
reduce our operating results.



| |                                                                                                                                                                  
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We may write-down the unamortized goodwill
    from our acquisitions or the investment in Adexa, Inc.
    (Adexa), which would reduce our financial
    results




We adopted the provisions of Statement of
Financial Accounting Standards (SFAS) No. 142,
Goodwill and Other Intangible Assets, on
January 1, 2002, and no longer record goodwill
amortization. In connection with adopting this standard, we
determined that the carrying value of Surplus Record, a
directory and network of dealers and buyers and an online
surplus asset trade site acquired in 2000, exceeded its
estimated fair value, as determined utilizing various valuation
techniques including discounted cash flow and comparative market
analysis. We recorded an impairment loss of $5.3 million in
2002 that was recognized as the cumulative effect of an
accounting change. The carrying value of goodwill on our
consolidated balance sheet as of December 31, 2003 was
$2.0 million. In accordance with SFAS No. 142, it is
our policy to assess the potential impairment of goodwill on an
annual basis or earlier as circumstances dictate. We completed
our annual impairment test of goodwill in Q1 2003, and concluded
we did not have any impairment of goodwill based on the
estimated fair value of discounted cash flows. The recognition
of any future impairment loss could have a material effect on
our financial results.




As part of the agreement to mutually terminate
our proposed merger with Adexa in 2001, we agreed to make an
investment in Adexa in the amount of $6.0 million. We concluded
in 2002 that there was an other-than-temporary decline in the
value of our investment based on a valuation determined by a
financing completed by Adexa. As a result, we recorded a
$5.1 million loss on our investment in 2002. The carrying
value of the investment as of December 31, 2003 was
$889,000. Any further write-downs of this investment based on
additional other-than-temporary declines in fair value could
have a material effect on our financial results.




In January 2004, we acquired the auction and
services business of Covisint for $16.3 million. The
acquisition is being accounted for as a purchase business
combination, and we anticipate recording a portion of the
purchase price to goodwill. Any future impairment loss of
goodwill could have a material effect on our financial results.






| |                                                         
| | --------------------------------------------------------
| | We have historically used more cash than we
    generate

Since our inception, our operating and investing
activities have used more cash than they have generated. We
generated positive cash flows in 2003, and believe that our
current resources will be sufficient to meet our working capital
and capital expenditures for at least the next 18 to
24 months.

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However, if we are unable to control costs, our
resources may be depleted, and accordingly, our current
resources may only be sufficient for a shorter period. In either
event, thereafter, we may find it necessary to obtain additional
financing. In the event that additional financing is required,
we may not be able to raise it on terms acceptable to us, if at
all.




| |                                          
| | -----------------------------------------
| | We have historically generated
    losses

We achieved a modest profit in 1998, but incurred
losses of $21.8 million, $156.4 million,
$295.2 million, $17.6 million and $30.9 million
in 1999, 2000, 2001, 2002 and 2003, respectively, as a result of
our efforts to invest in the actual and anticipated growth of
our business. Since our inception in 1995, we have accumulated
losses of $525.1 million. Our achievement of profitability
in the future will depend on whether we can implement the
strategic transition from a company that offers a single
technology-enhanced service to one with multiple software and
service solutions and increase revenues while controlling costs.
We may not achieve profitability in the future, or sustain any
future profitability.



| |                                                                                             
| | --------------------------------------------------------------------------------------------
| | Customers may not purchase our services if
    we are unable to generate significant savings

If our software and services increase the
efficiency of any particular supply market, the future
likelihood of significant savings to our customers in that
market may decrease. Factors beyond our control may limit our
ability to generate savings. If the magnitude of savings in
particular product categories decreases, we may have difficulty
in the future selling our software and services to buyers in
those markets, or attracting willing suppliers in other markets,
either of which will reduce our revenues and operating results.



| |                                                                                                                    
| | -------------------------------------------------------------------------------------------------------------------
| | We may not be able to adjust our spending
    quickly; if we cannot, then our operating results will be
    reduced

Our planned expense levels are relatively fixed
in the short term and are based on our anticipation of future
revenues. We may not be able to accurately forecast revenues.
The difficulty of forecasting our revenues is increased due to
current challenging economic conditions that face many of our
existing and potential customers, and which may cause them to
defer or postpone their purchasing decisions in response to
changes in their business. If we fail to accurately predict
revenues in relation to our planned expense levels, then we may
be unable to adjust our costs in a timely manner in response to
lower-than-expected revenues, and our operating results may be
negatively affected.



| |                                                         
| | --------------------------------------------------------
| | We may not be able to hire or retain
    qualified staff

If we cannot attract and retain adequate
qualified and skilled staff, the growth of our business may be
limited. Our ability to provide software and services to
customers and grow our business depends, in part, on our ability
to attract and retain staff with college and graduate degrees,
as well as professional experiences that are relevant for
sourcing, supply management, software development and other
functions we perform. Competition for personnel with these skill
sets is intense. Some technical job categories are under
conditions of severe shortage in the United States. In addition,
restrictive immigration quotas could prevent us from recruiting
skilled staff from outside the United States. We may not be able
to recruit or retain the caliber of staff required to carry out
essential functions at the pace necessary to sustain or grow our
business. Our ability to recruit and retain qualified personnel
may be adversely affected by the decline in the price of our
common stock. Stock options are an important component of our
overall compensation package and, in current market conditions,
may not provide appropriate incentives to our current and
prospective employees.



| |                                                                                                                                                                               
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our sales cycle is long and uncertain and
    may not result in revenues; factors outside of our control may
    affect the decision to purchase our software and
    services

Our sales cycle is long, typically taking from
two to six months from initial customer contact until we sign a
contract. Not every potential customer that we solicit actually
purchases our products and services.

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Because we offer solutions to address the
evolving GSM market, we must educate potential customers on the
use and benefits of our products and services. We need to spend
a significant amount of time with multiple decision makers in a
prospective customers organization to sell our products
and services. Other factors that contribute to the length and
uncertainty of our sales cycle and that may reduce the
likelihood that customers will purchase our solutions include:




| |   |                                                                                                       
| | - | ------------------------------------------------------------------------------------------------------
| |  | budgeting constraints;                                                                                
|
| |  | incentive structures that do not reward decision
    makers for savings achieved through cost-cutting;
|
| |  | the strength of pre-existing supplier
    relationships;                                              
|
| |  | competition from other providers of GSM
    solutions; and                                            
|
| |  | an aversion to new purchasing methods.                                                                



| |                                                                                                                         
| | ------------------------------------------------------------------------------------------------------------------------
| | If our short-term agreements do not lead to
    long-term customer relationships, our business may not be
    profitable

Frequently, we begin a relationship with a new
customer by entering into a short-term agreement that we hope
will lead to a long-term agreement. Failure to move a sufficient
number of customers from short-term to long-term agreements
could hurt our operating results. For example, our initial
agreement with a customer for our FullSource offering usually
involves a period of trial and evaluation. This initial period,
in which we learn about our customers business and its
related product categories, and educate our customer about the
best use of our products for its organization, requires a very
significant expenditure of our time and resources. A subsequent
longer-term agreement is often more productive given the parties
are more familiar with each other, and typically provides for
higher gross margins. Customers may decide not to enter into a
long-term agreement with us, or may delay entering into such an
agreement until a later time. Because we invest a significant
amount of time and resources early in a customer relationship,
our cost of revenues as a percentage of revenues are typically
higher at the outset of a relationship than those which we may
incur later. Further, we may be diverting personnel from
higher-margin opportunities to develop a new relationship,
without any assurance that the new relationship will endure. We
expect similar purchasing patterns to occur with our more recent
offerings as customers become accustomed to our new solutions.



| |                                                                                                                                                              
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Factors outside our control could result in
    disappointing market results; disappointed customers may cancel
    or fail to renew their agreements with us

The actual savings achieved through the use of
our solutions vary widely and depend upon many factors outside
of our control. These factors include:



| |   |                                                                                                                                                  
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the current state of supply and demand in the
    supply market for the products and services being purchased;                                   
|
| |  | the past performance of our customers
    purchasing organization in negotiating favorable terms with
    suppliers;                            
|
| |  | the willingness of a sufficient number of
    qualified suppliers to bid for business using our solutions;                                       
|
| |  | reductions in the number of suppliers in
    particular markets due to mergers, acquisitions or suppliers
    exiting from supply industries; and
|
| |  | seasonal and cyclical trends that influence all
    purchasing decision making.                                                                  

Because factors outside of our control affect a
customers perception of the value of our solutions,
customers may cancel our agreements or choose not to renew them,
even if we have performed well. Any non-renewal or cancellation
of agreements may reduce our revenues and operating results.

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| |                                                                                                              
| | -------------------------------------------------------------------------------------------------------------
| | Failures of hardware systems or software
    could undermine our customers confidence in our
    reliability

A significant disruption in the availability of
our technology could seriously undermine our customers
confidence in our business. Our customers hold us to a high
standard of reliability and performance. From time to time, we
have experienced service interruptions in our technology, with
the most significant being a breakdown in the connectivity
between suppliers and our technology. This connectivity is
provided to us by an outside vendor, and this kind of
interruption may occur in the future. During these disruptions,
participants may lose their online connection or we may not
receive their bids or other information in a timely manner. Any
interruptions in the availability of our software, services or
other information may undermine actual and potential
customers confidence in the reliability of our business.

Conducting online markets, as well as providing
other Global Supply Management software via the World Wide Web,
requires the successful technical operation of an entire chain
of software, hardware and telecommunications equipment. This
chain includes our software, the personal computers and network
connections of suppliers and buyers, our network servers,
operating systems, databases and networking equipment such as
routers. A failure of any element in this chain can partially or
completely disrupt the delivery of our solutions to customers.

Some of the elements set forth above are not
within our control, such as Internet connectivity and software,
hardware and telecommunications equipment we purchase from
others. We frequently have supplier and buyer participants from
outside North America who may use older or inferior technologies
that may not operate properly. In addition, hardware and
software are potentially vulnerable to interruption from power
failures, telecommunications outages, network service outages
and disruptions, natural disasters and vandalism and other
misconduct. Our business interruption insurance would not
compensate us fully for any losses that may result from these
disruptions.



| |                                                              
| | -------------------------------------------------------------
| | The loss of our key executives could
    disrupt our business




None of our executive officers or other key
employees is bound by an employment agreement. We rely on the
leadership and vision of the executive officers identified in
this Form 10-K/A, and the loss of any of these executives
could disrupt our business.






| |                                                                               
| | ------------------------------------------------------------------------------
| | If we fail to continually improve our
    technology, our business will suffer

Our solutions and the GSM market are
characterized by rapidly changing technologies and frequent new
product and service introductions. We may fail to introduce new
technology on a timely basis or at all. If we fail to introduce
new technology or to improve our existing technology in response
to industry developments, we could experience frustration from
our customers that could lead to a loss of revenues.



| |                                                                                                                                                    
| | ---------------------------------------------------------------------------------------------------------------------------------------------------
| | If we do not adequately maintain our
    customers confidential information, our reputation could
    be harmed and we could incur legal liability

Any breach of security relating to our
customers confidential information could result in legal
liability for us and a reduction in use or cancellation of our
products and services, either of which could materially harm our
business. Our personnel receive highly confidential information
from buyers and suppliers that is stored in our files and on our
computer systems. For example, we often possess blueprints and
product plans that could be valuable to our customers
competitors if misappropriated. Similarly, we receive sensitive
pricing information that has historically been maintained as a
matter of utmost confidence within buyer and supplier
organizations. We enter into standard non-disclosure and
confidentiality agreements with virtually all of our customers.

We currently have practices and procedures in
place to ensure the confidentiality of our customers
information. However, our security procedures to protect against
the risk of inadvertent disclosure or intentional breaches of
security might fail to adequately protect information that we
are obligated to keep confidential. We may not be successful in
adopting more effective systems for maintaining confidential
information, so our exposure to the risk of disclosure of the
confidential information of others may grow

12



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with increases in the amount of information we
possess. If we fail to adequately maintain our customers
confidential information, some of our customers could end their
business relationships with us and we could be subject to legal
liability.




| |                                                                                                                                     
| | ------------------------------------------------------------------------------------------------------------------------------------
| | If we are not able to adequately protect
    our intellectual property rights, then others may be able to
    duplicate our services

We rely in part upon our proprietary technology,
including our software, to conduct our business. Our failure to
adequately protect our intellectual property rights could harm
our business by making it easier for others to duplicate our
services. We have obtained eight patents on aspects of our
technology and business processes, and have filed applications
for additional patents. However, we cannot assure you that our
existing patents or any patent that may be issued in the future
will not be successfully challenged by others or invalidated,
that they will adequately protect our technology and processes,
or that they will result in commercial advantages for us. We
have also obtained and applied for United States and foreign
registrations for certain trademarks, domain names and logos,
and our software, documentation and other written materials are
copyrighted, but these protections may not be adequate. Although
we require each of our employees to enter into a confidentiality
agreement and some key employees are subject to non-competition
agreements, these agreements may not satisfactorily safeguard
our intellectual property against unauthorized disclosure.

Third parties may infringe or misappropriate our
proprietary rights or will not independently develop similar
proprietary information. Any infringement, misappropriation or
independent development could harm our future financial results.
In addition, effective patent, trademark, copyright and trade
secret protection may not be available in every country where we
do business. We may, at times, have to incur significant legal
costs and spend time defending our trademarks, copyrights and,
if issued, our patents. Any defense efforts, whether successful
or not, would divert both time and resources from the operation
and growth of our business.

There is also significant uncertainty regarding
the applicability to the Internet of existing laws regarding
matters such as property ownership, patents, copyrights and
other intellectual property rights. Legislatures adopted the
vast majority of these laws prior to the advent of the Internet
and, as a result, these laws do not contemplate or address the
unique issues of the Internet and related technologies. We
cannot be sure what laws and regulations may ultimately affect
our business or intellectual property rights.



| |                                                                                       
| | --------------------------------------------------------------------------------------
| | Others may assert that our technology
    infringes their intellectual property rights

We do not believe that we infringe the
proprietary rights of others, but we may be subject to
infringement claims in the future. The defense of any claims of
infringement made against us by third parties could involve
significant legal costs and require our management to divert
time from our business operations. Either of these consequences
of an infringement claim could have a material adverse effect on
our operating results. If we are unsuccessful in defending any
claims of infringement, we may be forced to obtain licenses or
to pay royalties to continue to use our technology. We may not
be able to obtain any necessary licenses on commercially
reasonable terms or at all. If we fail to obtain necessary
licenses or other rights, or if these licenses are too costly,
our operating results may suffer either from reductions in
revenues through our inability to serve customers or from
increases in costs to license third-party technology.



| |                                                                                                                            
| | ---------------------------------------------------------------------------------------------------------------------------
| | Others may refuse to license important
    technology to us or may increase the fees they charge us for
    this technology

We rely on third parties to provide us with some
software and hardware, for which we pay fees. This software has
been readily available, and to date, we have not paid
significant fees for its use. These third parties may
significantly increase their fees or refuse to license their
software or provide their hardware to us. While other vendors
may provide the same or similar technology, we cannot be certain
that we can obtain the required technology on favorable terms,
if at all. If we are unable to obtain required technology

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at a reasonable cost, our growth prospects and
operating results may be harmed due to impairment of our ability
to conduct business or increased cost.




| |                                                                                                               
| | --------------------------------------------------------------------------------------------------------------
| | Future government regulation of the
    Internet and online market services may add to our operating
    costs

Like many Internet-based businesses, we operate
in an environment of tremendous uncertainty as to potential
government regulation. We believe that we are not currently
subject to direct regulation of online sourcing or supply
management, other than regulations generally applicable to all
businesses. However, the Internet has rapidly emerged as a
sourcing and supply management medium, and governmental agencies
have not yet been able to adapt all existing regulations to the
Internet environment. Laws and regulations may be introduced and
court decisions reached that affect the Internet or other online
services, covering issues such as user pricing, user privacy,
freedom of expression, access charges, content and quality of
products and services, advertising, intellectual property rights
and information security. In addition, because we offer our
services worldwide and globally facilitate sales of goods to
customers, foreign jurisdictions may claim that we are required
to comply with their laws. Any future regulation may have a
negative impact on our business by restricting our method of
operation or imposing additional costs.

As a company that conducts a portion of our
business over the Internet, it is unclear in which jurisdictions
we are actually conducting business. Our failure to qualify to
do business in a jurisdiction that requires us to do so could
subject us to fines or penalties, and could result in our
inability to enforce contracts in that jurisdiction.

Numerous jurisdictions have laws and regulations
regarding the conduct of auctions and the liability of
auctioneers. We do not believe that these laws and regulations,
which were enacted for consumer protection many years ago, apply
to our GSM solutions. However, one or more jurisdictions may
attempt to impose these laws and regulations on our operations
in the future.



| |                                                                                                        
| | -------------------------------------------------------------------------------------------------------
| | We may become subject to certain sales and
    other taxes that could adversely affect our
    business

The imposition of sales, value-added or similar
taxes could diminish our competitiveness and harm our business.
We do not collect sales or other similar taxes for goods
purchased through our online markets. Our customers are large
purchasing organizations that typically manage and pay their own
sales and use taxes. However, we may be subject to sales tax
collection obligations in the future.



| |                                                                       
| | ----------------------------------------------------------------------
| | Our international operations subject us to
    risks and uncertainties

We face risks in doing business internationally.
We provide our solutions to international buyers and often have
international suppliers use our solutions and participate in our
markets. We have locations in Europe, Asia, Australia and South
America that serve our customers based abroad, as well as the
European, Asian, Australian and South American operations of our
multinational customers based in the United States. We may
establish similar locations in other parts of the world. We have
experienced, and expect to continue to experience, significant
costs for our international operations as we add staff and
facilities in foreign countries. These costs, together with the
costs of the overhead needed to comply with legal, regulatory
and accounting requirements that differ from those in the United
States, may reduce our operating results. Finally, our
international operations are subject to disruption from
political and economic instability in the countries in which
they are located, which may interrupt our ability to conduct
business and impose additional costs upon us.

We are subject to risks associated with currency
fluctuations with respect to our international sales and
expenditures denominated in foreign currencies. We hedge risks
associated with foreign currency transactions in order to
minimize the impact of changes in foreign currency exchange
rates. We utilize forward contracts to hedge trade and
intercompany receivables and payables. All hedge contracts are
marked to market through operations each period. There can be no
reasonable assurance that such hedging strategy will be
successful and that currency exchange rate fluctuations will not
have a material adverse effect on our operating results.

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| |                                                                                           
| | ------------------------------------------------------------------------------------------
| | Our stock price is volatile, which could
    result in substantial losses for stockholders

The market price for our common stock is highly
volatile and subject to wide fluctuations in response to the
risks described above and many other factors, some of which are
beyond our control. The market prices for stocks of Internet
companies and other companies whose businesses are heavily
dependent on the Internet have generally proven to be highly
volatile, particularly over the last three years.

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EXECUTIVE OFFICERS OF THE REGISTRANT

The following table sets forth information
regarding our executive officers as of February 1, 2004.

|                   |  |     |    |             |  |                                                                             
|------------------ |  | --- | -- | ----------- |  | ----------------------------------------------------------------------------
|Name               |  | Age |    | Position(s)
|                   |  |     |    |            
|Glen T. Meakem     |  |     | 40 |             |  | Founder and Chairman of the Board of Directors                              
|David H. McCormick |  |     | 38 |             |  | President, Chief Executive Officer and Director                             
|Sean M. Rollman    |  |     | 33 |             |  | Vice President, Controller, Treasurer and Acting
    Chief Financial Officer

Glen T. Meakemco-founded FreeMarkets in 1995 and has served as its Chairman of
the Board of Directors since inception. Mr. Meakem also
held the offices of President and Chief Executive Officer from
FreeMarkets inception until June 2000 and January 2003,
respectively. Prior to co-founding FreeMarkets, from May 1994 to
February 1995, Mr. Meakem was employed as a manager in the
Corporate Business Development Group of General Electric Co.
From January 1992 through April 1994, he was employed as a
consultant with McKinsey & Company, Inc.
Mr. Meakem earned his B.A. degree cum laude from Harvard
College and an M.B.A. from Harvard Business School.

David H. McCormickhas served as President since October 2002 and Chief Executive
Officer and a Director since January 2003. Before becoming
President, Mr. McCormick served as an Executive Vice
President since May 2001, as Senior Vice President and General
Manager of Core Business Markets since June 2000 and as Vice
President and General Manager of Core Business Markets since
December 1999. Prior to joining FreeMarkets, Mr. McCormick
was a consultant with McKinsey & Company, Inc.
Mr. McCormick holds a B.S. in Mechanical Engineering from
the United States Military Academy and a Ph.D. in Public and
International Affairs from Princeton University.

Sean M. Rollmanhas
served as Vice President, Treasurer and acting Chief Financial
Officer since October 2003 and as Controller since January 2000.
Before becoming Controller, Mr. Rollman served as Manager
of Financial Planning and Assistant Controller since April 1998.
Prior to joining FreeMarkets, from 1992 to 1998,
Mr. Rollman worked for Coopers & Lybrand as a
Manager in Assurance Services serving clients in the technology
and real estate industries. Mr. Rollman holds a B.S. in
Accounting and Economics from Indiana University of Pennsylvania.






|        |           
|------- | ----------
|Item 2. | Properties

Our corporate offices are located in leased space
at FreeMarkets Center, 210 Sixth Avenue, Pittsburgh,
Pennsylvania. The telephone number of our principal executive
office is (412) 434-0500.

Our headquarters in Pittsburgh, Pennsylvania
currently occupy 128,000 square feet of office space under a
lease covering 182,000 square feet that expires in May 2010.
Since January 1, 2003, we have abandoned a total of 54,000
square feet in our headquarters. We also lease office space in
five other North American metropolitan areas, as well as four in
Europe, seven in Asia and Australia and one in South America. We
believe that our existing facilities in Pittsburgh are adequate
for our needs for the next several years. We may add additional
offices in the United States and in other countries as growth
opportunities present themselves, as well as from time to time
abandon locations that are no longer required to meet the needs
of our business.






|        |                  
|------- | -----------------
|Item 3. | Legal Proceedings

Since April 27, 2001, eleven securities
fraud class action complaints have been filed against the
Company and two executive officers in federal court in
Pittsburgh, Pennsylvania. The complaints, all of which assert
the same claims, stem from the Companys announcement on
April 23, 2001 that, as a result of discussions with the
Securities and Exchange Commission (SEC), the
Company was considering amending its 2000 financial statements
for the purpose of reclassifying fees earned by the Company
under a service contract with Visteon. All of the cases have
been consolidated into a single proceeding. On October 30,
2001, the Company filed a motion seeking to dismiss all of the
cases in their entirety. On

16



---



##### Table of Contents






January 17, 2003, the Court denied the
motion to dismiss. On March 10, 2004, the Court certified the
case as a class action. The case is now in the discovery phase.
In addition, on September 24, 2001, an individual claiming
to be a FreeMarkets shareholder filed a shareholders
derivative action, nominally on behalf of FreeMarkets, against
all of the Companys directors and certain of its executive
officers. FreeMarkets is also named as a nominal defendant. The
suit is based on the same facts alleged in the foregoing
securities fraud class actions. The Company believes that the
plaintiffs allegations are without merit and it intends to
defend these claims vigorously.





Since July 31, 2001, several securities
fraud class action complaints have been filed in the United
States District Court for the Southern District of New York
alleging violations of the securities laws in connection with
the Companys December 1999 initial public offering
(IPO). In four of the complaints, the Company and
certain of its officers are named as defendants, together with
the underwriters that are the subject of the plaintiffs
allegations. Each of these cases has been consolidated for
pretrial purposes into an earlier lawsuit against the
underwriters of the Companys IPO. In addition, the cases
have been consolidated for pretrial purposes with approximately
1,000 other lawsuits filed against other issuers, their
officers, and underwriters of their initial public offerings. On
April 19, 2002, a consolidated amended class action
complaint (the Consolidated Complaint) was filed.
The Consolidated Complaint alleges claims against the Company
and seven of its officers and/or directors, as well as seven
investment banking firms who either served as underwriters or
are successors in interest to underwriters of the Companys
IPO. The Consolidated Complaint alleges that the prospectus used
in the Companys IPO contained material misstatements or
omissions regarding the underwriters allocation practices
and compensation in connection with the IPO, and also alleges
that the underwriters manipulated the aftermarket for the
Companys stock. Damages in an unspecified amount are
sought, together with interest, costs and attorneys fees.
The defendants filed a motion to dismiss the Consolidated
Complaint. By stipulation and order dated October 9, 2002,
the individual defendants were dismissed without prejudice from
the Consolidated Complaint. On February 19, 2003, the court
denied the Companys motion to dismiss. On June 25,
2003, a Special Committee of the Board of Directors of the
Company approved a proposed settlement of the litigation under
terms set forth in a memorandum of understanding and authorized
the Company to enter into a definitive settlement agreement to
be prepared in accordance with the memorandum of understanding.
The anticipated settlement will be subject to court approval
following notice to class members and a fairness hearing. Based
on the memorandum of understanding, the Company believes that
the anticipated settlement will have no material effect on the
Company.






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

Not applicable.




PART II






|        |                                                                          
|------- | -------------------------------------------------------------------------
|Item 5. | Market for Registrants Common Equity
    and Related Stockholder Matters

Market for the Companys Common
Stock

Our common stock has been quoted on the Nasdaq
National Market since December 10, 1999 under the symbol
FMKT. On February 1, 2004, the closing price of
our common stock was $9.21 per share. The following table
sets forth the range of high and low sales prices of our common
stock for the periods indicated.

|                      |      |                    |   |          |  |               |   |              |  |  |   |      |  |  |   |      | 
|--------------------- | ---- | ------------------ | - | -------- |  | ------------- | - | ------------ |  |  | - | ---- |  |  | - | ---- | 
|                      |      |                   
|                      |      | Three Months Ended
|                      |      |                   
|                      |      | March 31,          |   | June 30, |  | September 30, |   | December 31,
|                      |      | 2003               |   | 2003     |  | 2003          |   | 2003        
|                      |      |                    |   |          |  |               |   |             
|Price range per share |      |                    |   |          |  |               |   |              |  |  |   |      |  |  |   |     
|                      | Low  |                    | $ | 3.50     |  |               | $ | 5.11         |  |  | $ | 6.24 |  |  | $ | 5.30 | 
|                      | High |                    | $ | 6.64     |  |               | $ | 7.77         |  |  | $ | 9.86 |  |  | $ | 9.82 | 

17



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##### Table of Contents



|                      |      |                    |   |          |  |               |   |              |  |  |   |       |  |  |   |      | 
|--------------------- | ---- | ------------------ | - | -------- |  | ------------- | - | ------------ |  |  | - | ----- |  |  | - | ---- | 
|                      |      |                   
|                      |      | Three Months Ended
|                      |      |                   
|                      |      | March 31,          |   | June 30, |  | September 30, |   | December 31,
|                      |      | 2002               |   | 2002     |  | 2002          |   | 2002        
|                      |      |                    |   |          |  |               |   |             
|Price range per share |      |                    |   |          |  |               |   |              |  |  |   |       |  |  |   |     
|                      | Low  |                    | $ | 18.04    |  |               | $ | 9.71         |  |  | $ | 4.71  |  |  | $ | 4.49 | 
|                      | High |                    | $ | 29.09    |  |               | $ | 23.38        |  |  | $ | 14.10 |  |  | $ | 9.40 | 

As of February 1, 2004, there were
approximately 427 holders of record of our common stock. We
believe that a substantially larger number of beneficial owners
hold shares of our common stock in depository or nominee form.

Dividend Policy

We have never declared or paid cash dividends on
our capital stock. We do not anticipate paying any cash
dividends in the foreseeable future, as we intend to retain any
future earnings to finance the expansion of our business.
Moreover, our bank credit facility restricts our ability to pay
cash dividends.






|        |                        
|------- | -----------------------
|Item 6. | Selected Financial Data




|                                               |                                                  |                                       |         |        |  |      |         |        |   |      |          |         |  |   |          |        |  |   |         |        | 
|---------------------------------------------- | ------------------------------------------------ | ------------------------------------- | ------- | ------ |  | ---- | ------- | ------ | - | ---- | -------- | ------- |  | - | -------- | ------ |  | - | ------- | ------ | 
|                                               |                                                  |                                      
|                                               |                                                  | Year Ended December 31,              
|                                               |                                                  |                                      
|                                               |                                                  | 2003                                  |         | 2002   |  | 2001 |         | 2000   |   | 1999
|                                               |                                                  |                                       |         |        |  |      |         |        |   |     
|                                               |                                                  |                                      
|                                               |                                                  | (in thousands, except per share data)
|Consolidated Statement of Operations
    Data: |                                                  |                                       |         |        |  |      |         |        |   |      |          |         |  |   |          |        |  |   |         |       
|Revenues                                       |                                                  | $                                     | 138,716 |        |  | $    | 170,441 |        |   | $    | 155,342  |         |  | $ | 90,467   |        |  | $ | 23,103  |       
|                                               |                                                  |                                       |         |        |  |      |         |        |   |      |          |         |  |   |          |        |  |   |         |       
|Operating costs and expenses:                  |                                                  |                                       |         |        |  |      |         |        |   |      |          |         |  |   |          |        |  |   |         |       
|                                               | Cost of revenues                                 |                                       |         | 69,651 |  |      |         | 76,129 |   |      |          | 78,582  |  |   |          | 56,024 |  |   |         | 14,389 | 
|                                               | Research and development                         |                                       |         | 24,551 |  |      |         | 27,019 |   |      |          | 20,067  |  |   |          | 19,121 |  |   |         | 4,913  | 
|                                               | Sales and marketing                              |                                       |         | 35,584 |  |      |         | 45,612 |   |      |          | 51,304  |  |   |          | 41,505 |  |   |         | 11,939 | 
|                                               | General and administrative                       |                                       |         | 21,425 |  |      |         | 23,674 |   |      |          | 32,086  |  |   |          | 33,720 |  |   |         | 9,294  | 
|                                               | Stock compensation and warrant costs(2)          |                                       |         | 6,783  |  |      |         | 7,998  |   |      |          | 8,569   |  |   |          | 6,411  |  |   |         | 5,200  | 
|                                               | Investment write-down                            |                                       |         |       |  |      |         | 5,111  |   |      |          |        |  |   |          |       |  |   |         |       | 
|                                               | Restructuring charges                            |                                       |         | 14,161 |  |      |         | (303   | ) |      |          | 6,432   |  |   |          |       |  |   |         |       | 
|                                               | Terminated merger-related costs                  |                                       |         |       |  |      |         |       |   |      |          | 3,385   |  |   |          |       |  |   |         |       | 
|                                               | Goodwill amortization and impairment(1)          |                                       |         |       |  |      |         |       |   |      |          | 252,031 |  |   |          | 90,749 |  |   |         |       | 
|                                               | Write-off of in-process research and development |                                       |         |       |  |      |         |       |   |      |          |        |  |   |          | 7,397  |  |   |         |       | 
|                                               |                                                  |                                       |         |        |  |      |         |        |   |      |          |         |  |   |          |        |  |   |         |       
|Total operating costs and expenses             |                                                  |                                       | 172,155 |        |  |      | 185,240 |        |   |      | 452,456  |         |  |   | 254,927  |        |  |   | 45,735  |       
|                                               |                                                  |                                       |         |        |  |      |         |        |   |      |          |         |  |   |          |        |  |   |         |       
|Operating loss                                 |                                                  |                                       | (33,439 | )      |  |      | (14,799 | )      |   |      | (297,114 | )       |  |   | (164,460 | )      |  |   | (22,632 | )     
|                                               | Interest and other income, net                   |                                       |         | 3,733  |  |      |         | 3,243  |   |      |          | 2,665   |  |   |          | 8,409  |  |   |         | 833    | 
|                                               |                                                  |                                       |         |        |  |      |         |        |   |      |          |         |  |   |          |        |  |   |         |       
|Loss before taxes and change in accounting     |                                                  |                                       | (29,706 | )      |  |      | (11,556 | )      |   |      | (294,449 | )       |  |   | (156,051 | )      |  |   | (21,799 | )     
|                                               | Provision for income taxes                       |                                       |         | 1,188  |  |      |         | 712    |   |      |          | 782     |  |   |          | 361    |  |   |         | 22     | 
|                                               |                                                  |                                       |         |        |  |      |         |        |   |      |          |         |  |   |          |        |  |   |         |       




18



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##### Table of Contents



|                                             |                                                            |                                       |         |        |   |      |         |        |   |      |          |        |   |   |          |        |   |   |         |        |  
|-------------------------------------------- | ---------------------------------------------------------- | ------------------------------------- | ------- | ------ | - | ---- | ------- | ------ | - | ---- | -------- | ------ | - | - | -------- | ------ | - | - | ------- | ------ | -
|                                             |                                                            |                                      
|                                             |                                                            | Year Ended December 31,              
|                                             |                                                            |                                      
|                                             |                                                            | 2003                                  |         | 2002   |   | 2001 |         | 2000   |   | 1999
|                                             |                                                            |                                       |         |        |   |      |         |        |   |     
|                                             |                                                            |                                      
|                                             |                                                            | (in thousands, except per share data)
|Loss before change in accounting             |                                                            |                                       | (30,894 | )      |   |      | (12,268 | )      |   |      | (295,231 | )      |   |   | (156,412 | )      |   |   | (21,821 | )     
|                                             | Cumulative effect of accounting change for
    goodwill(1) |                                       |         |       |   |      |         | (5,327 | ) |      |          |       |   |   |          |       |   |   |         |       |  
|                                             |                                                            |                                       |         |        |   |      |         |        |   |      |          |        |   |   |          |        |   |   |         |       
|Net loss                                     |                                                            | $                                     | (30,894 | )      |   | $    | (17,595 | )      |   | $    | (295,231 | )      |   | $ | (156,412 | )      |   | $ | (21,821 | )     
|                                             |                                                            |                                       |         |        |   |      |         |        |   |      |          |        |   |   |          |        |   |   |         |       
|Earnings per share before accounting change: |                                                            |                                       |         |        |   |      |         |        |   |      |          |        |   |   |          |        |   |   |         |       
|                                             | Basic and diluted                                          |                                       | $       | (0.74  | ) |      | $       | (0.30  | ) |      | $        | (7.48  | ) |   | $        | (4.21  | ) |   | $       | (1.46  | )
|Earnings per share after accounting change:  |                                                            |                                       |         |        |   |      |         |        |   |      |          |        |   |   |          |        |   |   |         |       
|                                             | Basic and diluted                                          |                                       | $       | (0.74  | ) |      | $       | (0.42  | ) |      | $        | (7.48  | ) |   | $        | (4.21  | ) |   | $       | (1.46  | )
|Weighted average shares:                     |                                                            |                                       |         |        |   |      |         |        |   |      |          |        |   |   |          |        |   |   |         |       
|                                             | Basic and diluted                                          |                                       |         | 42,002 |   |      |         | 41,553 |   |      |          | 39,492 |   |   |          | 37,189 |   |   |         | 14,914 |  

|                                          |  |                    |         |      |  |      |         |      |  |      |         |  |  |   |         |  |  |   |         | 
|----------------------------------------- |  | ------------------ | ------- | ---- |  | ---- | ------- | ---- |  | ---- | ------- |  |  | - | ------- |  |  | - | ------- | 
|                                          |  |                   
|                                          |  | As of December 31,
|                                          |  |                   
|                                          |  | 2003               |         | 2002 |  | 2001 |         | 2000 |  | 1999
|                                          |  |                    |         |      |  |      |         |      |  |     
|                                          |  |                   
|                                          |  | (in thousands)    
|Consolidated Balance Sheet Data:          |  |                    |         |      |  |      |         |      |  |      |         |  |  |   |         |  |  |   |         | 
|Cash and marketable investments           |  | $                  | 136,674 |      |  | $    | 135,023 |      |  | $    | 103,489 |  |  | $ | 121,148 |  |  | $ | 210,244 | 
|Working capital                           |  |                    | 108,850 |      |  |      | 119,218 |      |  |      | 88,622  |  |  |   | 108,873 |  |  |   | 208,850 | 
|Total assets                              |  |                    | 183,149 |      |  |      | 193,667 |      |  |      | 189,392 |  |  |   | 462,546 |  |  |   | 231,654 | 
|Long-term debt, excluding current portion |  |                    | 342     |      |  |      | 1,328   |      |  |      | 2,904   |  |  |   | 544     |  |  |   | 3,278   | 
|Total stockholders equity                |  |                    | 144,217 |      |  |      | 157,511 |      |  |      | 149,645 |  |  |   | 416,797 |  |  |   | 218,654 | 



---



|    |                                                                                                                                                                                                                                                       
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(1) | As described in Note 6 to the consolidated
    financial statements, the Company adopted SFAS No. 142
    Goodwill and Other Intangible Assets on January 1,
    2002. As a result, goodwill with indefinite lives is no longer
    being amortized.
|   
|   
|   
|(2) | Stock compensation and warrant costs are
    attributable to the following operating expense categories:                                                                                                                                              
|   




|                           |  |      |       |      |  |      |       |      |  |      |       |  |  |   |       |  |  |   |       | 
|-------------------------- |  | ---- | ----- | ---- |  | ---- | ----- | ---- |  | ---- | ----- |  |  | - | ----- |  |  | - | ----- | 
|                           |  | 2003 |       | 2002 |  | 2001 |       | 2000 |  | 1999
|                           |  |      |       |      |  |      |       |      |  |     
|Research and development   |  | $    | 50    |      |  | $    | 95    |      |  | $    | 158   |  |  | $ | 443   |  |  | $ | 283   | 
|Sales and marketing        |  |      | 6,733 |      |  |      | 7,903 |      |  |      | 8,411 |  |  |   | 5,965 |  |  |   | 4,669 | 
|General and administrative |  |      |      |      |  |      |      |      |  |      |      |  |  |   | 3     |  |  |   | 248   | 
|                           |  |      |       |      |  |      |       |      |  |      |       |  |  |   |       |  |  |   |       | 
|                           |  | $    | 6,783 |      |  | $    | 7,998 |      |  | $    | 8,569 |  |  | $ | 6,411 |  |  | $ | 5,200 | 
|                           |  |      |       |      |  |      |       |      |  |      |       |  |  |   |       |  |  |   |       | 









|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 7. | Managements Discussion and Analysis
    of Financial Condition and Results of Operations

The following discussion and analysis of our
financial condition and results of operations should be read in
conjunction with our consolidated financial statements and
related notes.

Overview

FreeMarkets provides software, services and
solutions to help companies improve their sourcing and supply
management processes and enhance the capabilities of their
supply management organization. Our customers are buyers of
industrial parts, raw materials, commodities and services. As of
December 31, 2003, we serve our customers from 17 locations
in 13 countries on five continents. Our team members provide
services to customers in more than 35 languages through
operations centers in Pittsburgh and Singapore.

19



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##### Table of Contents



Since our inception, FreeMarkets has provided
software and services to help companies identify savings,
enhance their sourcing efficiency and achieve their strategic
sourcing goals by enabling them to source goods and services in
our online markets. In providing these services, we work with
our customers to identify and screen suppliers and to assemble a
request for quotation that provides detailed, clear and
consistent information for suppliers to use in our online
markets. Our web-based technology enables suppliers from around
the world to submit bids for our customers purchase orders
in real-time interactive competition featuring downward
price dynamic bidding. While we have provided this
technology-enhanced service to buyers since 1995, we began to
describe it using the FullSource name in 2001. In
2001, we also introduced our QS solution, which enables
customers to conduct their own sourcing projects, including
running their own online markets. During the second half of 2002
and beginning of 2003, we introduced a number of new product
offerings to expand our solutions beyond sourcing to address a
broader set of supply management activities. Our development of
a broader set of solutions in 2002 and 2003 is part of a
strategic transition from a company that offers a single
technology-enhanced service to one with multiple software and
service solutions. These activities include supply analysis and
strategy, spend requirements management, sourcing, supplier
development and supplier relationship management. We refer to
these activities as Global Supply Management, or GSM.

Our solutions combine software, services and
information to address the GSM market. These solutions are
ultimately designed to help companies lower costs and reduce
their supply risks.

Recent Events




In January 2004, we announced a definitive
agreement to merge with Ariba, a provider of Enterprise Spend
Management products and services. Under terms of the agreement,
shareholders of our common stock will receive 2.25 Ariba
common shares and $2.00 in cash for each outstanding share of
FreeMarkets. The transaction is subject to customary closing
conditions, including regulatory review and approval by the
stockholders of each company, and is expected to close in the
latter part of the second quarter. Because the merger is subject
to factors beyond the parties control, however, we cannot
predict whether or when the merger will be completed.







Also, in January 2004, we acquired the auction
and services business of Covisint, an independent e-business
service provider for the global automotive industry, for
$16.3 million.







Also in January 2004, we executed a restructuring
plan resulting in the elimination of 65 positions in our global
workforce. Additionally, in February 2004, we evaluated our
office space in Pittsburgh, Pennsylvania, and determined that we
will cease using one of the floors we currently lease in our
global headquarters, as well as close two domestic offices. In
accordance with SFAS No. 146, we will record a
restructuring charge of approximately $4.4 million in the
first quarter of 2004, covering these severance and lease costs.




Overview of 2003 Financial Results




Our operating results during 2003 should be
considered within the context of the macroeconomic environment
and our transition to a provider of multiple software and
service solutions. Revenues decreased 19% from 2002 due to a
combination of factors, including a change in the mix of
products and services deployed by our customers, as well as the
continued weak economic environment which we believe has caused
our customers to either reduce or defer their purchasing
decisions. In 2003, several large customers renewed their
FullSource service agreements at lower market volumes than the
volumes provided in previously existing agreements, resulting in
33% lower revenues from our FullSource offering in 2003. In
addition, with the introduction of our less-costly QS solution
in early 2001 and several other products in late 2002 and early
2003, several FullSource-only customers have expanded their use
of our solutions to include a broader mix of FullSource, QS and
related offerings. As customers gain experience with our
sourcing solutions, certain entities have migrated a portion of
their sourcing requirements to our self-service technologies. In
some cases, increased sales of additional solutions to existing
customers have resulted in lower total revenues due to this
migration.




20



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##### Table of Contents






Our QS solution and our newer software products
are less costly than our FullSource solution. In 2003, many of
our customers expanded their use of our QS solution and newer
products, and decreased the amounts they were spending on our
FullSource solution. Because the increased sales attributable to
our QS solution and newer offerings did not make up for the
decreased sales attributable to our FullSource solution, our
revenues declined 19% in 2003 compared with 2002, and could
decline further in the future if this trend continues.




Total operating expenses declined from 2002
primarily due to reduced depreciation expense, cost cutting
measures in discretionary spending such as marketing and
advertising, travel and recruiting, as well as a 3% decrease in
the average number of employees. We ended the year with 967
employees versus 1,068 at December 31, 2002. Finally, total
cash and investments increased by approximately
$1.7 million during 2003.

Critical Accounting Policies and
Estimates

The accompanying discussion and analysis of our
financial condition and results of operations are based upon our
consolidated financial statements, which have been prepared in
accordance with generally accepted accounting principles in the
United States of America (US GAAP). 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. These estimates form the
basis for making judgments about the carrying values of assets
and liabilities that are not readily apparent from other
sources. We base our estimates and judgments on historical
experience and all available information. However, future events
are subject to change, and the best estimates and judgments
routinely require adjustment. US GAAP requires us to make
estimates and judgments in several areas, including those
related to recording various accruals (such as incentive
compensation and restructuring costs), income taxes, the useful
lives of long-lived assets such as property and equipment and
potential losses from contingencies and litigation. We believe
the policies discussed below are the most critical to our
financial statements because they are affected significantly by
managements judgments, assumptions and estimates.



| |                    
| | -------------------
| | Revenue recognition

As discussed in Note 2 to our consolidated
financial statements, we generate revenues under service and
access agreements with our customers. While the vast majority of
our agreements contain standard business terms and conditions,
there are many agreements that contain complex terms and
conditions. As a result, we are required to evaluate the scope
and significance of contract provisions in order to determine
the appropriate accounting. In addition, our revenue recognition
policy requires an assessment as to whether the collectibility
is probable, which inherently requires us to evaluate the
creditworthiness of our customers.




For all offerings, the Company recognizes revenue
when all of the following criteria are met as set forth in Staff
Accounting Bulletin No. 101:






| |     |                                                                                                   
| | --- | --------------------------------------------------------------------------------------------------
|
| | (1) | Persuasive evidence of an arrangement exists
    (contract is signed and legally binding),        
|
|
|
| | (2) | Services have been rendered or access has been
    provided (with no future obligations),         
|
|
|
| | (3) | The fee is fixed and determinable (amount is
    known and not contingent upon future events), and
|
|
|
| | (4) | Collectibility is probable (high degree of
    confidence that the customer will pay).            
|

Our FullSource service agreements typically
provide revenues from fixed monthly fees, and may also include
performance incentive payments based on volume and/or savings.
The structure in a particular service agreement may vary,
depending upon the needs of our customer and the conventional
practices in the supply market where our customer obtains its
materials, commodities or services. The fees that we receive are
for the use of our technology, supplier and supply market
information, sourcing operations staff and facilities.
Negotiated fees vary by customer, and reflect both the
anticipated volume and the staffing,

21



---



##### Table of Contents



expertise and technology we anticipate committing
to complete the services requested by our customers. We
recognize revenues from our fixed monthly FullSource fees
ratably as we provide access to our services over the related
contract period. Our agreements range in length from a few
months to as many as five years. At any given time, we have
agreements of varying lengths with staggered expirations. Some
of our agreements permit early termination without cause by our
customers without penalty.


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




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




The agreements for ES, Spend Visibility and
Supplier Implementation provide for revenues from fixed monthly
access fees. The fees that we receive are for providing access
to our technology and for certain services. We recognize
revenues from these new offerings as we provide access or
services.




The majority of our customer agreements include
multiple service offerings. Each service offering consists of a
single element. In determining the appropriate amount of revenue
to be recognized for each offering, we evaluate whether these
arrangements contain separate units of accounting. This
determination is based on whether: the delivered item has value
to the customer on a standalone basis (that is, if it is sold
separately by any vendor or the customer could resell the
deliverable); there is objective and reliable evidence of fair
value of the undelivered items in the arrangement; and if the
arrangement includes a general right of return relative to the
delivered item, delivery or performance of the undelivered
item(s) is considered probable and substantially in the control
of the vendor. In instances where all of these conditions are
satisfied, we recognize revenue for the offerings that have been
delivered to the customer based on the relative fair value of
the delivered item when compared to the total arrangement
considered, subject to certain limitations. The fair value for
each element is established based on the sales price charged
when the same element is sold separately.




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



| |                                    
| | -----------------------------------
| | Allowance for doubtful
    accounts

We evaluate the collectibility of our accounts
receivable based on a combination of factors. In cases where we
are aware of circumstances that may impair a customers
ability to meet its financial obligations to us, we record a
specific allowance against amounts due to us. For all customers,
we recognize allowance for doubtful accounts based on the length
of time the receivables are past due, the current business
environment and our historical experience. If the financial
condition of our customers deteriorates or if the economic
conditions worsen, additional allowances may be required in the
future.



| |                   
| | ------------------
| | Stock compensation

As discussed in Note 2 to our consolidated
financial statements, SFAS No. 123, Accounting for
Stock-Based Compensation, as amended by
SFAS No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure, gives
companies the option to adopt the fair value method for expense
recognition of employee stock options or to continue to account
for employee stock options using the intrinsic value method, as
outlined under Accounting Principles Board (APB)
Opinion No. 25, Accounting for Stock Issued to
Employees. We have elected to continue to apply the
intrinsic value

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method to account for employee stock options and
disclose the pro forma effect as if the fair value method had
been applied in the notes to our consolidated financial
statements.




| |                        
| | -----------------------
| | Lease abandonment costs




Lease abandonment costs for abandoned facilities
are estimated to include the impairment of leasehold improvement
and remaining lease liabilities, offset by estimated sublease
income, if appropriate. Estimates related to sublease costs and
income are based on assumptions regarding the period required to
locate and contract with suitable sub-lessees. Each quarter, we
review these estimates, and to the extent that our assumptions
change, the ultimate restructuring expenses for these abandoned
facilities could vary from current estimates. In Q2 2001, we
recorded a $1.7 million charge for the closing of our
Austin facility and two other small offices. In 2003, we
recorded a $6.5 million charge for the closing of our
Brussels facility and abandonment of two leased floors in our
global headquarters office space in Pittsburgh. In Q1 2004, we
recorded a $2.4 million charge for the abandonment of one
additional leased floor in our Pittsburgh facility, as well as
closed two domestic offices.




Determination of FullSource Market Volume and
Achievable Savings




Revenues from our FullSource offering represented
66% of our revenues in 2003. Therefore, we believe that one
indicator of our market acceptance is the dollar volume of
materials, commodities and services for which we create markets
on behalf of our customers as part of our FullSource offering.
We measure this market volume by multiplying the lowest bid
price per unit in each market by the estimated number of units
that our customer expects to purchase. When our customers
specify multi-year purchases in a request for quotation, we
calculate volume for the estimated term. We do not report QS
volume since this is a hosted application that enables customers
to create and run their own markets, and as a result, we do not
believe that volume from these markets can be adequately
validated.




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

|                         |  |                         |        |      |  |      |        |      |  |      |        |  |  |   |       |  |  |   |       | 
|------------------------ |  | ----------------------- | ------ | ---- |  | ---- | ------ | ---- |  | ---- | ------ |  |  | - | ----- |  |  | - | ----- | 
|                         |  |                        
|                         |  | Year Ended December 31,
|                         |  |                        
|                         |  | 2003                    |        | 2002 |  | 2001 |        | 2000 |  | 1999
|                         |  |                         |        |      |  |      |        |      |  |     
|                         |  |                        
|                         |  | (in millions)          
|FullSource market volume |  | $                       | 18,847 |      |  | $    | 20,346 |      |  | $    | 16,669 |  |  | $ | 9,928 |  |  | $ | 2,725 | 

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

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

Treatment of Visteon Fees




In April 2000, we entered into a five-year
agreement with Visteon under which we agreed to provide our
FullSource technology-enhanced services, and Visteon agreed to
pay us fixed monthly fees plus the possibility of additional
variable fees based on performance. We have also received
marketing and public relations benefits as a result of our
relationship with Visteon. At the time we executed this service




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agreement, we granted to Visteon a warrant for
1.75 million shares of our common stock, with an exercise
price of $.01 per share. The warrant was valued at
$95.5 million using the Black-Scholes pricing model at the
date of the grant in April 2000. We exclude from our revenues
the fees we earn under our service agreement with Visteon;
however, our cost of revenues includes the costs that we incur
in serving Visteon under this agreement.








The service agreement with Visteon expires in
April 2005, and because we have classified the fees we earn
under this agreement as payment for the warrant, we do not
expect to recognize revenues under this agreement during the
remainder of its term.




|                                               |  |                         |         |      |  |      |         |  |  |   |         | 
|---------------------------------------------- |  | ----------------------- | ------- | ---- |  | ---- | ------- |  |  | - | ------- | 
|                                               |  |                        
|                                               |  | Year Ended December 31,
|                                               |  |                        
|                                               |  | 2003                    |         | 2002 |  | 2001
|                                               |  |                         |         |      |  |     
|                                               |  |                        
|                                               |  | (in thousands)         
|Revenues and fees                              |  | $                       | 151,109 |      |  | $    | 181,691 |  |  | $ | 166,592 | 
|Less fees characterized as payment for warrant |  |                         | 12,393  |      |  |      | 11,250  |  |  |   | 11,250  | 
|                                               |  |                         |         |      |  |      |         |  |  |   |         | 
|Revenues                                       |  | $                       | 138,716 |      |  | $    | 170,441 |  |  | $ | 155,342 | 
|                                               |  |                         |         |      |  |      |         |  |  |   |         | 

Results of Operations

The following table sets forth our consolidated
statement of operations data as a percentage of revenues for the
periods indicated:

|                                           |                                                         |              |     |      |  |      |     |    |   |  |      |     | 
|------------------------------------------ | ------------------------------------------------------- | ------------ | --- | ---- |  | ---- | --- | -- | - |  | ---- | --- | 
|                                           |                                                         |             
|                                           |                                                         | Year Ended  
|                                           |                                                         | December 31,
|                                           |                                                         |             
|                                           |                                                         | 2003         |     | 2002 |  | 2001
|                                           |                                                         |              |     |      |  |     
|Revenues                                   |                                                         |              | 100 | %    |  |      | 100 | %  |   |  | 100  | %  
|Operating costs and expenses:              |                                                         |              |     |      |  |      |     |    |   |  |      |    
|                                           | Cost of revenues                                        |              |     | 50   |  |      |     | 45 |   |  |      | 51  | 
|                                           | Research and development                                |              |     | 18   |  |      |     | 16 |   |  |      | 13  | 
|                                           | Sales and marketing                                     |              |     | 26   |  |      |     | 27 |   |  |      | 33  | 
|                                           | General and administrative                              |              |     | 15   |  |      |     | 14 |   |  |      | 21  | 
|                                           | Stock compensation and warrant costs                    |              |     | 5    |  |      |     | 4  |   |  |      | 5   | 
|                                           | Investment write-down                                   |              |     |     |  |      |     | 3  |   |  |      |    | 
|                                           |                                                         |              |     |      |  |      |     |    |   |  |      |    
|                                           | Restructuring charges                                   |              |     | 10   |  |      |     | (0 | ) |  |      | 4   | 
|                                           |                                                         |              |     |      |  |      |     |    |   |  |      |    
|                                           | Terminated merger-related costs                         |              |     |     |  |      |     |   |   |  |      | 2   | 
|                                           | Goodwill amortization and impairment                    |              |     |     |  |      |     |   |   |  |      | 162 | 
|                                           |                                                         |              |     |      |  |      |     |    |   |  |      |    
|Operating loss                             |                                                         |              | (24 | )    |  |      | (9  | )  |   |  | (191 | )  
|                                           | Interest and other income, net                          |              |     | 3    |  |      |     | 2  |   |  |      | 1   | 
|                                           |                                                         |              |     |      |  |      |     |    |   |  |      |    
|Loss before taxes and change in accounting |                                                         |              | (21 | )    |  |      | (7  | )  |   |  | (190 | )  
|                                           | Provision for income taxes                              |              |     | 1    |  |      |     | 0  |   |  |      | 0   | 
|                                           |                                                         |              |     |      |  |      |     |    |   |  |      |    
|Loss before change in accounting           |                                                         |              | (22 | )    |  |      | (7  | )  |   |  | (190 | )  
|                                           | Cumulative effect of accounting change for
    goodwill |              |     |     |  |      |     | (3 | ) |  |      |    | 
|                                           |                                                         |              |     |      |  |      |     |    |   |  |      |    
|Net loss                                   |                                                         |              | (22 | )%   |  |      | (10 | )% |   |  | (190 | )% 
|                                           |                                                         |              |     |      |  |      |     |    |   |  |      |    



| |                                           
| | ------------------------------------------
| | Years Ended December 31, 2003 and
    2002



| |         
| | --------
| | Revenues




Revenues decreased 19% from $170.4 million
in 2002 to $138.7 million in 2003. The decrease in revenues
is due to a combination of factors, including a change in the
mix of products and services deployed by our customers, as well
as the continued weak economic environment which we believe has
caused our customers to either reduce or defer their purchasing
decisions. In 2003, several large customers




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renewed their FullSource service agreements at
lower market volumes than the volumes provided in previously
existing agreements, resulting in 33% lower revenues from our
FullSource offering in 2003. In addition, with the introduction
of our less-costly QS solution in early 2001 and several other
new offerings late 2002 and early 2003, several FullSource-only
customers have expanded their use of our solutions to include a
broader mix of FullSource, QS and related offerings. As
customers gain experience with our sourcing solutions, certain
entities have migrated a portion of their sourcing requirements
to our self-service technologies. In some cases, increased sales
of additional solutions to existing customers have resulted in
lower total revenues due to this migration.








To illustrate this migration, our top 20
customers in 2002, which accounted for approximately 60% of
total revenues, reduced their use of FullSource by
$42.6 million in 2003 as compared with 2002. Those same
20 customers migrated a portion of their sourcing solutions
needs to our QS and other less costly offerings over the same
time period, resulting in an increase in our revenues from those
customers for these solutions of $5.0 million, or 65%.
However, the growth in those less-costly solutions did not
offset the decline in revenues from our FullSource solution.







We anticipate that our FullSource offering will
continue to account for a majority of our revenues in 2004.
However, the percentage of total revenues and absolute dollars
attributable to FullSource will continue to decrease, but at a
lower rate than experienced in 2003. We also expect to see
continued growth in sales of our QS and other offerings to
current and new customers.







The following is a breakdown of revenues by
offering (in thousands):







|               |  |                   |         |                   |  |   |     |            |  |   |         |  |  |  |     |  
|-------------- |  | ----------------- | ------- | ----------------- |  | - | --- | ---------- |  | - | ------- |  |  |  | --- | -
|               |  |                   |         |                  
|               |  | Year Ended        |         | Year Ended       
|               |  | December 31, 2003 |         | December 31, 2002
|               |  |                   |         |                  
|               |  | $                 |         | % of Total        |  | $ |     | % of Total
|               |  |                   |         |                   |  |   |     |           
|FullSource     |  | $                 | 92,093  |                   |  |   | 66  | %          |  | $ | 138,420 |  |  |  | 81  | %
|All other      |  |                   | 46,623  |                   |  |   | 34  |            |  |   | 32,021  |  |  |  | 19  |  
|               |  |                   |         |                   |  |   |     |            |  |   |         |  |  |  |     |  
|Total revenues |  | $                 | 138,716 |                   |  |   | 100 | %          |  | $ | 170,441 |  |  |  | 100 | %
|               |  |                   |         |                   |  |   |     |            |  |   |         |  |  |  |     |  







Also included in revenues are reimbursements for
travel and other out-of-pocket costs of $5.1 million in
2002 and $3.7 million in 2003. An equivalent amount of
reimbursable expenses for the same items is included in cost of
revenues in accordance with EITF 01-14 Income
Statement Characterization of Reimbursements Received for
Out-of-Pocket Expenses Incurred.






| |                             
| | ----------------------------
| | Operating costs and expenses

Cost of revenues.Cost of revenues decreased from $76.1 million, or 45% of
revenues in 2002 to $69.7 million, or 50% of revenues in
2003. The increase in cost of revenues as a percentage of
revenues from 2002 to 2003 is primarily the result of the 19%
decrease in revenues, partially offset by a 9% overall decrease
in cost of revenues. The decrease in absolute dollar amounts
from 2002 to 2003 is primarily attributable to: (1) reduced
overhead in the amount of $3.5 million, primarily comprised
of reduced depreciation expense in the amount of
$4.0 million due to reduced capital expenditures over the
past four years. The reduction in capital expenditures in 2002
and 2003 compared to 2000 and 2001 is primarily due to our
investment in the growth of our business in 2000 and 2001;
(2) cost cutting measures in discretionary spending such as
travel costs and reimbursements in the amount of
$1.8 million; and (3) reduced compensation and
benefits expenses in the amount of $1.4 million, primarily
due to a 4% decrease in the average number of account
management, global sourcing services and market operations staff
resulting from the 2003 restructuring activities described
below. Cost of revenues includes the costs we incur in
performing our obligations under the Visteon service contract,
even though the fees we earn under that contract are excluded
from revenues.

Research and
development.Research and development
costs decreased from $27.0 million, or 16% of revenues in
2002, to $24.6 million, or 18% of revenues in 2003. The
decrease in absolute dollars and a percentage of revenues is
primarily attributable to reduced consulting costs in the amount
of $4.0 million in 2003 compared to 2002, associated with the
investments in our product development pipeline in 2002,

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partially offset by an increase in compensation
and benefits expense in the amount of $2.1 million,
primarily due to a 23% increase in average research and
development staff in 2003. In late 2001, we embarked on a
software development initiative to build additional solutions
and expand our portfolio of offerings. From 2001 to 2002, we
increased our research and development spending by 34% by
increasing both headcount and the use of external consultants.
We introduced a number of new offerings in late 2002 and early
2003 to expand our solutions beyond sourcing to address a
broader set of supply management activities. After we released
these new offerings in early 2003, we reduced the number of
external consultants to reduce total research and development
costs, offset by an increase in headcount and compensation and
benefits by $2.1 million.





Sales and marketing.Sales and marketing costs decreased from $45.6 million, or 27%
of revenues in 2002, to $35.6 million, or 26% of revenues
in 2003. The decrease is primarily attributable to:
(1) cost cutting measures in discretionary spending such as
marketing and advertising in the amount of $3.4 million and
recruiting and relocation costs in the amount of $508,000;
(2) reduced overhead in the amount of $2.8 million,
primarily comprised of reduced depreciation expense in the
amount of $1.5 million; and (3) reduced compensation
and benefits expenses in the amount of $2.7 million,
primarily due to a 15% decrease in the average number of sales
and marketing staff resulting from the 2003 restructuring
activities described below.

General and
administrative.General and
administrative costs decreased from $23.7 million, or 14%
of revenues in 2002, to $21.4 million, or 15% of revenues
in 2003. The decrease in absolute dollars is primarily
attributable to: (1) reduced operating taxes in the amount
of $1.2 million, partially due to reduced revenues in 2003
as compared to 2002; (2) reduced compensation and benefits
expense in the amount of $838,000, primarily due to a 9%
decrease in the average number of personnel in the areas of
human resources, finance and facilities management in 2003
compared to 2002 resulting from the 2003 restructuring
activities described below; and (3) reduced overhead in the
amount of $625,000, primarily comprised of reduced depreciation
expense.

Stock compensation and warrant
costs.We recorded $2.0 million
of unearned stock compensation related to employee stock options
granted in June and July 1999, which is being amortized
over a five-year period ending June 2004. In 2002 and 2003,
$150,000 and $80,000, respectively, was amortized related to
these grants. In April 2000, we recorded $95.5 million
of unearned warrant costs related to a warrant granted to
Visteon. This value was calculated using the Black-Scholes
pricing model at the date of grant and is being amortized over a
five-year period ending April 2005. In each of 2002 and
2003, $19.1 million was amortized related to this warrant,
with $11.3 million and $12.4 million reflected as a
reduction to our revenues in 2002 and 2003, respectively
(reducing the revenues under the Visteon service contract to
zero) and $7.8 million and $6.7 million as stock
compensation and warrant costs in 2002 and 2003, respectively.

Investment
write-down.In Q1 2002, we recorded a
$4.7 million loss on our investment in Adexa based on our
review of its financial results and general market conditions.
In Q3 2002, we recorded an additional $371,000 loss on our
investment in Adexa based on a valuation determined by financing
completed by Adexa in July 2002. We concluded after each of
these reviews that there was an other-than-temporary decline in
the value of our investment in Adexa. As of December 31,
2003, the remaining carrying value of our original
$6.0 million investment in Adexa was $889,000.

Restructuring
charges.In 2002, we re-commenced use
of office space included in the 2001 restructuring program and
revised our estimate for employee severance and termination
benefit costs. As a result, we reduced the restructuring reserve
by $303,000.




Throughout 2003, we initiated three restructuring
programs. These programs were focused on eliminating certain
positions throughout our global workforce, re-assessing our
facility needs and consolidating European operations to create a
more profitable and efficient business. We expect to generate
annual savings of approximately $13.0 million as a result
of these programs, of which $11.2 million relates to
compensation and benefits and $1.8 million relates to rent
and depreciation. Annual savings are expected to be realized in
the following income statement line items: $7.5 million in
cost of revenues;




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$1.3 million in research and development;
$2.9 million in sales and marketing; and $1.3 million
in general and administrative. The following is a summary of
these programs:








Workforce Reduction
Plan.In Q1 2003, in response to the
continued economic slowdown, we executed a restructuring plan
resulting in the elimination of 79 positions in our global
workforce. This represented approximately 7% of total employees.
We recorded a restructuring charge of $1.8 million in Q1
2003 covering these severance costs. The liability for employee
severance and termination benefit costs related to this activity
was paid by December 31, 2003; and therefore no incremental
liquidity resources will be utilized in the future to implement
this plan. Annual savings from this plan are $6.4 million,
of which $5.9 million was realized in compensation and
benefits costs in our 2003 operating results. Annual savings
from this plan are expected to be realized in the following
income statement line items: $3.7 million in cost of
revenues; $1.0 million in research and development;
$1.0 million in sales and marketing; and $642,000 in
general and administrative.







Facility Reduction
Plan.Also in 2003, we reassessed our
global headquarters office space in Pittsburgh, Pennsylvania,
and ceased using two of the floors we lease through
May 2010. We recorded a restructuring charge of
$3.0 million and $2.0 million in Q1 2003 and
Q4 2003, respectively. We intend to sub-lease these floors,
and estimated sublease income based on current real estate
market conditions. The facility reduction plan includes
$2.9 million and $1.8 million of estimated future
obligations for non-cancelable lease payments generated by
exiting excess leased floors in Q1 2003 and Q4 2003,
respectively, and $89,000 and $282,000 for the impairment of
property and equipment (leasehold improvements) that were no
longer in use in Q1 2003 and Q4 2003, respectively.
The accrual for lease costs (net of anticipated sub-lease
proceeds) will be paid over the lease term though May 2010.
As of December 31, 2003, $674,000 of the $4.3 million
accrual for lease costs will be paid in 2004, and is therefore
classified as a current liability in our consolidated balance
sheet. The $674,000 current liability also represents our
expected liquidity requirements in 2004 to continue the
implementation of this plan. Annual savings from this plan are
$717,000, of which $395,000 was realized in rent and
depreciation costs in our 2003 operating results. Annual savings
from this plan are expected to be realized in the following
income statement line items: $447,000 in cost of revenues;
$123,000 in research and development; $123,000 in sales and
marketing; and $24,000 in general and administrative.




We are continuing to evaluate our office space
requirements at our headquarters, and as a result may incur
additional lease-related charges in the future.




European Restructuring
Plan.In Q3 2003, in order to
better serve our customers and enable us to create a more
leveraged, profitable and efficient business across Europe, we
initiated a restructuring plan resulting in the elimination of
74 net positions in our European business. There were 105
positions eliminated with the closing of our Brussels facility,
offset by 31 positions added to our existing European facilities
in London, Paris and Frankfurt. We recorded a restructuring
charge of $3.2 million in Q3 2003 covering these
severance costs and legal fees. While most of the severance
costs have been paid in accordance with local employment laws,
we expect to pay the remaining severance portion of the
restructuring accrual of $93,000 in Q1 2004, which
represents our expected liquidity requirements to conclude this
portion of the Europe plan.




In Q4 2003, we recorded an additional charge
of $4.2 million. This charge includes $847,000 of severance
costs, $1.8 million of estimated future obligations for
non-cancelable lease payments generated by exiting the Brussels
facility, $1.2 million for the impairment of property and
equipment (primarily leasehold improvements) that were no longer
in use, and $308,000 for restructuring plan implementation
costs, primarily comprised of legal and other professional fees.
We intend to sub-lease the facility, and we estimated sublease
income based on current real estate market conditions. As of
December 31, 2003, all employees to be terminated as a
result of the restructuring have been notified. We expect to pay
the remaining restructuring accrual relating to severance and
implementation in the amount of $917,000 over the next few
quarters. The accrual for lease costs (net of anticipated
sub-lease proceeds) will be paid over the lease term through
August 2006. As of December 31, 2003, $1.0 million of
the $1.8 million accrual for lease costs will be paid in
2004, and is therefore classified as a current liability in our
consolidated balance

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sheet. The $917,000 remaining payments for
severance and $1.0 million current liability for lease
costs represents our expected liquidity requirements in 2004 to
continue the implementation of this plan. Annual savings from
this plan are $5.8 million, of which $799,000 was realized
in compensation and benefits costs and $83,000 in rent and
depreciation costs in our 2003 operating results. Annual savings
from this plan are expected to be realized in the following
income statement line items: $3.4 million in cost of
revenues; $159,000 in research and development;
$1.7 million in sales and marketing; and $579,000 in
general and administrative.





The following table sets forth an analysis of the
restructuring accrual activity for the three years ended
December 31, 2003:

|                                  |                                   |                         |        |                         |  |               |       |               |  |            |        |       |  |   |        |       |  |   |        |       |  |   |        |       | 
|--------------------------------- | --------------------------------- | ----------------------- | ------ | ----------------------- |  | ------------- | ----- | ------------- |  | ---------- | ------ | ----- |  | - | ------ | ----- |  | - | ------ | ----- |  | - | ------ | ----- | 
|                                  |                                   |                         |        |                         |  |               |       |              
|                                  |                                   | 2003 Restructuring Plan |        |                        
|                                  |                                   |                         |        | 2001 Restructuring Plan
|                                  |                                   | Workforce               |        | Facility                |  | European      |       |              
|                                  |                                   | Reduction               |        | Reduction               |  | Restructuring |       | Severance and |  | Facilities |        |      
|                                  |                                   | Plan                    |        | Plan                    |  | Plan          |       | Benefits      |  | Related    |        | Total
|                                  |                                   |                         |        |                         |  |               |       |               |  |            |        |      
|Restructuring charge in 2001:     |                                   |                         |        |                         |  |               |       |               |  |            |        |       |  |   |        |       |  |   |        |       |  |   |        |      
|                                  | Severance and benefits            |                         | $      |                        |  |               | $     |              |  |            | $      |      |  |   | $      | 2,347 |  |   | $      |      |  |   | $      | 2,347 | 
|                                  | Accrued lease costs               |                         |        |                        |  |               |       |              |  |            |        |      |  |   |        |      |  |   |        | 1,719 |  |   |        | 1,719 | 
|                                  | Property and equipment impairment |                         |        |                        |  |               |       |              |  |            |        |      |  |   |        |      |  |   |        | 2,179 |  |   |        | 2,179 | 
|                                  | Implementation costs              |                         |        |                        |  |               |       |              |  |            |        |      |  |   |        |      |  |   |        | 187   |  |   |        | 187   | 
|Cash paid                         |                                   |                         |       |                         |  |               |      |               |  |            |       |       |  |   | (2,164 | )     |  |   | (1,226 | )     |  |   | (3,390 | )    
|Non-cash charges                  |                                   |                         |       |                         |  |               |      |               |  |            |       |       |  |   |       |       |  |   | (2,179 | )     |  |   | (2,179 | )    
|                                  |                                   |                         |        |                         |  |               |       |               |  |            |        |       |  |   |        |       |  |   |        |       |  |   |        |      
|Balance as of December 31, 2001   |                                   |                         |       |                         |  |               |      |               |  |            |       |       |  |   | 183    |       |  |   | 680    |       |  |   | 863    |      
|Cash paid                         |                                   |                         |       |                         |  |               |      |               |  |            |       |       |  |   | (31    | )     |  |   | (410   | )     |  |   | (441   | )    
|Restructuring accrual adjustment  |                                   |                         |       |                         |  |               |      |               |  |            |       |       |  |   | (152   | )     |  |   | (151   | )     |  |   | (303   | )    
|                                  |                                   |                         |        |                         |  |               |       |               |  |            |        |       |  |   |        |       |  |   |        |       |  |   |        |      
|Balance as of December 31, 2002   |                                   |                         |       |                         |  |               |      |               |  |            |       |       |  |   |       |       |  |   | 119    |       |  |   | 119    |      
|Restructuring charge in 2003:     |                                   |                         |        |                         |  |               |       |               |  |            |        |       |  |   |        |       |  |   |        |       |  |   |        |      
|                                  | Severance and benefits            |                         |        | 1,754                   |  |               |       |              |  |            |        | 3,979 |  |   |        |      |  |   |        |      |  |   |        | 5,733 | 
|                                  | Accrued lease costs               |                         |        |                        |  |               |       | 4,642         |  |            |        | 1,842 |  |   |        |      |  |   |        |      |  |   |        | 6,484 | 
|Property and equipment impairment |                                   |                         |       |                         |  |               | 371   |               |  |            | 1,190  |       |  |   |       |       |  |   |       |       |  |   | 1,561  |      
|Implementation costs              |                                   |                         |       |                         |  |               |      |               |  |            | 383    |       |  |   |       |       |  |   |       |       |  |   | 383    |      
|Cash paid                         |                                   |                         | (1,754 | )                       |  |               | (324  | )             |  |            | (3,442 | )     |  |   |       |       |  |   | (119   | )     |  |   | (5,639 | )    
|Non-cash charges                  |                                   |                         |       |                         |  |               | (371  | )             |  |            | (1,190 | )     |  |   |       |       |  |   |       |       |  |   | (1,561 | )    
|                                  |                                   |                         |        |                         |  |               |       |               |  |            |        |       |  |   |        |       |  |   |        |       |  |   |        |      
|Balance as of December 31, 2003   |                                   | $                       |       |                         |  | $             | 4,318 |               |  | $          | 2,762  |       |  | $ |       |       |  | $ |       |       |  | $ | 7,080  |      
|                                  |                                   |                         |        |                         |  |               |       |               |  |            |        |       |  |   |        |       |  |   |        |       |  |   |        |      



| |                               
| | ------------------------------
| | Interest and other income, net

Interest and other income, net was
$3.2 million in 2002 and $3.7 million in 2003. The
increase was primarily attributable to cash collections of
$850,000 from the settlement of patent infringement lawsuits and
an increase in gains from foreign exchange contracts in the
amount of $465,000, partially offset by reduced interest income
from a lower weighted-average rate of return due to general
market conditions. In 2002, we earned $3.1 million at a
weighted-average rate of return of 2.6%, compared to
$2.2 million at a rate of return of 1.6% in 2003.

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| |                           
| | --------------------------
| | Provision for income taxes

Provision for income taxes was $712,000 in 2002
and $1.2 million in 2003. The increase is primarily
attributable to increased foreign income taxes in 2003 compared
to 2002.



| |                                                        
| | -------------------------------------------------------
| | Cumulative effect of accounting change for
    goodwill

In Q1 2002, in connection with the implementation
of SFAS No. 142, Goodwill and Other Intangible
Assets, we tested goodwill related to Surplus Record for
impairment, and based on estimated future cash flows, recorded
an impairment charge of $5.3 million. We completed our
annual test for impairment in Q1 2003 and concluded at that
time, that we did not have any impairment of goodwill based on
the estimated fair value as determined by discounted cash flows.
For further discussion, see Note 6 to the consolidated financial
statements.



| |                                           
| | ------------------------------------------
| | Years Ended December 31, 2002 and
    2001



| |         
| | --------
| | Revenues




Revenues increased 10% from $155.3 million
in 2001 to $170.4 million in 2002. The increase in revenues
and fees is primarily attributable to the introduction of our QS
offering in early 2001, as well as the addition of new customers
for which we conducted online markets and the introduction of
other offerings in 2002. Revenues from our QS offering increased
$16.5 million, or 306% from 2001 to 2002, while revenues
from other new offerings released in 2002 contributed an
incremental $3.5 million. The number of customers served
increased 12% from 125 in 2001 to 140 in 2002.







The following is a breakdown of revenues by
offering (in thousands):







|               |  |                   |         |                   |  |   |     |            |  |   |         |  |  |  |     |  
|-------------- |  | ----------------- | ------- | ----------------- |  | - | --- | ---------- |  | - | ------- |  |  |  | --- | -
|               |  |                   |         |                  
|               |  | Year Ended        |         | Year Ended       
|               |  | December 31, 2002 |         | December 31, 2001
|               |  |                   |         |                  
|               |  | $                 |         | % of Total        |  | $ |     | % of Total
|               |  |                   |         |                   |  |   |     |           
|FullSource     |  | $                 | 138,420 |                   |  |   | 81  | %          |  | $ | 143,336 |  |  |  | 92  | %
|All other      |  |                   | 32,021  |                   |  |   | 19  |            |  |   | 12,006  |  |  |  | 8   |  
|               |  |                   |         |                   |  |   |     |            |  |   |         |  |  |  |     |  
|Total revenues |  | $                 | 170,441 |                   |  |   | 100 | %          |  | $ | 155,342 |  |  |  | 100 | %
|               |  |                   |         |                   |  |   |     |            |  |   |         |  |  |  |     |  







Although customers and FullSource volume
increased from 2001 to 2002, revenues per customer have
decreased over the same period. This decrease is primarily
related to a more diversified international mix of customers, as
well as a change in the mix of products and services deployed by
our customers. Our international customers generally provide
less revenue than domestic customers. With the introduction of
our less-costly QS Solution in early 2001, several
FullSource-only customers have expanded their use of our
solutions to include a broader mix of FullSource, QS and QS
services. As customers gain experience with our sourcing
solutions, certain entities have migrated a portion of their
sourcing requirements to our self-service technologies. In some
cases, increased sales of additional offerings to existing
customers have resulted in lower total revenues due to this
migration.







Also included in revenues are reimbursements for
travel and other out-of-pocket costs of $7.7 million in
2001 and $5.1 million in 2002. An equivalent amount of
reimbursable expenses for the same items is included in cost of
revenues in accordance with EITF 01-14 Income
Statement Characterization of Reimbursement Received for
Out-of-Pocket Expenses Incurred.






| |                             
| | ----------------------------
| | Operating costs and expenses

Cost of revenues.Cost of revenues decreased from $78.6 million in 2001 to
$76.1 million in 2002. As a percentage of revenues, cost of
revenues decreased from 51% in 2001 to 45% in 2002. The decrease
in absolute dollar amounts and as a percentage of revenues from
2001 to 2002 is primarily the result of increased staff
productivity as our personnel became more specialized in various
sourcing activities, as well as a decrease in incentive
compensation in 2002. Also, we have attained some operating
efficiencies from our investments in information tools to
automate portions of our sourcing process, as well as organizing
our

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sourcing staff in such a way to take advantage of
our domain expertise in various supply markets. The decrease is
also attributable to: (1) cost cutting measures in
discretionary spending such as travel costs, reimbursements and
recruiting costs in the amount of $4.7 million;
(2) reduced provision for bad debts in the amount of
$1.6 million, primarily due to an unusually large write-off
against the allowance in 2001; and (3) reduction in
incentive compensation costs in the amount of $1.0 million.
The large write-off in 2001 was $1.8 million earned from a
Brazilian former customer in 2000. See Liquidity and Capital
Resources. The decrease in cost of revenue is partially offset
by an increase in compensation and benefits expenses in the
amount of $2.8 million, primarily due to a 6% increase in
the average number of account management, global sourcing
services and market operations staff. Cost of revenues includes
the costs we incur in performing our obligations under the
Visteon service contract, even though the fees we earn under
that contract are excluded from revenues.





Research and
development.Research and development
costs increased from $20.1 million, or 13% of revenues in
2001, to $27.0 million, or 16% of revenues in 2002. The
increase was primarily related to an increase in compensation
and benefits expense in the amount of $2.1 million,
primarily due to a 24% increase in average research and
development staff in 2002 and increased consulting fees in the
amount of $3.4 million to fund ongoing investments in our
product development pipeline. These increases are partially
offset by a reduction in incentive compensation costs in the
amount of $533,000.

Sales and marketing.Sales and marketing costs decreased from $51.3 million, or
33% of revenues in 2001, to $45.6 million, or 27% of
revenues in 2002. The decrease is primarily attributable to cost
cutting measures in discretionary spending such as marketing and
advertising, recruiting and relocation costs in the amount of
$4.0 million. The decrease is also attributable to a
decrease in compensation and benefits expense in the amount of
$795,000 primarily due to a slight decrease in the average
number of sales and marketing staff.

General and
administrative.General and
administrative costs decreased from $32.1 million, or 21%
of revenues in 2001, to $23.7 million, or 14% of revenues
in 2002. The decrease is primarily attributed to an 18% decrease
in the average number of personnel in the areas of human
resources, finance and facilities management in 2002 compared to
2001. The decrease is also attributable to: (1) reduced tax
consulting costs associated with our international expansion in
2000 and 2001 in the amount of $701,000; (2) reduced legal
costs incurred in connection with the class action lawsuits
filed against the Company in 2001 in the amount of $462,000;
(3) cost cutting measures in discretionary spending such as
travel, recruiting and relocation costs in the amount of
$1.7 million; and (4) reduced incentive compensation
costs in the amount of $193,000.

Stock compensation and warrant
costs.We recorded $2.0 million
of unearned stock compensation related to employee stock options
granted in June and July 1999, which is being amortized over a
five-year period ending June 2004. In 2001 and 2002, $253,000
and $150,000, respectively, was amortized related to these
grants. In April 2000, we recorded $95.5 million of
unearned warrant costs related to a warrant granted to Visteon.
This value was calculated using the Black-Scholes pricing model
at the date of grant and is being amortized over a five-year
period ending April 2005. In each of 2001 and 2002,
$19.1 million was amortized related to this warrant, with
$11.3 million reflected as a reduction to our revenues
(reducing the revenues under the Visteon service contract to
zero) and $7.8 million as stock compensation and warrant
costs. In 2001, $470,000 of stock compensation was recorded
primarily due to modifications of stock options held by former
employees.

Investment
write-down.In Q1 2002, we recorded a
$4.7 million loss on our investment in Adexa based on our
review of its financial results and general market conditions.
In Q3 2002, we recorded an additional $371,000 loss on our
investment in Adexa based on a valuation determined by financing
completed by Adexa in July 2002. We concluded after each of
these reviews that there was an other-than-temporary decline in
the value of our investment in Adexa. As of December 31,
2002, the remaining carrying value of our original
$6.0 million investment in Adexa was $889,000.

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Restructuring
charges.In 2001, we recorded a
$6.4 million restructuring charge covering the severance
and facility closing costs related to our Austin office, as well
as severance costs associated with other employees who were
terminated. In 2002, we re-commenced use of office space and
revised for employee severance and termination benefit costs. As
a result of these reviews, we reduced the restructuring reserve
by $303,000.

Terminated merger-related
costs.In February 2001, we signed a
merger agreement to acquire Adexa. In June 2001, the parties
mutually agreed to terminate their proposed merger without
payment of any termination fees. We incurred merger-related
costs of approximately $3.4 million related to financial
advisor and other professional fees, which were all expensed in
2001.

Goodwill amortization and
impairment.In connection with our
acquisitions of iMark and Surplus Record in March 2000, we
recorded goodwill of $354.3 million, of which
$47.8 million was amortized in 2001. In Q2 2001, we
re-evaluated our product and technology strategy and determined
that we would no longer use the technology platform or the
market strategy that we acquired with iMark. As a result of this
determination and the closing of our Austin facility, we
recorded a $204.3 million impairment charge in Q2 2001. In
Q1 2002, we adopted SFAS No. 141, Business
Combinations and SFAS No. 142, Goodwill
and Other Intangible Assets, and no longer record goodwill
amortization.



| |                               
| | ------------------------------
| | Interest and other income, net

Interest and other income, net was
$2.7 million in 2001 and $3.2 million in 2002. The
increase was primarily attributable to increased average cash
and marketable investment balances, partially offset by a
reduced weighted-average rate of return due to general market
conditions. In 2001, we earned $4.5 million at a
weighted-average rate of return of 4.0%, compared to
$3.1 million at a rate of return of 2.6% in 2002. Interest
and other income in 2001 was partially offset by asset
write-offs of $500,000.



| |                           
| | --------------------------
| | Provision for income taxes

Provision for income taxes was $782,000 in 2001
and $712,000 in 2002. The decrease is primarily attributable to
reduced foreign income taxes in 2002 compared to 2001.



| |                                                        
| | -------------------------------------------------------
| | Cumulative effect of accounting change for
    goodwill

In Q1 2002, in connection with the implementation
of SFAS No. 142, Goodwill and Other Intangible
Assets, we tested goodwill related to Surplus Record for
impairment, and based on estimated future cash flows, recorded
an impairment charge of $5.3 million. For further
discussion, see Note 6 to the consolidated financial
statements.

Liquidity and Capital Resources

|                                     |                            |                  |         |         |   |      |         |        |  |      |         |         |   |   |         |        |  |   |         |         |  
|------------------------------------ | -------------------------- | ---------------- | ------- | ------- | - | ---- | ------- | ------ |  | ---- | ------- | ------- | - | - | ------- | ------ |  | - | ------- | ------- | -
|                                     |                            | 2003             |         | Change  |   | 2002 |         | Change |  | 2001
|                                     |                            |                  |         |         |   |      |         |        |  |     
|                                     |                            |                 
|                                     |                            | ($ in thousands)
|Cash and cash equivalents            |                            | $                | 102,935 |         |   | $    | 8,342   |        |  | $    | 94,593  |         |   | $ | 14,111  |        |  | $ | 80,482  |        
|Marketable investments               |                            |                  | 33,739  |         |   |      | (6,691  | )      |  |      | 40,430  |         |   |   | 17,423  |        |  |   | 23,007  |        
|                                     |                            |                  |         |         |   |      |         |        |  |      |         |         |   |   |         |        |  |   |         |        
|                                     | Total cash and investments |                  | $       | 136,674 |   |      | $       | 1,651  |  |      | $       | 135,023 |   |   | $       | 31,534 |  |   | $       | 103,489 |  
|                                     |                            |                  |         |         |   |      |         |        |  |      |         |         |   |   |         |        |  |   |         |        
|                                     | Percentage of total assets |                  |         | 75      | % |      |         | 5pts   |  |      |         | 70      | % |   |         | 15pts  |  |   |         | 55      | %
|Working capital                      |                            | $                | 108,850 |         |   | $    | (10,368 | )      |  | $    | 119,218 |         |   | $ | 30,596  |        |  | $ | 88,622  |        
|Days sales outstanding (DSO)         |                            |                  | 60      |         |   |      |         |        |  |      | 57      |         |   |   |         |        |  |   | 65      |        
|Cash flows from operating activities |                            | $                | (2,256  | )       |   | $    | (23,540 | )      |  | $    | 21,284  |         |   | $ | 36,033  |        |  | $ | (14,749 | )      
|Cash flows from investing activities |                            | $                | 1,877   |         |   | $    | 26,396  |        |  | $    | (24,519 | )       |   | $ | (48,902 | )      |  | $ | 24,383  |        
|Cash flows from financing activities |                            | $                | 8,721   |         |   | $    | (8,625  | )      |  | $    | 17,346  |         |   | $ | (511    | )      |  | $ | 17,857  |        

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Net cash used in operating activities totaled
$14.7 million in 2001 and $2.3 million in 2003,
compared to net cash provided by operating activities of
$21.3 million in 2002. The use of cash in 2001 related
primarily to the operating losses generated by our investment in
the growth of our business. Improved cash provided by operating
activities in 2002 was due to cash collections on revenues that
were 10% higher than 2001 and improved DSOs in 2002
compared to 2001. Our DSOs improved by 12%, or 8 days
due primarily to a change in our billing practices for new
contracts entered into in 2002. Rather than billing monthly in
arrears, we now invoice at the beginning of each month for the
majority of new contracts. Additionally, operating costs
decreased in 2002. This was primarily attributable to cost
cutting measures in discretionary spending such as marketing and
advertising, travel, recruiting and relocation costs, as well as
reduced incentive compensation costs. The use of cash in 2003
related primarily to operating losses resulting from the 19%
decrease in revenues from 2002 to 2003. The use of cash in 2003
is also attributable to the increase in DSOs from 57 days
to 60 days in 2002 and 2003, respectively. Net cash from
operating activities in 2001, 2002 and 2003 does not reflect
$10.3 million, $12.2 million and $12.2 million,
respectively, received under our service contract with Visteon.







Net cash provided by investing activities totaled
$24.4 million in 2001 and $1.9 million in 2003,
compared to net cash used in investing activities of
$24.5 million in 2002. In 2001, 2002 and 2003, we incurred
$17.3 million, $6.9 million and $4.7 million,
respectively, of capital expenditures primarily related to our
continued expansion of information technology hardware, and to a
lesser extent certain office space improvements. In June 2001,
we also invested $6.0 million in Adexa concurrently with
the termination of our merger agreement that had been signed in
February 2001. Net cash used in investing activities in 2002 was
primarily due to the investment of funds in the normal course of
our treasury management activities, which includes the movement
of funds in and out of cash and cash equivalents and marketable
investments to maximize our rate of return. Net cash provided by
investing activities in 2003 was primarily due to maturities of
marketable investments, partially offset by purchases of
marketable investments in the normal course of our treasury
management activities. The net cash inflow from this activity
was $45.3 million and $6.6 million in 2001 and 2003,
respectively, while our net cash outflow from treasury
activities in 2002 was $17.6 million. We expect capital
expenditures will be relatively flat in future periods.







Net cash provided by financing activities totaled
$17.9 million in 2001, $17.3 million in 2002 and
$8.7 million in 2003. The positive financing cash flows in
all years primarily reflect the net proceeds from the issuance
of stock (including issuance of stock under the employee stock
purchase plan, the exercise of stock options and an equity
investment of $3.0 million by Mitsubishi Corporation in
2001). Cash provided by financing activities in 2001, 2002 and
2003 includes $10.3 million, $12.2 million and
$12.2 million, respectively, received under our service
contract with Visteon. We classify these receipts as payment for
the warrant that we granted to Visteon in April 2000. Net cash
provided by financing activities in 2003 was partially offset by
payments to acquire treasury stock in the amount of
$6.4 million.




In November 2000, we entered into a one-year
revolving credit facility with a maximum principal amount of
$25.0 million. In October 2001, we amended our bank credit
facility to consist of a revolving credit facility with a
maximum principal amount of $20.0 million and a
$4.0 million term loan to be paid in 36 monthly
installments, $3.7 million of which was used to retire
borrowings under the old revolving credit facility. Borrowings
under the revolving credit facility and the term loan bear
interest at the lenders prime rate and prime rate +0.50%,
respectively. In October 2002 and December 2002, we entered into
a fourth and fifth amendment, respectively, which extended the
expiration date of the revolving credit facility through
December 2002 and February 2003, respectively. In February 2003,
we entered into the sixth amendment, which reduced the
availability under the revolving credit facility from
$20.0 million to $15.0 million and extended the
maturity date through February 2004. In December 2003, we
entered into the seventh amendment, which modified the financial
covenant on minimum earnings to exclude non-recurring
restructuring charges relating to our Facilities Reduction Plan
and the European Restructuring Plan for the quarter ended
December 31, 2003. In February 2004, we entered into the
eighth amendment, which extends the maturity date through the
earlier of August 31, 2004 or one business day before the
effective date of the anticipated merger with Ariba. As of
December 31, 2003, $722,000 was outstanding

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under the term loan and the interest rate was
4.5%. At December 31, 2003, $13.6 million was
available under the revolving credit facility based on eligible
accounts receivable.


Our current bank credit facility contains
restrictive covenants, including a limitation on incurring
additional indebtedness and paying dividends. Our bank credit
facility also includes financial covenants as to maximum capital
expenditures, minimum tangible net worth, minimum earnings and
minimum quick ratio. We have pledged substantially all of our
tangible assets as collateral for the current credit facility.
As of December 31, 2003, we are in compliance with all
covenants.

We will continue to invest in the growth of our
business. In Q1 and Q2 2004, we anticipate negative net cash
flows as a result of the $16.3 million cash acquisition of
Covisint in January 2004, the timing of our annual
incentive-based compensation payments, capital expenditures
related to our data center migration project and operating
losses in the first half of 2004, with positive net cash flows
in the second half of 2004. We believe that our current
resources will be sufficient to meet our working capital and
capital expenditures for at least the next 18 to 24 months.
We may decide to use cash resources to fund acquisitions of
complementary businesses and technologies and, if we do so, we
may experience negative cash flows. Our allocation between cash
and cash equivalents and marketable investments reflects our
anticipated cash flow requirements in the future and current
market interest rates. As of December 31, 2003, our
marketable investment allocation represents 25% of total cash
and investments, compared to 30% at December 31, 2002. If
we are unable to continue to control costs, our resources may be
depleted more quickly than we currently anticipate. In the event
that additional financing is required, we may not be able to
raise it on terms acceptable to us, if at all.

In January 2003, the Board of Directors
authorized the purchase of up to 15% of our outstanding common
stock from time to time on the open market or in one or more
negotiated transactions. As of December 31, 2003, we had
purchased and retired 1,298,500 shares or 3% of outstanding
common shares as of December 31, 2002 at a weighted average
share price of $4.93.




In September 2003, an arbitrator ruled in our
favor in proceedings against a Brazilian former customer for
amounts earned in 2000, which we wrote-off in 2001. The amount
of the arbitration award was $1.7 million, which includes
accrued interest from the date the invoices were due. We will
record this award as a reduction to bad debt expense in cost of
revenues on the cash basis of accounting due to the uncertainty
of collection.




Our contractual obligations and commercial
commitments as of December 31, 2003 are as follows (in
thousands):

|                                          |  |                       |        |           |  |           |       |           |  |         |        |  |  |   |        |  |  |   |       | 
|----------------------------------------- |  | --------------------- | ------ | --------- |  | --------- | ----- | --------- |  | ------- | ------ |  |  | - | ------ |  |  | - | ----- | 
|                                          |  |                      
|                                          |  | Payment Due by Period
|                                          |  |                      
|                                          |  |                       |        | Less Than |  |           |       | After    
|Contractual Cash Obligations              |  | Total                 |        | 1 Year    |  | 1-3 Years |       | 4-5 Years |  | 5 Years
|                                          |  |                       |        |           |  |           |       |           |  |        
|Long-term debt, including current portion |  | $                     | 1,160  |           |  | $         | 818   |           |  | $       | 306    |  |  | $ | 36     |  |  | $ |      | 
|Purchase obligations                      |  |                       | 707    |           |  |           | 466   |           |  |         | 241    |  |  |   |       |  |  |   |      | 
|Operating leases                          |  |                       | 35,682 |           |  |           | 6,741 |           |  |         | 16,271 |  |  |   | 10,445 |  |  |   | 2,225 | 
|                                          |  |                       |        |           |  |           |       |           |  |         |        |  |  |   |        |  |  |   |       | 
|Total contractual cash obligations        |  | $                     | 37,549 |           |  | $         | 8,025 |           |  | $       | 16,818 |  |  | $ | 10,481 |  |  | $ | 2,225 | 
|                                          |  |                       |        |           |  |           |       |           |  |         |        |  |  |   |        |  |  |   |       | 

|                             |  |           |     |                                             |  |       |     |       |  |       |   |  |  |  |   |  |  |  |   | 
|---------------------------- |  | --------- | --- | ------------------------------------------- |  | ----- | --- | ----- |  | ----- | - |  |  |  | - |  |  |  | - | 
|                             |  |           |     |                                            
|                             |  |           |     | Amount of Commercial Expirations per Period
|                             |  |           |     |                                            
|                             |  | Total     |     | Less                                        |  |       |     | Over 
|                             |  | Amounts   |     | Than 1                                      |  | 1-3   |     | 4-5   |  | 5    
|Other Commercial Commitments |  | Committed |     | Year                                        |  | Years |     | Years |  | Years
|                             |  |           |     |                                             |  |       |     |       |  |      
|Standby letters of credit    |  | $         | 836 |                                             |  | $     | 836 |       |  |       |  |  |  |  |  |  |  |  |  | 

Purchase obligations include purchase orders for
goods and services purchased in the normal course of business.

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Income Taxes

The provision for income taxes consisted of
foreign taxes of $782,000, $712,000 and $1.2 million in
2001, 2002 and 2003, respectively. There has been no provision
for U.S. federal or state income taxes as we have incurred a net
taxable loss in each of these periods. We recorded foreign
income tax provisions relating to taxes withheld from customer
payments and remitted to foreign taxing jurisdictions on our
behalf, as well as income taxes generated in certain foreign
jurisdictions.

As of December 31, 2003, we had net
operating loss carryforwards for federal and state income tax
purposes of approximately $146.2 million that will expire
beginning in years 2010 and 2005, respectively.

In addition, we had federal tax credit
carryforwards of approximately $4.7 million, which expire
beginning in 2010.

Utilization of our net operating loss and tax
credit carryforwards may be subject to a substantial annual
limitation due to the ownership change limitations imposed by
Internal Revenue Code Section 382 and similar state
provisions. Such an annual limitation could result in the
expiration of the net operating loss and tax credit
carryforwards before utilization.

Earnings per Share

Under the provisions of SFAS No. 128,
Earnings per Share, basic earnings per share is
computed by dividing the net (loss) income for the period
by the weighted average number of common shares outstanding
during the period. Diluted earnings per share is computed by
dividing the net (loss) income for the period by the
weighted average number of common and potentially dilutive
common shares outstanding during the period. Potentially
dilutive common shares are comprised of the weighted average
outstanding stock options and warrants during each respective
period, as determined by the treasury stock method. In 2001,
2002, and 2003, potentially dilutive common shares of
4.9 million, 3.1 million and 3.1 million,
respectively, were excluded from earnings per share because of
our net loss position.

Recently Issued Accounting
Pronouncements

In January 2003, the FASB issued Interpretation
No. 46, Consolidation of Variable Interest
Entities (FIN 46). This interpretation of
Accounting Research Bulletin No. 51, Consolidation of
Financial Statements, addresses consolidation by business
enterprises of variable interest entities (VIE) that
either: (1) do not have sufficient equity investment at
risk to permit the entity to finance its activities without
additional subordinated financial support, or (2) the
equity investors lack an essential characteristic of a
controlling interest. This interpretation applies to all
special-purpose entities no later than the end of the first
reporting period ending after December 15, 2003 and to all
VIEs no later than the end of the first reporting period
ending after March 15, 2004. As of December 31, 2003,
we do not have any entities that require disclosure or new
consolidation as a result of adopting the provision of
FIN 46.






|         |                                                               
|-------- | --------------------------------------------------------------
|Item 7A. | Quantitative and Qualitative Disclosures
    About Market Risk

Foreign Currency Exchange Risk

The majority of our revenues recognized to date
have been denominated in United States dollars and are primarily
from customers headquartered in the United States. We have
several locations in Europe, Asia, Australia and South America.
In the future, a larger portion of the revenues we derive from
international operations may be denominated in foreign
currencies. We incur costs for our international offices in the
local currency of those offices for staffing, rent,
telecommunications and other services. As a result, our
operating results are subject to fluctuations based upon changes
in the exchange rates of those 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 services less competitive in
international markets.

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##### Table of Contents



We believe that a significant risk related to
foreign currency is cash flow risk. In 2003, the majority of our
foreign currency denominated cash flows relate to funding the
operations of our Belgian, United Kingdom and Singapore
subsidiaries. While the Singapore dollar relative to the United
States dollar did not fluctuate materially during 2003, the Euro
and Great British Pound strengthened 21% and 11%, respectively,
versus the United States dollar from January 1, 2003 to
December 31, 2003. Although we anticipate our foreign
currency exposure related to the Euro to be reduced in 2004
compared to 2003 as a result of the European Restructuring Plan,
we may experience foreign currency risk that could impact our
earnings as our initial 2004 plan did not contemplate such a
continued material change in foreign currency rates. We have and
will continue to monitor our exposure to currency fluctuations,
and when appropriate, we will continue to use financial hedging
techniques to minimize the effect of these fluctuations in the
future.

The following table provides information about
our foreign exchange forward contracts outstanding as of
December 31, 2003 (in thousands):

|                        |  |           |   |            |  |          |                       |            |  |   |       |  |  |   |     | 
|----------------------- |  | --------- | - | ---------- |  | -------- | --------------------- | ---------- |  | - | ----- |  |  | - | --- | 
|                        |  |           |   |            |  | Contract |                       | Unrealized
|                        |  | Number of |   | Remaining  |  | Value    |                       | Gain      
|                        |  | Contracts |   | Maturities |  | (USD)    |                       | (USD)     
|                        |  |           |   |            |  |          |                       |           
|European currency units |  |           | 9 |            |  |          | One to four months    |            |  | $ | 3,225 |  |  | $ | 233 | 
|Singapore dollars       |  |           | 2 |            |  |          | One to two months     |            |  | $ | 813   |  |  | $ | 11  | 
|Australian dollars      |  |           | 2 |            |  |          | One to four months    |            |  | $ | 544   |  |  | $ | 55  | 
|Japanese yen            |  |           | 3 |            |  |          | One to two months     |            |  | $ | 370   |  |  | $ | 22  | 
|Brazilian real          |  |           | 1 |            |  |          | Less than four months |            |  | $ | 163   |  |  | $ | 3   | 

The unrealized gain represents the difference
between the contract value and the market value of the contract
based on market rates at December 31, 2003. A hypothetical
10% change in applicable December 31, 2003 forward rates
would result in a pretax gain or loss of approximately $575,000
related to these open positions. We cannot assure you that
exchange rate fluctuations will not harm our business in the
future.

Interest Rate Risk

Our interest income is sensitive to changes in
the general level of United States interest rates, particularly
because most of our investments are in short-term instruments.
At December 31, 2003, our cash and marketable investments
were $136.7 million and our average rate of return was
1.6%. A 10% hypothetical change in this average rate would
increase or decrease our investment income by approximately
$200,000. Based on the current market environment, we anticipate
our rate of return in 2004 to approximate 1% to 3%.

Borrowings under our existing revolving credit
facility and term loan are also interest rate sensitive, because
the applicable rate varies with changes in the prime rate of
lending. We had $2.8 million and $1.2 million of debt
outstanding at December 31, 2002 and 2003, respectively.
Average effective interest rates were 6.6% in 2002 and 5.2% in
2003. A hypothetical change of 10% in our effective interest
rate from year end 2003 levels would increase or decrease
interest expense by approximately $10,000. We cannot assure you
that interest rate fluctuations will not harm our business in
the future.

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|        |                                                
|------- | -----------------------------------------------
|Item 8. | Financial Statements and Supplementary
    Data

INDEX TO CONSOLIDATED FINANCIAL
STATEMENTS




|                                                                                                                          |  |  |    | 
|------------------------------------------------------------------------------------------------------------------------- |  |  | -- | 
|Report of Independent Auditors                                                                                            |  |  | 37 | 
|Consolidated Balance Sheets as of
    December 31, 2003 and 2002                                                          |  |  | 38 | 
|Consolidated Statements of Operations for each of
    the three years in the period ended December 31, 2003               |  |  | 39 | 
|Consolidated Statements of Stockholders
    Equity for each of the three years in the period ended
    December 31, 2003 |  |  | 40 | 
|Consolidated Statements of Cash Flows for each of
    the three years in the period ended December 31, 2003               |  |  | 41 | 
|Notes to Consolidated Financial Statements                                                                                |  |  | 42 | 




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##### Table of Contents



REPORT OF INDEPENDENT AUDITORS

To the Board of Directors and Stockholders

of FreeMarkets, Inc. and Subsidiaries:


In our opinion, the accompanying consolidated
balance sheets and the related consolidated statements of
operations, stockholders equity and cash flows present
fairly, in all material respects, the financial position of
FreeMarkets, Inc. and Subsidiaries (the Company) at
December 31, 2003 and 2002 and the results of their
operations and their cash flows for each of the three years in
the period ended December 31, 2003, in conformity with
accounting principles generally accepted in the United States of
America. These financial statements are the responsibility of
the Companys management; our responsibility is to express
an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of
America, which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by
management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable
basis for our opinion.

As discussed in note 6 to the Consolidated
Financial Statements, the Company adopted Statement of Financial
Accounting Standards No. 142, Goodwill and Other
Intangible Assets. Accordingly, the Company changed its
method of accounting for goodwill in 2002.



| |                               
| | ------------------------------
| | /S/ PRICEWATERHOUSECOOPERS LLP

Pittsburgh, Pennsylvania

February 6, 2004


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FREEMARKETS, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands)


|                                         |                                                                                                                                                                 |                                            |        |          |         |  |        |          |         | 
|---------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------ | -------- | ------- |  | ------ | -------- | ------- | 
|                                         |                                                                                                                                                                 |                                           
|                                         |                                                                                                                                                                 | December 31,                              
|                                         |                                                                                                                                                                 |                                           
|                                         |                                                                                                                                                                 | 2003                                       |        | 2002    
|                                         |                                                                                                                                                                 |                                            |        |         
|ASSETS                                  
|Current assets:                          |                                                                                                                                                                 |                                            |        |          |         |  |        |         
|                                         | Cash and cash equivalents                                                                                                                                       |                                            | $      | 102,935  |         |  | $      | 94,593   |        
|                                         | Short-term marketable investments                                                                                                                               |                                            |        | 8,663    |         |  |        | 25,323   |        
|                                         | Accounts receivable, net of allowance for
    doubtful accounts of $2,120 and $1,915 as of December 31,
    2003 and 2002, respectively                         |                                            |        | 25,039   |         |  |        | 25,673   |        
|                                         | Other current assets                                                                                                                                            |                                            |        | 6,399    |         |  |        | 8,457    |        
|                                         |                                                                                                                                                                 |                                            |        |          |         |  |        |         
|                                         |                                                                                                                                                                 | Total current assets                       |        |          | 143,036 |  |        |          | 154,046 | 
|Long-term marketable investments         |                                                                                                                                                                 |                                            | 25,076 |          |         |  | 15,107 |         
|Property and equipment, net              |                                                                                                                                                                 |                                            | 10,571 |          |         |  | 20,159 |         
|Goodwill and other assets                |                                                                                                                                                                 |                                            | 4,466  |          |         |  | 4,355  |         
|                                         |                                                                                                                                                                 |                                            |        |          |         |  |        |         
|                                         |                                                                                                                                                                 | Total assets                               |        | $        | 183,149 |  |        | $        | 193,667 | 
|                                         |                                                                                                                                                                 |                                            |        |          |         |  |        |         
|                                        
|LIABILITIES AND STOCKHOLDERS
    EQUITY
|Current liabilities:                     |                                                                                                                                                                 |                                            |        |          |         |  |        |         
|                                         | Accounts payable                                                                                                                                                |                                            | $      | 4,757    |         |  | $      | 4,063    |        
|                                         | Accrued incentive compensation                                                                                                                                  |                                            |        | 6,915    |         |  |        | 7,536    |        
|                                         | Accrued restructuring charges                                                                                                                                   |                                            |        | 2,676    |         |  |        | 119      |        
|                                         | Other current liabilities                                                                                                                                       |                                            |        | 19,020   |         |  |        | 21,608   |        
|                                         | Current portion of long-term debt                                                                                                                               |                                            |        | 818      |         |  |        | 1,502    |        
|                                         |                                                                                                                                                                 |                                            |        |          |         |  |        |         
|                                         |                                                                                                                                                                 | Total current liabilities                  |        |          | 34,186  |  |        |          | 34,828  | 
|Long-term restructuring charges          |                                                                                                                                                                 |                                            | 4,404  |          |         |  |       |         
|Long-term debt                           |                                                                                                                                                                 |                                            | 342    |          |         |  | 1,328  |         
|                                         |                                                                                                                                                                 |                                            |        |          |         |  |        |         
|                                         |                                                                                                                                                                 | Total liabilities                          |        |          | 38,932  |  |        |          | 36,156  | 
|Commitments and contingencies            |                                                                                                                                                                 |                                            |        |          |         |  |        |         
|Stockholders equity:                    |                                                                                                                                                                 |                                            |        |          |         |  |        |         
|                                         | Preferred stock, $.01 par value, 5,000 shares
    authorized; zero shares issued and outstanding as of
    December 31, 2003 and 2002                           |                                            |        |         |         |  |        |         |        
|                                         | Common stock, $.01 par value, 500,000 shares
    authorized; 42,337 and 42,376 shares issued and outstanding as
    of December 31, 2003 and 2002, respectively |                                            |        | 423      |         |  |        | 424      |        
|                                         | Additional capital                                                                                                                                              |                                            |        | 592,343  |         |  |        | 575,043  |        
|                                         | Unearned stock-based compensation                                                                                                                               |                                            |        | (24      | )       |  |        | (104     | )      
|                                         | Stock purchase warrants                                                                                                                                         |                                            |        | 76,388   |         |  |        | 76,388   |        
|                                         | Accumulated other comprehensive income (loss)                                                                                                                   |                                            |        | 220      |         |  |        | (1       | )      
|                                         | Accumulated deficit                                                                                                                                             |                                            |        | (525,133 | )       |  |        | (494,239 | )      
|                                         |                                                                                                                                                                 |                                            |        |          |         |  |        |         
|                                         |                                                                                                                                                                 | Total stockholders equity                 |        |          | 144,217 |  |        |          | 157,511 | 
|                                         |                                                                                                                                                                 |                                            |        |          |         |  |        |         
|                                         |                                                                                                                                                                 | Total liabilities and stockholders equity |        | $        | 183,149 |  |        | $        | 193,667 | 
|                                         |                                                                                                                                                                 |                                            |        |          |         |  |        |         

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

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FREEMARKETS, INC.

CONSOLIDATED STATEMENTS OF
OPERATIONS

(In thousands, except per share
amounts)





|                                                        |                                            |                         |         |         |   |      |         |         |   |   |         |          |  
|------------------------------------------------------- | ------------------------------------------ | ----------------------- | ------- | ------- | - | ---- | ------- | ------- | - | - | ------- | -------- | -
|                                                        |                                            |                        
|                                                        |                                            | Year Ended December 31,
|                                                        |                                            |                        
|                                                        |                                            | 2003                    |         | 2002    |   | 2001
|                                                        |                                            |                         |         |         |   |     
|Revenues                                                |                                            | $                       | 138,716 |         |   | $    | 170,441 |         |   | $ | 155,342 |         
|                                                        |                                            |                         |         |         |   |      |         |         |   |   |         |         
|Operating costs and expenses:                           |                                            |                         |         |         |   |      |         |         |   |   |         |         
|                                                        | Cost of revenues                           |                         |         | 69,651  |   |      |         | 76,129  |   |   |         | 78,582   |  
|                                                        | Research and development                   |                         |         | 24,551  |   |      |         | 27,019  |   |   |         | 20,067   |  
|                                                        | Sales and marketing                        |                         |         | 35,584  |   |      |         | 45,612  |   |   |         | 51,304   |  
|                                                        | General and administrative                 |                         |         | 21,425  |   |      |         | 23,674  |   |   |         | 32,086   |  
|                                                        | Stock compensation and warrant costs(1)    |                         |         | 6,783   |   |      |         | 7,998   |   |   |         | 8,569    |  
|                                                        | Investment write-down                      |                         |         |        |   |      |         | 5,111   |   |   |         |         |  
|                                                        | Restructuring charges                      |                         |         | 14,161  |   |      |         | (303    | ) |   |         | 6,432    |  
|                                                        | Terminated merger-related costs            |                         |         |        |   |      |         |        |   |   |         | 3,385    |  
|                                                        | Goodwill amortization and impairment       |                         |         |        |   |      |         |        |   |   |         | 252,031  |  
|                                                        |                                            |                         |         |         |   |      |         |         |   |   |         |         
|Total operating costs and expenses                      |                                            |                         | 172,155 |         |   |      | 185,240 |         |   |   | 452,456 |         
|                                                        |                                            |                         |         |         |   |      |         |         |   |   |         |         
|                                                        | Operating loss                             |                         |         | (33,439 | ) |      |         | (14,799 | ) |   |         | (297,114 | )
|Interest and other income, net                          |                                            |                         | 3,733   |         |   |      | 3,243   |         |   |   | 2,665   |         
|                                                        |                                            |                         |         |         |   |      |         |         |   |   |         |         
|                                                        | Loss before taxes and change in accounting |                         |         | (29,706 | ) |      |         | (11,556 | ) |   |         | (294,449 | )
|Provision for income taxes                              |                                            |                         | 1,188   |         |   |      | 712     |         |   |   | 782     |         
|                                                        |                                            |                         |         |         |   |      |         |         |   |   |         |         
|                                                        | Loss before change in accounting           |                         |         | (30,894 | ) |      |         | (12,268 | ) |   |         | (295,231 | )
|Cumulative effect of accounting change for
    goodwill |                                            |                         |        |         |   |      | (5,327  | )       |   |   |        |         
|                                                        |                                            |                         |         |         |   |      |         |         |   |   |         |         
|                                                        | Net loss                                   |                         | $       | (30,894 | ) |      | $       | (17,595 | ) |   | $       | (295,231 | )
|                                                        |                                            |                         |         |         |   |      |         |         |   |   |         |         
|Earnings per share:                                     |                                            |                         |         |         |   |      |         |         |   |   |         |         
|                                                        | Basic and diluted before accounting change |                         | $       | (0.74   | ) |      | $       | (0.30   | ) |   | $       | (7.48    | )
|                                                        |                                            |                         |         |         |   |      |         |         |   |   |         |         
|                                                        | Basic and diluted after accounting change  |                         | $       | (0.74   | ) |      | $       | (0.42   | ) |   | $       | (7.48    | )
|                                                        |                                            |                         |         |         |   |      |         |         |   |   |         |         
|Weighted average common shares outstanding:             |                                            |                         |         |         |   |      |         |         |   |   |         |         
|                                                        | Basic and diluted                          |                         |         | 42,002  |   |      |         | 41,553  |   |   |         | 39,492   |  
|                                                        |                                            |                         |         |         |   |      |         |         |   |   |         |         






---






|    |                                                                                                         
|--- | --------------------------------------------------------------------------------------------------------
|(1) | Stock compensation and warrant costs are
    attributable to the following operating expense categories:







|                         |  |      |       |      |  |      |       |  |  |   |       | 
|------------------------ |  | ---- | ----- | ---- |  | ---- | ----- |  |  | - | ----- | 
|                         |  | 2003 |       | 2002 |  | 2001
|                         |  |      |       |      |  |     
|Research and development |  | $    | 50    |      |  | $    | 95    |  |  | $ | 158   | 
|Sales and marketing      |  |      | 6,733 |      |  |      | 7,903 |  |  |   | 8,411 | 
|                         |  |      |       |      |  |      |       |  |  |   |       | 
|                         |  | $    | 6,783 |      |  | $    | 7,998 |  |  | $ | 8,569 | 
|                         |  |      |       |      |  |      |       |  |  |   |       | 







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




39



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FREEMARKETS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS
EQUITY

(In thousands)





|                             |                                                                                 |           |   |        |  |            |     |              |   |          |         |               |   |             |      |          |  |       |        |         |   |   |      |      |   |   |          |          |   |   |   |        |   |   |         |          |  
|---------------------------- | ------------------------------------------------------------------------------- | --------- | - | ------ |  | ---------- | --- | ------------ | - | -------- | ------- | ------------- | - | ----------- | ---- | -------- |  | ----- | ------ | ------- | - | - | ---- | ---- | - | - | -------- | -------- | - | - | - | ------ | - | - | ------- | -------- | -
|                             |                                                                                 |           |   |        |  |            |     |              |   |          |         | Accumulated   |   |             |      |          |  |      
|                             |                                                                                 |           |   |        |  |            |     |              |   |          |         | Other         |   |             |      |          |  |      
|                             |                                                                                 |           |   |        |  |            |     | Unearned     |   | Stock    |         | Comprehensive |   |             |      |          |  |      
|                             |                                                                                 | Preferred |   | Common |  | Additional |     | Stock-based  |   | Purchase |         | Income        |   | Accumulated |      | Treasury |  |      
|                             |                                                                                 | Stock     |   | Stock  |  | Capital    |     | Compensation |   | Warrants |         | (Loss)        |   | Deficit     |      | Stock    |  | Total
|                             |                                                                                 |           |   |        |  |            |     |              |   |          |         |               |   |             |      |          |  |      
|Balance at December 31, 2000 |                                                                                 | $         |  |        |  | $          | 388 |              |   | $        | 503,065 |               |   | $           | (556 | )        |  | $     | 95,484 |         |   | $ | (171 | )    |   | $ | (181,413 | )        |   | $ |  |        |   | $ | 416,797 |         
|                             | Net loss                                                                        |           |   |        |  |            |     |              |   |          |         |               |   |             |      |          |  |       |        |         |   |   |      |      |   |   |          | (295,231 | ) |   |   |        |   |   |         | (295,231 | )
|                             | Translation adjustments                                                         |           |   |       |  |            |     |             |   |          |         |              |   |             |      |         |  |       |        |        |   |   |      | 540  |   |   |          |         |   |   |   |       |   |   |         | 540      |  
|                             | Change in unrealized gain (loss) on
    investments, net                        |           |   |       |  |            |     |             |   |          |         |              |   |             |      |         |  |       |        |        |   |   |      | 182  |   |   |          |         |   |   |   |       |   |   |         | 182      |  
|                             |                                                                                 |           |   |        |  |            |     |              |   |          |         |               |   |             |      |          |  |       |        |         |   |   |      |      |   |   |          |          |   |   |   |        |   |   |         |         
|                             | Total comprehensive loss                                                        |           |   |       |  |            |     |             |   |          |         |              |   |             |      |         |  |       |        |        |   |   |      |     |   |   |          |         |   |   |   |       |   |   |         | (294,509 | )
|                             | Stock purchase warrants exercised                                               |           |   |       |  |            |     | 3            |   |          |         | 19,096        |   |             |      |         |  |       |        | (19,096 | ) |   |      |     |   |   |          |         |   |   |   |       |   |   |         | 3        |  
|                             | Options exercised                                                               |           |   |       |  |            |     | 12           |   |          |         | 2,578         |   |             |      |         |  |       |        |        |   |   |      |     |   |   |          |         |   |   |   |       |   |   |         | 2,590    |  
|                             | Unearned stock-based compensation                                               |           |   |       |  |            |     |             |   |          |         | 421           |   |             |      | 302      |  |       |        |        |   |   |      |     |   |   |          |         |   |   |   |       |   |   |         | 723      |  
|                             | Amortization of stock purchase warrants,
    including $11,250 of customer fees |           |   |       |  |            |     |             |   |          |         | 19,097        |   |             |      |         |  |       |        |        |   |   |      |     |   |   |          |         |   |   |   |       |   |   |         | 19,097   |  
|                             | Common stock issuance under Employee Stock
    Purchase Plan                    |           |   |       |  |            |     | 2            |   |          |         | 1,942         |   |             |      |         |  |       |        |        |   |   |      |     |   |   |          |         |   |   |   |       |   |   |         | 1,944    |  
|                             | Common stock issuance to Mitsubishi                                             |           |   |       |  |            |     | 2            |   |          |         | 2,998         |   |             |      |         |  |       |        |        |   |   |      |     |   |   |          |         |   |   |   |       |   |   |         | 3,000    |  
|                             |                                                                                 |           |   |        |  |            |     |              |   |          |         |               |   |             |      |          |  |       |        |         |   |   |      |      |   |   |          |          |   |   |   |        |   |   |         |         
|Balance at December 31, 2001 |                                                                                 |           |  |        |  |            | 407 |              |   |          | 549,197 |               |   |             | (254 | )        |  |       | 76,388 |         |   |   | 551  |      |   |   | (476,644 | )        |   |   |  |        |   |   | 149,645 |         
|                             | Net loss                                                                        |           |   |        |  |            |     |             |   |          |         |              |   |             |      |         |  |       |        |        |   |   |      |     |   |   |          | (17,595  | ) |   |   |       |   |   |         | (17,595  | )
|                             | Translation adjustments                                                         |           |   |       |  |            |     |             |   |          |         |              |   |             |      |         |  |       |        |        |   |   |      | (403 | ) |   |          |         |   |   |   |       |   |   |         | (403     | )
|                             | Change in unrealized gain (loss) on
    investments, net                        |           |   |       |  |            |     |             |   |          |         |              |   |             |      |         |  |       |        |        |   |   |      | (149 | ) |   |          |         |   |   |   |       |   |   |         | (149     | )
|                             |                                                                                 |           |   |        |  |            |     |              |   |          |         |               |   |             |      |          |  |       |        |         |   |   |      |      |   |   |          |          |   |   |   |        |   |   |         |         
|                             | Total comprehensive loss                                                        |           |   |       |  |            |     |             |   |          |         |              |   |             |      |         |  |       |        |        |   |   |      |     |   |   |          |         |   |   |   |       |   |   |         | (18,147  | )
|                             | Options exercised                                                               |           |   |       |  |            |     | 13           |   |          |         | 3,617         |   |             |      |         |  |       |        |        |   |   |      |     |   |   |          |         |   |   |   |       |   |   |         | 3,630    |  
|                             | Unearned stock-based compensation                                               |           |   |       |  |            |     |             |   |          |         |              |   |             |      | 150      |  |       |        |        |   |   |      |     |   |   |          |         |   |   |   |       |   |   |         | 150      |  
|                             | Amortization of stock purchase warrants,
    including $11,250 of customer fees |           |   |       |  |            |     |             |   |          |         | 19,097        |   |             |      |         |  |       |        |        |   |   |      |     |   |   |          |         |   |   |   |       |   |   |         | 19,097   |  
|                             | Common stock issuance under Employee Stock
    Purchase Plan                    |           |   |       |  |            |     | 4            |   |          |         | 3,132         |   |             |      |         |  |       |        |        |   |   |      |     |   |   |          |         |   |   |   |       |   |   |         | 3,136    |  
|                             |                                                                                 |           |   |        |  |            |     |              |   |          |         |               |   |             |      |          |  |       |        |         |   |   |      |      |   |   |          |          |   |   |   |        |   |   |         |         
|Balance at December 31, 2002 |                                                                                 |           |  |        |  |            | 424 |              |   |          | 575,043 |               |   |             | (104 | )        |  |       | 76,388 |         |   |   | (1   | )    |   | $ | (494,239 | )        |   |   |  |        |   |   | 157,511 |         
|                             | Net loss                                                                        |           |   |        |  |            |     |             |   |          |         |              |   |             |      |         |  |       |        |        |   |   |      |     |   |   |          | (30,894  | ) |   |   |       |   |   |         | (30,894  | )
|                             | Translation adjustments                                                         |           |   |       |  |            |     |             |   |          |         |              |   |             |      |         |  |       |        |        |   |   |      | 350  |   |   |          |         |   |   |   |       |   |   |         | 350      |  
|                             | Change in unrealized gain (loss) on
    investments, net                        |           |   |       |  |            |     |             |   |          |         |              |   |             |      |         |  |       |        |        |   |   |      | (129 | ) |   |          |         |   |   |   |       |   |   |         | (129     | )
|                             |                                                                                 |           |   |        |  |            |     |              |   |          |         |               |   |             |      |          |  |       |        |         |   |   |      |      |   |   |          |          |   |   |   |        |   |   |         |         
|                             | Total comprehensive loss                                                        |           |   |        |  |            |     |              |   |          |         |              |   |             |      |         |  |       |        |        |   |   |      |     |   |   |          |         |   |   |   |       |   |   |         | (30,673  | )
|                             | Options exercised                                                               |           |   |       |  |            |     | 8            |   |          |         | 2,477         |   |             |      |         |  |       |        |        |   |   |      |     |   |   |          |         |   |   |   |       |   |   |         | 2,485    |  
|                             | Unearned stock-based compensation                                               |           |   |       |  |            |     |             |   |          |         |              |   |             |      | 80       |  |       |        |        |   |   |      |     |   |   |          |         |   |   |   |       |   |   |         | 80       |  
|                             | Amortization of stock purchase warrants,
    including $12,393 of customer fees |           |   |       |  |            |     |             |   |          |         | 19,096        |   |             |      |         |  |       |        |        |   |   |      |     |   |   |          |         |   |   |   |       |   |   |         | 19,096   |  
|                             | Purchase of common stock                                                        |           |   |       |  |            |     |             |   |          |         |              |   |             |      |         |  |       |        |        |   |   |      |     |   |   |          |         |   |   |   | (6,398 | ) |   |         | (6,398   | )
|                             | Retirement of treasury stock                                                    |           |   |       |  |            |     | (13          | ) |          |         | (6,385        | ) |             |      |         |  |       |        |        |   |   |      |     |   |   |          |         |   |   |   | 6,398  |   |   |         |         |  
|                             | Common stock issuance under                                                     |           |   |        |  |            |     |              |   |          |         |               |   |             |      |          |  |       |        |         |   |   |      |      |   |   |          |          |   |   |   |        |   |   |         |          |  
|                             | Employee Stock Purchase Plan                                                    |           |   |       |  |            |     | 4            |   |          |         | 2,112         |   |             |      |         |  |       |        |        |   |   |      |     |   |   |          |         |   |   |   |       |   |   |         | 2,116    |  
|                             |                                                                                 |           |   |        |  |            |     |              |   |          |         |               |   |             |      |          |  |       |        |         |   |   |      |      |   |   |          |          |   |   |   |        |   |   |         |         
|Balance at December 31, 2003 |                                                                                 | $         |  |        |  | $          | 423 |              |   | $        | 592,343 |               |   | $           | (24  | )        |  | $     | 76,388 |         |   | $ | 220  |      |   | $ | (525,133 | )        |   | $ |  |        |   | $ | 144,217 |         
|                             |                                                                                 |           |   |        |  |            |     |              |   |          |         |               |   |             |      |          |  |       |        |         |   |   |      |      |   |   |          |          |   |   |   |        |   |   |         |         




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

40



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##### Table of Contents



FREEMARKETS, INC.

CONSOLIDATED STATEMENTS OF CASH
FLOWS

(In thousands)


|                                                 |                                                                              |                                                         |                                                         |         |         |        |        |         |         |         |        |          |         |         |  
|------------------------------------------------ | ---------------------------------------------------------------------------- | ------------------------------------------------------- | ------------------------------------------------------- | ------- | ------- | ------ | ------ | ------- | ------- | ------- | ------ | -------- | ------- | ------- | -
|                                                 |                                                                              |                                                        
|                                                 |                                                                              | Year Ended December 31,                                
|                                                 |                                                                              |                                                        
|                                                 |                                                                              | 2003                                                    |                                                         | 2002    |         | 2001  
|                                                 |                                                                              |                                                         |                                                         |         |         |       
|Cash flows from operating activities:            |                                                                              |                                                         |                                                         |         |         |        |        |         |         |         |        |         
|                                                 | Net loss                                                                     |                                                         | $                                                       | (30,894 | )       |        | $      | (17,595 | )       |         | $      | (295,231 | )      
|                                                 | Adjustments to reconcile net loss to net cash
    from operating activities: |                                                         |                                                         |         |         |        |        |         |         |         |        |          |        
|                                                 |                                                                              | Depreciation and amortization                           |                                                         |         | 12,756  |        |        |         | 19,394  |         |        |          | 18,344  |        
|                                                 |                                                                              | Provision for bad debts                                 |                                                         |         | 1,501   |        |        |         | 1,555   |         |        |          | 3,123   |        
|                                                 |                                                                              | Stock compensation and warrant costs                    |                                                         |         | 6,783   |        |        |         | 7,998   |         |        |          | 8,569   |        
|                                                 |                                                                              | Investment write-down                                   |                                                         |         |        |        |        |         | 5,111   |         |        |          |        |        
|                                                 |                                                                              | Cumulative effect of accounting change for
    goodwill |                                                         |         |        |        |        |         | 5,327   |         |        |          |        |        
|                                                 |                                                                              | Non-cash restructuring costs                            |                                                         |         | 1,561   |        |        |         | (303    | )       |        |          | 2,179   |        
|                                                 |                                                                              | Goodwill amortization and impairment                    |                                                         |         |        |        |        |         |        |         |        |          | 252,031 |        
|                                                 |                                                                              | Loss on disposal of property and equipment              |                                                         |         |        |        |        |         |        |         |        |          | 1,138   |        
|                                                 | Cash provided by (used in) changes in:                                       |                                                         |                                                         |         |         |        |        |         |         |         |        |          |        
|                                                 |                                                                              | Accounts receivable                                     |                                                         |         | (662    | )      |        |         | 4,180   |         |        |          | (6,670  | )      
|                                                 |                                                                              | Other assets                                            |                                                         |         | 1,903   |        |        |         | (3,360  | )       |        |          | (165    | )      
|                                                 |                                                                              | Accounts payable                                        |                                                         |         | 694     |        |        |         | (618    | )       |        |          | (543    | )      
|                                                 |                                                                              | Other liabilities                                       |                                                         |         | 4,102   |        |        |         | (405    | )       |        |          | 2,476   |        
|                                                 |                                                                              |                                                         |                                                         |         |         |        |        |         |         |         |        |         
|                                                 |                                                                              |                                                         | Net cash (used in) provided by operating
    activities |         |         | (2,256 | )      |         |         | 21,284  |        |          |         | (14,749 | )
|                                                 |                                                                              |                                                         |                                                         |         |         |        |        |         |         |         |        |         
|                                                 | Cash flows from investing activities:                                        |                                                         |                                                         |         |         |        |        |         |         |         |        |          |        
|                                                 |                                                                              | Purchases of marketable investments                     |                                                         |         | (46,853 | )      |        |         | (29,648 | )       |        |          | (57,196 | )      
|                                                 |                                                                              | Maturities of marketable investments                    |                                                         |         | 53,415  |        |        |         | 12,075  |         |        |          | 102,528 |        
|                                                 |                                                                              | Proceeds from disposal of property and equipment        |                                                         |         |        |        |        |         |        |         |        |          | 2,544   |        
|                                                 |                                                                              | Investment in Adexa, Inc.                               |                                                         |         |        |        |        |         |        |         |        |          | (6,000  | )      
|                                                 |                                                                              | Capital expenditures, net                               |                                                         |         | (4,685  | )      |        |         | (6,946  | )       |        |          | (17,307 | )      
|                                                 |                                                                              | Patent and trademark costs                              |                                                         |         |        |        |        |         |        |         |        |          | (186    | )      
|                                                 |                                                                              |                                                         |                                                         |         |         |        |        |         |         |         |        |         
|                                                 |                                                                              |                                                         | Net cash provided by (used in) investing
    activities |         |         | 1,877  |        |         |         | (24,519 | )      |          |         | 24,383  |  
|                                                 |                                                                              |                                                         |                                                         |         |         |        |        |         |         |         |        |         
|                                                 | Cash flows from financing activities:                                        |                                                         |                                                         |         |         |        |        |         |         |         |        |          |        
|                                                 |                                                                              | Proceeds from debt                                      |                                                         |         | 500     |        |        |         |        |         |        |          | 4,000   |        
|                                                 |                                                                              | Repayment of debt                                       |                                                         |         | (2,170  | )      |        |         | (1,608  | )       |        |          | (3,993  | )      
|                                                 |                                                                              | Proceeds from issuance of common stock, net             |                                                         |         | 2,116   |        |        |         | 3,136   |         |        |          | 4,944   |        
|                                                 |                                                                              | Proceeds from customer fees applied to warrant          |                                                         |         | 12,188  |        |        |         | 12,188  |         |        |          | 10,313  |        
|                                                 |                                                                              | Payments to acquire treasury stock                      |                                                         |         | (6,398  | )      |        |         |        |         |        |          |        |        
|                                                 |                                                                              | Options and warrants exercised                          |                                                         |         | 2,485   |        |        |         | 3,630   |         |        |          | 2,593   |        
|                                                 |                                                                              |                                                         |                                                         |         |         |        |        |         |         |         |        |         
|                                                 |                                                                              |                                                         | Net cash provided by financing activities               |         |         | 8,721  |        |         |         | 17,346  |        |          |         | 17,857  |  
|                                                 |                                                                              |                                                         |                                                         |         |         |        |        |         |         |         |        |         
|Net change in cash and cash equivalents          |                                                                              |                                                         | 8,342                                                   |         |         |        | 14,111 |         |         |         | 27,491 |         
|Cash and cash equivalents at beginning of period |                                                                              |                                                         | 94,593                                                  |         |         |        | 80,482 |         |         |         | 52,991 |         
|                                                 |                                                                              |                                                         |                                                         |         |         |        |        |         |         |         |        |         
|Cash and cash equivalents at end of period       |                                                                              | $                                                       | 102,935                                                 |         |         | $      | 94,593 |         |         | $       | 80,482 |         
|                                                 |                                                                              |                                                         |                                                         |         |         |        |        |         |         |         |        |         
|Supplemental disclosure:                         |                                                                              |                                                         |                                                         |         |         |        |        |         |         |         |        |         
|                                                 | Cash paid for interest                                                       |                                                         | $                                                       | 112     |         |        | $      | 235     |         |         | $      | 347      |        
|                                                 |                                                                              |                                                         |                                                         |         |         |        |        |         |         |         |        |         
|                                                 | Cash paid for income taxes                                                   |                                                         | $                                                       | 1,276   |         |        | $      | 462     |         |         | $      | 362      |        
|                                                 |                                                                              |                                                         |                                                         |         |         |        |        |         |         |         |        |         
|Supplemental non-cash disclosures:               |                                                                              |                                                         |                                                         |         |         |        |        |         |         |         |        |         
|                                                 | Amounts due from customer characterized as
    payment for warrant           |                                                         | $                                                       | 3,016   |         |        | $      | 2,813   |         |         | $      | 3,750    |        
|                                                 |                                                                              |                                                         |                                                         |         |         |        |        |         |         |         |        |         

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

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##### Table of Contents



FREEMARKETS, INC.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS

Note 1.     Description
of Business

FreeMarkets, Inc. and Subsidiaries (the
Company) provides software, services and solutions to help
companies improve their sourcing and supply management processes
and enhance the capabilities of their supply management
organizations. These solutions are ultimately designed to help
companies lower costs and reduce their supply risk. The
Companys customers are buyers of industrial parts, raw
materials, commodities and services. As of December 31,
2003, the Company serves its customers from 17 locations in
13 countries on five continents through operations centers
in Pittsburgh and Singapore.

Note 2.     Summary
of Significant Accounting Policies



| |                            
| | ---------------------------
| | Principles of consolidation

The consolidated financial statements include the
accounts of the Company and its wholly-owned subsidiaries. The
Company has three subsidiaries in Europe and seven subsidiaries
in Asia and Australia and one in South America. There are also
five in North America, three of which are Delaware holding
companies. All material intercompany accounts and transactions
have been eliminated.



| |                          
| | -------------------------
| | Cash and cash equivalents

The Company considers all unrestricted, highly
liquid investments with maturities of three months or less at
the time of purchase to be cash equivalents.



| |                                    
| | -----------------------------------
| | Allowance for doubtful
    accounts

At December 31, 2003 and 2002, the allowance
for doubtful accounts was $2.1 million and
$1.9 million, respectively. The Company evaluates the
collectibility of accounts receivable based on a combination of
factors. In cases where the Company is aware of circumstances
that may impair a customers ability to meet its financial
obligations, it records a specific allowance against amounts
due. For all customers, the Company recognizes allowance for
doubtful accounts based on the length of time the receivables
are past due, the current business environment and the
Companys historical experience. If the financial condition
of the Companys customers deteriorates or if the economic
conditions worsen, additional allowances may be required in the
future.



| |                       
| | ----------------------
| | Marketable investments

As of December 31, 2003 and 2002, marketable
investments consisted of corporate bonds and
U.S. government agency notes and bonds. Short-term
investments are marketable securities with maturities of greater
than three months at the time of purchase and less than one year
from the balance sheet date. The Company classifies its
investments as available for sale. Such investments are recorded
at fair value based on quoted market prices, with unrealized
gains and losses, which are considered to be temporary, recorded
as accumulated other comprehensive income or loss until
realized. Realized gains and losses are recorded based on the
specific identification method.



| |                            
| | ---------------------------
| | Foreign currency management

The Company occasionally uses foreign exchange
contracts to reduce its net exposures to foreign currency risks.
These risks primarily relate to cash flow risks associated with
funding its Belgian, United Kingdom and Singapore subsidiaries.
The forward foreign exchange contracts require the Company to
exchange foreign currencies for U.S. dollars or vice versa,
and generally mature in six months or less.

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##### Table of Contents



FREEMARKETS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

The following table provides information about
the Companys foreign exchange forward contracts
outstanding as of December 31, 2003 (in thousands):

|                        |  |           |   |            |  |          |                       |            |  |   |       |  |  |   |     | 
|----------------------- |  | --------- | - | ---------- |  | -------- | --------------------- | ---------- |  | - | ----- |  |  | - | --- | 
|                        |  |           |   |            |  | Contract |                       | Unrealized
|                        |  | Number of |   | Remaining  |  | Value    |                       | Gain      
|                        |  | Contracts |   | Maturities |  | (USD)    |                       | (USD)     
|                        |  |           |   |            |  |          |                       |           
|European currency units |  |           | 9 |            |  |          | One to four months    |            |  | $ | 3,225 |  |  | $ | 233 | 
|Singapore dollars       |  |           | 2 |            |  |          | One to two months     |            |  | $ | 813   |  |  | $ | 11  | 
|Australian dollars      |  |           | 2 |            |  |          | One to four months    |            |  | $ | 544   |  |  | $ | 55  | 
|Japanese yen            |  |           | 3 |            |  |          | One to two months     |            |  | $ | 370   |  |  | $ | 22  | 
|Brazilian real          |  |           | 1 |            |  |          | Less than four months |            |  | $ | 163   |  |  | $ | 3   | 

The unrealized gain represents the difference
between the contract value and the market value of the contract
based on market rates at December 31, 2003. These contracts
resulted in gains in the amount of approximately $502,000 in
2003 and immaterial gains in 2002 and 2001.



| |                            
| | ---------------------------
| | Property and equipment, net

Property and equipment are recorded at cost and
depreciated on the straight-line method over their estimated
useful lives. Qualified internally developed software costs for
internal use are capitalized subsequent to both the preliminary
project stage and when management has committed to funding, in
accordance with Statement of Position 98-1,
Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use. Repairs and maintenance
expenditures, which are not considered improvements and do not
extend the useful life of the property and equipment, are
expensed as incurred. The cost and related accumulated
depreciation applicable to property and equipment no longer in
service are eliminated from the accounts and any gain or loss is
included in operations.



| |                                   
| | ----------------------------------
| | Goodwill and other assets,
    net

The excess of costs over net assets acquired
(goodwill) was being amortized on the straight-line method over
its estimated useful life, which was three years. Effective
January 1, 2002, and in accordance with SFAS No. 142,
goodwill is no longer amortized. The Company completed its
annual test for impairment in Q1 2003 and concluded at that
time, that the Company did not have any impairment of goodwill
based on the estimated fair value as determined by discounted
cash flows. Patents and trademarks are being amortized on the
straight-line method over the shorter of their estimated useful
lives or seventeen years. Other assets also include an
investment in Adexa, Inc. (Adexa), which is stated
at cost, reduced for other-than-temporary declines in fair value.



| |                                    
| | -----------------------------------
| | Impairment of long-lived
    assets

The carrying values of long-lived assets, which
include property and equipment and other assets, are evaluated
for impairment whenever events or changes in circumstances
indicate the carrying amount may not be recoverable. An
impairment would be determined based on a comparison of future
undiscounted cash flows to the underlying assets. If required,
adjustments would be measured based on discounted cash flows.



| |                    
| | -------------------
| | Legal contingencies

As discussed in Note 9, the Company is
currently involved in various claims and legal proceedings.
Periodically, the Company reviews the status of each significant
matter and assesses its potential financial exposure. If the
potential loss from any claim or legal proceeding is considered
probable and the amount

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##### Table of Contents



FREEMARKETS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

can be estimated, the Company accrues a liability
for the estimated loss. Because of uncertainties related to
these matters, accruals are based on the best information
available at the time.



| |                              
| | -----------------------------
| | Concentrations of credit risk

The majority of cash and cash equivalents is
maintained with several major financial institutions in the
United States. Deposits with these banks exceed the amount of
insurance provided on such deposits; however, these deposits
typically may be redeemed upon demand and therefore, bear
minimal risk.




Financial instruments that potentially subject
the Company to concentrations of credit risk consist primarily
of marketable investments and trade receivables. Investment
policies have been implemented that limit the concentration of
investments, as well as affix minimum standards for credit
quality. The risk of trade receivables is mitigated by credit
evaluations we perform on our customers. However, as of
December 31, amounts due from one customer in 2003 and two
customers in 2002 individually exceeded 10% of total gross
accounts receivable.






| |                    
| | -------------------
| | Revenue recognition




For all offerings, the Company recognizes revenue
when all of the following criteria are met as set forth in Staff
Accounting Bulletin No. 101:






| |     |                                                                                                   
| | --- | --------------------------------------------------------------------------------------------------
|
| | (1) | Persuasive evidence of an arrangement exists
    (contract is signed and legally binding),        
|
|
|
| | (2) | Services have been rendered or access has been
    provided (with no future obligations),         
|
|
|
| | (3) | The fee is fixed and determinable (amount is
    known and not contingent upon future events), and
|
|
|
| | (4) | Collectibility is probable (high degree of
    confidence that the customer will pay).            
|




The Company recognizes revenue from the fixed
monthly fees for its FullSource offering ratably as the access
to those services are provided over the related contract
periods. In the case of contracts with performance incentive
payments based on market volume and/or savings generated, as
defined in the respective contracts, revenue is recognized as
those thresholds are achieved. The Company recognizes fees for
providing access to its QS hosted technology offering ratably as
that access is provided. Revenue excludes fees earned under a
FullSource service contract with Visteon Corporation
(Visteon).







Some customer agreements include multiple service
offerings. Each service offering consists of a single element.
In determining the appropriate amount of revenue to be
recognized for each offering, the Company evaluates whether
these arrangements contain separate units of accounting. This
determination is based on whether: the delivered item has value
to the customer on a standalone basis (that is, if it is sold
separately by any vendor or the customer could resell the
deliverable); there is objective and reliable evidence of fair
value of the undelivered items in the arrangement; and if the
arrangement includes a general right of return relative to the
delivered item, delivery or performance of the undelivered
item(s) is considered probable and substantially in the control
of the vendor. In instances where all of these conditions are
satisfied, the Company recognizes revenue for the offerings that
have been delivered to the customer based on the relative fair
value of the delivered item when compared to the total
arrangement considered, subject to certain limitations. The fair
value for each element is established based on the sales price
charged when the same element is sold separately.




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

Revenue in excess of billings is recorded as
unbilled receivables and is included in trade accounts
receivable. Billings in excess of revenue are recorded as
deferred revenue until revenue recognition criteria are met.

44



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##### Table of Contents



FREEMARKETS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)



| |              
| | -------------
| | Related party

United Technologies invested $20.0 million
in the Company in September 1999. This investment represented
greater than 5% of the Companys outstanding common stock
as of December 31, 2001. Revenues from United Technologies
were 5% of revenues in 2001. United Technologies no longer holds
greater than 5% of the Companys outstanding common stock.



| |                 
| | ----------------
| | Cost of revenues

Cost of revenues consists primarily of the
expenses related to staffing and operation of the Companys
global sourcing service organization and market operations
centers. Staffing costs include a proportional allocation of
overhead costs based on headcount, such as rent and depreciation.



| |                                   
| | ----------------------------------
| | Research and development
    costs

Research and development costs are expensed as
incurred, and include costs to develop, enhance and manage the
Companys proprietary software technology. The fair value
of purchased in-process research and development is estimated by
assessing the percentage-of-completion of the research project,
costs required to complete the project, and expected future
revenues from the related products, and discounting such amounts
using an appropriate risk-weighted discount rate. Amounts
allocated in an acquisition to in-process research and
development are expensed in the period in which the acquisition
is consummated.



| |                  
| | -----------------
| | Advertising costs

Advertising costs are expensed at the time the
advertisement is first aired or the promotion is held, and
amounted to $5.7 million in 2003, $9.2 million in 2002
and $10.9 million in 2001.



| |               
| | --------------
| | Start-up costs

Start-up costs are expensed as incurred, and
include costs to establish new locations, operations or
subsidiaries.



| |                   
| | ------------------
| | Stock compensation

At December 31, 2003, the Company has four
stock-based employee compensation plans, which are described
more fully in Note 12. SFAS No. 123, Accounting
for Stock-Based Compensation, gives companies the option
to adopt the fair value method for expense recognition of
employee stock options or to continue to account for employee
stock options using the intrinsic value method, as outlined
under Accounting Principles Board (APB) Opinion
No. 25, Accounting for Stock Issued to
Employees. The Company has elected to continue to apply
the intrinsic value method to account for employee stock options
and discloses the pro forma effect as if the fair value method
had been applied in Note 12. The Company records unearned
stock compensation for stock options granted at exercise prices
less than fair value. Such unearned stock compensation is
amortized on an accelerated basis over the vesting period of
each individual award in accordance with Financial Accounting
Standards Board (FASB) Interpretation

45



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##### Table of Contents



FREEMARKETS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

No. 28. The following table illustrates the
effect on net loss and earnings per share if the Company had
applied the fair value recognition provisions of SFAS
No. 123 to stock-based employee compensation:

|                                                                                                            |                   |                                          |         |      |       |      |         |   |       |   |          |   |       |  
|----------------------------------------------------------------------------------------------------------- | ----------------- | ---------------------------------------- | ------- | ---- | ----- | ---- | ------- | - | ----- | - | -------- | - | ----- | -
|                                                                                                            |                   |                                         
|                                                                                                            |                   | Year Ended December 31,                 
|                                                                                                            |                   |                                         
|                                                                                                            |                   | 2003                                     |         | 2002 |       | 2001
|                                                                                                            |                   |                                          |         |      |       |     
|                                                                                                            |                   |                                         
|                                                                                                            |                   | (In thousands, except per share amounts)
|Net loss, as reported                                                                                       |                   | $                                        | (30,894 | )    |       | $    | (17,595 | ) |       | $ | (295,231 | )
|Add: Stock-based employee compensation expense
    included in reported net income                          |                   |                                          | 80      |      |       |      | 150     |   |       |   | 722      |  
|Less: Total stock-based employee compensation
    expense determined under fair value method for all awards |                   |                                          | (38,235 | )    |       |      | (53,134 | ) |       |   | (89,354  | )
|                                                                                                            |                   |                                          |         |      |       |      |         |   |       |   |          |  
|Pro forma net loss                                                                                          |                   | $                                        | (69,049 | )    |       | $    | (70,579 | ) |       | $ | (383,863 | )
|                                                                                                            |                   |                                          |         |      |       |      |         |   |       |   |          |  
|Earnings per share:                                                                                         |                   |                                          |         |      |       |      |         |   |       |   |          |  
|                                                                                                            | Basic and diluted |                                          |         |      |       |      |         |   |       |   |          |   |      
|                                                                                                            |                   | As reported                              |         | $    | (0.74 | )    |         | $ | (0.42 | ) |          | $ | (7.48 | )
|                                                                                                            |                   |                                          |         |      |       |      |         |   |       |   |          |  
|                                                                                                            |                   | Pro forma                                |         | $    | (1.64 | )    |         | $ | (1.70 | ) |          | $ | (9.72 | )
|                                                                                                            |                   |                                          |         |      |       |      |         |   |       |   |          |  

The weighted average fair value per option grant
to employees was $3.82 in 2003, $10.26 in 2002 and $14.71 in
2001. The fair value of each option grant was determined using
the minimum value method prior to the Companys December
1999 initial public offering (IPO) and using the
Black-Scholes pricing model subsequent to the IPO, with the
following assumptions for all grants:

|                                         |  |                         |              |      |  |      |      |   |  |  |     |  
|---------------------------------------- |  | ----------------------- | ------------ | ---- |  | ---- | ---- | - |  |  | --- | -
|                                         |  |                        
|                                         |  | Year Ended December 31,
|                                         |  |                        
|                                         |  | 2003                    |              | 2002 |  | 2001
|                                         |  |                         |              |      |  |     
|Weighted average risk-free interest rate |  |                         | 3.0% - 4.75% |      |  |      | 4.75 | % |  |  | 5.5 | %
|Expected life (number of years)          |  |                         | 5.9 - 6.5    |      |  |      | 6.2  |   |  |  | 5.0 |  
|Volatility                               |  |                         | 100% - 120%  |      |  |      | 100  | % |  |  | 130 | %



| |             
| | ------------
| | Income taxes

Deferred income taxes are recorded using the
liability method. Under this method, deferred tax assets and
liabilities are determined based on the differences between the
financial statement and tax bases of assets and liabilities
using enacted tax rates in effect in the years in which the
differences are expected to reverse. Valuation allowances are
established when necessary to reduce deferred tax assets to the
amount expected to be realized.



| |                         
| | ------------------------
| | International operations

The local currency is the functional currency for
the Companys operations outside of the United States.
Assets and liabilities are translated using the exchange rate at
the balance sheet date. Revenues, expenses, gains and losses are
translated at the exchange rate on the date those elements are
recognized.



| |                   
| | ------------------
| | Earnings per share

Under the provisions of SFAS No. 128,
Earnings per Share, basic earnings per share is
computed by dividing the net (loss) income for the period by the
weighted average number of common shares outstanding during the
period. Diluted earnings per share is computed by dividing the
net (loss) income for the period by the weighted average number
of common and potentially dilutive common shares outstanding
during the period. Potentially dilutive common shares consist of
the common shares issuable upon the exercise of stock options
and warrants (using the treasury stock method). Potentially
dilutive common shares are excluded from the calculation if
their effect is antidilutive.

46



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##### Table of Contents



FREEMARKETS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

In 2003, 2002 and 2001, potentially dilutive
common shares of 3.1 million, 3.1 million and
4.9 million, respectively, were excluded because their
effect was antidilutive.



| |                 
| | ----------------
| | Use of estimates

The preparation of financial statements in
conformity with generally accepted accounting principles
requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of
the financial statements, as well as the reported amounts of
revenues and expenses during the reporting periods. Actual
results could differ from those estimates.



| |                  
| | -----------------
| | Segment reporting

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




The Company serves its customers from locations
in the United States and 12 foreign countries. Many of the
Companys customers are multi-national companies. Over 90%
(96% in 2003 and 98% in 2002) of our customers contract with our
United States entities, and all of our contracts are approved
and ultimately sold by executives in the United States. In
addition, over 90% of the Companys assets are located in
the United States.






| |                        
| | -----------------------
| | Lease abandonment costs




Lease abandonment costs for abandoned facilities
are estimated to include the impairment of leasehold
improvements and remaining lease liabilities, offset by
estimated sublease income, if appropriate. Estimates related to
sublease costs and income are based on assumptions regarding the
period required to locate and contract with suitable
sub-lessees. Each quarter, the Company reviews these estimates,
and to the extent that its assumptions change, the ultimate
restructuring expenses for these abandoned facilities could vary
from current estimates.






| |                 
| | ----------------
| | Reclassification

Certain prior year amounts have been reclassified
to conform with the current presentation.



| |                                     
| | ------------------------------------
| | Recent accounting
    pronouncements

In June 2002, the FASB issued
SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities, which addresses
accounting for restructuring and similar costs.
SFAS No. 146 supersedes previous accounting guidance,
primarily EITF No. 94-3, Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a
Restructuring). Application of SFAS No. 146 is
required for restructuring activities initiated after
December 31, 2002. SFAS No. 146 requires
recognition of the liability for costs associated with an exit
or disposal activity when the liability is incurred. Under Issue
No. 94-3, a liability for an exit cost was recognized at
the date of the Companys commitment to an exit plan.
SFAS No. 146 also establishes that the liability
should initially be measured and recorded at fair value. The
Company adopted this standard effective January 1, 2003 and
applied the provisions of this standard to its 2003
restructuring activities.

In January 2003, the EITF released Issue
No. 00-21 (EITF 00-21), Revenue
Arrangements with Multiple Deliverables, which addresses
certain aspects of the accounting by a vendor for arrangements

47



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##### Table of Contents



FREEMARKETS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

under which it will perform multiple
revenue-generating activities. Specifically, EITF 00-21
addresses whether an arrangement contains more than one unit of
accounting and the measurement and allocation to the separate
units of accounting in the arrangement. EITF 00-21 is
effective for revenue arrangements entered into in fiscal
periods beginning after June 15, 2003. The adoption of this
standard did not have a material impact on the Companys
consolidated financial statements.

In January 2003, the FASB issued Interpretation
No. 46, Consolidation of Variable Interest
Entities (FIN 46). This interpretation of
Accounting Research Bulletin No. 51, Consolidation of
Financial Statements, addresses consolidation by business
enterprises of variable interest entities (VIE) that
either: (1) do not have sufficient equity investment at
risk to permit the entity to finance its activities without
additional subordinated financial support, or (2) the
equity investors lack an essential characteristic of a
controlling interest. This interpretation applies to all
special-purpose entities no later than the end of the first
reporting period ending after December 15, 2003 and to all
VIEs no later than the end of the first reporting period
ending after March 15, 2004. As of December 31, 2003,
the Company does not have any entities that require disclosure
or new consolidation as a result of adopting the provision of
FIN 46.

Note 3.     Restructuring
Charges, Terminated Merger-Related Costs and Goodwill
Impairment



| |                         
| | ------------------------
| | 2003 Restructuring Plans

Throughout 2003, the Company initiated three
restructuring programs. These programs were focused on
eliminating certain positions throughout its global workforce,
re-assessing the Companys facility needs and consolidating
European operations to create a more profitable and efficient
business. The following is a summary of these programs:



| |                         
| | ------------------------
| | Workforce Reduction Plan

In the first quarter of 2003, in response to the
continued economic slowdown, the Company executed a
restructuring plan resulting in the elimination of 79 positions
in its global workforce. This represented approximately 7% of
total employees. The Company recorded a restructuring charge of
$1.8 million in Q1 2003 covering these severance costs. The
liability for employee severance and termination benefit costs
related to this activity was paid by December 31, 2003.



| |                        
| | -----------------------
| | Facility Reduction Plan




Also in 2003, the Company re-assessed its global
headquarters office space in Pittsburgh, Pennsylvania, and
ceased using two of the floors it leases through May 2010. The
Company recorded a restructuring charge of $3.0 million and
$2.0 million in the Q1 2003 and Q4 2003, respectively. The
Company intends to sub-lease these floors, and estimated
sublease income based on current real estate market conditions.




The facility reduction plan includes
$2.9 million and $1.8 million of estimated future
obligations for non-cancelable lease payments generated by
exiting excess leased floors in Q1 2003 and Q4 2003,
respectively, and $89,000 and $282,000 for the impairment of
property and equipment (leasehold improvements) that were no
longer in use in Q1 2003 and Q4 2003, respectively. The accrual
for lease costs (net of anticipated sub-lease proceeds) will be
paid over the lease term though May 2010. As of
December 31, 2003, $674,000 of the $4.3 million
accrual will be paid in 2004 and is therefore classified as a
current liability in the Companys consolidated balance
sheet.

The Company is continuing to evaluate its office
space requirements at its headquarters, and as a result, the
Company may incur additional lease-related charges in the future.

48



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##### Table of Contents



FREEMARKETS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)



| |                            
| | ---------------------------
| | European Restructuring Plan




In Q3 2003, in order to better serve the
Companys customers and enable it to create a more
leveraged, profitable and efficient business across Europe, the
Company initiated a restructuring plan resulting in the net
elimination of 74 positions in its European business. There were
105 positions eliminated with the closing of the Brussels
facility, offset by 31 positions added to the existing European
facilities in London, Paris and Frankfurt. The Company recorded
a restructuring charge of $3.2 million in Q3 2003 covering
these severance costs and legal fees. While most of the
severance costs have been paid in accordance with local
employment laws, the Company expects to pay the remaining
severance portion of the restructuring accrual of $93,000 in Q1
2004.




In Q4 2003, the Company recorded an additional
charge of $4.2 million. This charge includes $847,000 of
severance costs, $1.8 million of estimated future
obligations for non-cancelable lease payments generated by
exiting the Brussels facility, $1.2 million for the
impairment of property and equipment (primarily leasehold
improvements) that were no longer in use, and $308,000 for
restructuring plan implementation costs, primarily comprised of
legal and other professional fees. The Company intends to
sub-lease the facility, and estimated sublease income based on
current real estate market conditions. As of December 31, 2003,
all employees to be terminated as a result of the restructuring
have been notified. The Company expects to pay the remaining
restructuring accrual relating to severance and implementation
in the amount of $917,000 over the next few quarters. The
accrual for lease costs (net of anticipated sub-lease proceeds)
will be paid over the lease term through August 2006. As of
December 31, 2003, $1.0 million of the $1.8 million
accrual for lease costs will be paid in 2004, and is therefore
classified as a current liability in the Companys
consolidated balance sheet.



| |                        
| | -----------------------
| | 2001 Restructuring Plan

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

The Company recorded initial restructuring
charges in Q2 2001 based on assumptions and related estimates
that it deemed appropriate for the economic environment that
existed at the time. In 2002, the Company re-commenced use of
office space and revised its estimate for employee severance and
termination benefit costs. As a result of these reviews, the
Company reversed $303,000 of the accrual through results of
operation.

The following table sets forth an analysis of the
restructuring accrual activity for the years ended
December 31, 2003, 2002 and 2001:

|                              |                        |                         |   |                         |  |               |   |              |  |            |   |       |  |  |   |       |  |  |   |       |  |  |   |       | 
|----------------------------- | ---------------------- | ----------------------- | - | ----------------------- |  | ------------- | - | ------------ |  | ---------- | - | ----- |  |  | - | ----- |  |  | - | ----- |  |  | - | ----- | 
|                              |                        |                         |   |                        
|                              |                        | 2003 Restructuring Plan |   | 2001 Restructuring Plan
|                              |                        |                         |   |                        
|                              |                        | Workforce               |   | Facility                |  | European      |   |             
|                              |                        | Reduction               |   | Reduction               |  | Restructuring |   | Severance    |  | Facilities |   |      
|                              |                        | Plan                    |   | Plan                    |  | Plan          |   | and Benefits |  | Related    |   | Total
|                              |                        |                         |   |                         |  |               |   |              |  |            |   |      
|Restructuring charge in 2001: |                        |                         |   |                         |  |               |   |              |  |            |   |       |  |  |   |       |  |  |   |       |  |  |   |      
|                              | Severance and benefits |                         | $ |                        |  |               | $ |             |  |            | $ |      |  |  | $ | 2,347 |  |  | $ |      |  |  | $ | 2,347 | 
|                              | Accrued lease costs    |                         |   |                        |  |               |   |             |  |            |   |      |  |  |   |      |  |  |   | 1,719 |  |  |   | 1,719 | 

49



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##### Table of Contents



FREEMARKETS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

|                                 |                                   |                         |        |                         |  |               |       |              |  |            |        |       |  |   |        |   |  |   |        |       |  |   |        |       | 
|-------------------------------- | --------------------------------- | ----------------------- | ------ | ----------------------- |  | ------------- | ----- | ------------ |  | ---------- | ------ | ----- |  | - | ------ | - |  | - | ------ | ----- |  | - | ------ | ----- | 
|                                 |                                   |                         |        |                        
|                                 |                                   | 2003 Restructuring Plan |        | 2001 Restructuring Plan
|                                 |                                   |                         |        |                        
|                                 |                                   | Workforce               |        | Facility                |  | European      |       |             
|                                 |                                   | Reduction               |        | Reduction               |  | Restructuring |       | Severance    |  | Facilities |        |      
|                                 |                                   | Plan                    |        | Plan                    |  | Plan          |       | and Benefits |  | Related    |        | Total
|                                 |                                   |                         |        |                         |  |               |       |              |  |            |        |      
|                                 | Property and equipment impairment |                         |        |                        |  |               |       |             |  |            |        |      |  |   |        |  |  |   |        | 2,179 |  |   |        | 2,179 | 
|                                 | Implementation costs              |                         |        |                        |  |               |       |             |  |            |        |      |  |   |        |  |  |   |        | 187   |  |   |        | 187   | 
|Cash paid                        |                                   |                         |       |                         |  |               |      |              |  |            |       |       |  |   | (2,164 | ) |  |   | (1,226 | )     |  |   | (3,390 | )    
|Non-cash charges                 |                                   |                         |       |                         |  |               |      |              |  |            |       |       |  |   |       |   |  |   | (2,179 | )     |  |   | (2,179 | )    
|                                 |                                   |                         |        |                         |  |               |       |              |  |            |        |       |  |   |        |   |  |   |        |       |  |   |        |      
|Balance as of December 31, 2001  |                                   |                         |       |                         |  |               |      |              |  |            |       |       |  |   | 183    |   |  |   | 680    |       |  |   | 863    |      
|Cash paid                        |                                   |                         |       |                         |  |               |      |              |  |            |       |       |  |   | (31    | ) |  |   | (410   | )     |  |   | (441   | )    
|Restructuring accrual adjustment |                                   |                         |       |                         |  |               |      |              |  |            |       |       |  |   | (152   | ) |  |   | (151   | )     |  |   | (303   | )    
|                                 |                                   |                         |        |                         |  |               |       |              |  |            |        |       |  |   |        |   |  |   |        |       |  |   |        |      
|Balance as of December 31, 2002  |                                   |                         |       |                         |  |               |      |              |  |            |       |       |  |   |       |   |  |   | 119    |       |  |   | 119    |      
|Restructuring charge in 2003:    |                                   |                         |        |                         |  |               |       |              |  |            |        |       |  |   |        |   |  |   |        |       |  |   |        |      
|                                 | Severance and benefits            |                         |        | 1,754                   |  |               |       |             |  |            |        | 3,979 |  |   |        |  |  |   |        |      |  |   |        | 5,733 | 
|                                 | Accrued lease costs               |                         |        |                        |  |               |       | 4,642        |  |            |        | 1,842 |  |   |        |  |  |   |        |      |  |   |        | 6,484 | 
|                                 | Property and equipment impairment |                         |        |                        |  |               |       | 371          |  |            |        | 1,190 |  |   |        |  |  |   |        |      |  |   |        | 1,561 | 
|                                 | Implementation costs              |                         |        |                        |  |               |       |             |  |            |        | 383   |  |   |        |  |  |   |        |      |  |   |        | 383   | 
|Cash paid                        |                                   |                         | (1,754 | )                       |  |               | (324  | )            |  |            | (3,442 | )     |  |   |       |   |  |   | (119   | )     |  |   | (5,639 | )    
|Non-cash charges                 |                                   |                         |       |                         |  |               | (371  | )            |  |            | (1,190 | )     |  |   |       |   |  |   |       |       |  |   | (1,561 | )    
|                                 |                                   |                         |        |                         |  |               |       |              |  |            |        |       |  |   |        |   |  |   |        |       |  |   |        |      
|Balance as of December 31, 2003  |                                   | $                       |       |                         |  | $             | 4,318 |              |  | $          | 2,762  |       |  | $ |       |   |  | $ |       |       |  | $ | 7,080  |      
|                                 |                                   |                         |        |                         |  |               |       |              |  |            |        |       |  |   |        |   |  |   |        |       |  |   |        |      



| |                    
| | -------------------
| | Goodwill Impairment

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



| |                                    
| | -----------------------------------
| | Terminated Merger-Related
    Costs

In addition, in February 2001, the Company signed
a definitive agreement to acquire Adexa, a provider of software
products that enable collaborative supply chain management and
optimization. However, in June 2001, the Company and Adexa
mutually agreed to terminate their proposed merger without
payment of any termination fees. The Company incurred
merger-related costs of approximately $3.4 million related
to financial advisor and other professional fees, which were all
expensed in Q2 2001.

50



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##### Table of Contents



FREEMARKETS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Note 4.     Marketable
Investments

Marketable investments consisted of the following:

|                                     |  |                   |        |                   |  |             |        |           |  |       |     |            |  |   |        |  |  |   |        |  |  |   |    | 
|------------------------------------ |  | ----------------- | ------ | ----------------- |  | ----------- | ------ | --------- |  | ----- | --- | ---------- |  | - | ------ |  |  | - | ------ |  |  | - | -- | 
|                                     |  |                   |        |                  
|                                     |  | December 31, 2003 |        | December 31, 2002
|                                     |  |                   |        |                  
|                                     |  | Amortized         |        | Fair              |  | Unrealized  |        | Amortized |  | Fair  |     | Unrealized
|                                     |  | Cost              |        | Value             |  | Gain (Loss) |        | Cost      |  | Value |     | Gain      
|                                     |  |                   |        |                   |  |             |        |           |  |       |     |           
|                                     |  |                  
|                                     |  | (In thousands)   
|Corporate notes and bonds            |  | $                 | 8,661  |                   |  | $           | 8,663  |           |  | $     | 2   |            |  | $ | 22,234 |  |  | $ | 22,267 |  |  | $ | 33 | 
|US Government Agency notes and bonds |  |                   | 25,159 |                   |  |             | 25,076 |           |  |       | (83 | )          |  |   | 18,148 |  |  |   | 18,163 |  |  |   | 15 | 
|                                     |  |                   |        |                   |  |             |        |           |  |       |     |            |  |   |        |  |  |   |        |  |  |   |    | 
|                                     |  | $                 | 33,820 |                   |  | $           | 33,739 |           |  | $     | (81 | )          |  | $ | 40,382 |  |  | $ | 40,430 |  |  | $ | 48 | 
|                                     |  |                   |        |                   |  |             |        |           |  |       |     |            |  |   |        |  |  |   |        |  |  |   |    | 

As of December 31, 2003, the amortized cost
and estimated fair values of short-term and long-term marketable
investments (excluding cash and cash equivalents) by contractual
maturity were as follows (in thousands):

|                    |  |                |        |       |  |   |        | 
|------------------- |  | -------------- | ------ | ----- |  | - | ------ | 
|                    |  |               
|                    |  | Amortized     
|                    |  |               
|                    |  |                |        | Fair 
|                    |  | Cost           |        | Value
|                    |  |                |        |      
|                    |  |               
|                    |  | (In thousands)
|Less than one year  |  | $              | 8,661  |       |  | $ | 8,663  | 
|Mature in 1-2 years |  |                | 25,159 |       |  |   | 25,076 | 
|                    |  |                |        |       |  |   |        | 
|                    |  | $              | 33,820 |       |  | $ | 33,739 | 
|                    |  |                |        |       |  |   |        | 

Investment income included in interest and other
income, net was $2.2 million in 2003, $3.1 million in
2002 and $4.5 million in 2001.

Note 5.     Property
and Equipment, net

Property and equipment, net (and their related
useful lives) consisted of the following:

|                                             |  |                |        |      |  |   |        | 
|-------------------------------------------- |  | -------------- | ------ | ---- |  | - | ------ | 
|                                             |  |               
|                                             |  | December 31,  
|                                             |  |               
|                                             |  | 2003           |        | 2002
|                                             |  |                |        |     
|                                             |  |               
|                                             |  | (In thousands)
|Computer and office equipment (2 to 4 years) |  | $              | 28,161 |      |  | $ | 28,954 | 
|Furniture and fixtures (5 years)             |  |                | 5,111  |      |  |   | 5,923  | 
|Leasehold improvements (1 to 5 years)        |  |                | 13,278 |      |  |   | 15,522 | 
|Software and development costs (3 years)     |  |                | 14,495 |      |  |   | 13,435 | 
|                                             |  |                |        |      |  |   |        | 
|                                             |  |                | 61,045 |      |  |   | 63,834 | 
|Less accumulated depreciation                |  |                | 50,474 |      |  |   | 43,675 | 
|                                             |  |                |        |      |  |   |        | 
|                                             |  | $              | 10,571 |      |  | $ | 20,159 | 
|                                             |  |                |        |      |  |   |        | 

Depreciation expense was $12.7 million in
2003, $19.4 million in 2002 and $18.3 million in 2001.

As a result of the 2003 restructuring activities,
the Company wrote-off property and equipment with a net book
value of $1.6 million associated with the Facilities
Reduction Plan and European Restructuring Plan. See Note 3
to the consolidated financial statements.

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##### Table of Contents



FREEMARKETS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Note 6.     Goodwill
and Other Assets, net

Goodwill and other assets, net consisted of the
following:

|                                                                                                                |  |                |       |      |  |   |       | 
|--------------------------------------------------------------------------------------------------------------- |  | -------------- | ----- | ---- |  | - | ----- | 
|                                                                                                                |  |               
|                                                                                                                |  | December 31,  
|                                                                                                                |  |               
|                                                                                                                |  | 2003           |       | 2002
|                                                                                                                |  |                |       |     
|                                                                                                                |  |               
|                                                                                                                |  | (In thousands)
|Goodwill                                                                                                        |  | $              | 2,000 |      |  | $ | 2,000 | 
|Investment in Adexa                                                                                             |  |                | 889   |      |  |   | 889   | 
|Patent and trademark costs and other assets, net
    of accumulated amortization of $173 and $129, respectively |  |                | 1,577 |      |  |   | 1,466 | 
|                                                                                                                |  |                |       |      |  |   |       | 
|                                                                                                                |  | $              | 4,466 |      |  | $ | 4,355 | 
|                                                                                                                |  |                |       |      |  |   |       | 

Amortization expense was $44,000, $44,000 and
$47.8 million in 2003, 2002 and 2001 respectively. The
Company adopted the provisions of SFAS No. 142,
Goodwill and Other Intangible Assets on
January 1, 2002, and no longer records goodwill
amortization. In connection with adopting this standard, a
transitional impairment loss of $5.3 million was recognized
as the cumulative effect of an accounting change. The Company
completed its annual impairment test of goodwill in Q1 2003 and
concluded at that time, that it did not have any impairment of
goodwill based on estimated fair value of discounted cash flows.
Estimated amortization expense for each of the successive five
years ended through 2008 is $44,000.

The following unaudited pro forma financial
information presents our results of operations and earnings per
share (EPS) as if goodwill had not been amortized or
impaired in 2001:




|                                          |  |                                          |         |      |  |      |       |     |  |   |         |     |  |   |       |   |  |   |          |   |  |   |       |  
|----------------------------------------- |  | ---------------------------------------- | ------- | ---- |  | ---- | ----- | --- |  | - | ------- | --- |  | - | ----- | - |  | - | -------- | - |  | - | ----- | -
|                                          |  |                                         
|                                          |  | Year Ended December 31,                 
|                                          |  |                                         
|                                          |  |                                          |         |      |  |     
|                                          |  | 2003                                     |         | 2002 |  | 2001
|                                          |  |                                          |         |      |  |     
|                                          |  | $                                        |         | EPS  |  | $    |       | EPS |  | $ |         | EPS
|                                          |  |                                          |         |      |  |      |       |     |  |   |         |    
|                                          |  |                                         
|                                          |  | (In thousands, except per share amounts)
|Reported loss before change in Accounting |  | $                                        | (30,894 | )    |  | $    | (0.74 | )   |  | $ | (12,268 | )   |  | $ | (0.30 | ) |  | $ | (295,231 | ) |  | $ | (7.48 | )
|Add back: Goodwill amortization           |  |                                          |        |      |  |      |      |     |  |   |        |     |  |   |      |   |  |   | 47,770   |   |  |   | 1.21  |  
|                                          |  |                                          |         |      |  |      |       |     |  |   |         |     |  |   |       |   |  |   |          |   |  |   |       |  
|Adjusted loss before change in accounting |  | $                                        | (30,894 | )    |  | $    | (0.74 | )   |  | $ | (12,268 | )   |  | $ | (0.30 | ) |  | $ | (247,461 | ) |  | $ | (6.27 | )
|                                          |  |                                          |         |      |  |      |       |     |  |   |         |     |  |   |       |   |  |   |          |   |  |   |       |  
|Reported net loss                         |  | $                                        | (30,894 | )    |  | $    | (0.74 | )   |  | $ | (17,595 | )   |  | $ | (0.42 | ) |  | $ | (295,231 | ) |  | $ | (7.48 | )
|Add back: Goodwill amortization           |  |                                          |        |      |  |      |      |     |  |   |        |     |  |   |      |   |  |   | 47,770   |   |  |   | 1.21  |  
|                                          |  |                                          |         |      |  |      |       |     |  |   |         |     |  |   |       |   |  |   |          |   |  |   |       |  
|Adjusted net loss                         |  | $                                        | (30,894 | )    |  | $    | (0.74 | )   |  | $ | (17,595 | )   |  | $ | (0.42 | ) |  | $ | (247,461 | ) |  | $ | (6.27 | )
|                                          |  |                                          |         |      |  |      |       |     |  |   |         |     |  |   |       |   |  |   |          |   |  |   |       |  




Concurrently with the termination of its proposed
merger, the Company made a $6.0 million investment in Adexa
in June 2001. This investment represented approximately 3%
of the outstanding shares of Adexa. In the first quarter of
2002, the Company recorded a $4.7 million loss on its
investment in Adexa based on a review of Adexas financial
results and general market conditions. Also, in the third
quarter of 2002, the Company recorded a $371,000 loss on its
investment in Adexa based on a valuation determined by financing
completed by Adexa in July 2002. The Company concluded
after each of these reviews that there was an
other-than-temporary decline in the value of its investment in
Adexa.

52



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FREEMARKETS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Note 7.     Other
Current Liabilities

Other current liabilities consisted of the
following:

|                                           |  |                |        |      |  |   |        | 
|------------------------------------------ |  | -------------- | ------ | ---- |  | - | ------ | 
|                                           |  |               
|                                           |  | December 31,  
|                                           |  |               
|                                           |  | 2003           |        | 2002
|                                           |  |                |        |     
|                                           |  |               
|                                           |  | (In thousands)
|Deferred revenue                           |  | $              | 6,505  |      |  | $ | 6,027  | 
|Accrued payroll, operating and other taxes |  |                | 6,661  |      |  |   | 6,780  | 
|Other                                      |  |                | 5,854  |      |  |   | 8,801  | 
|                                           |  |                |        |      |  |   |        | 
|                                           |  | $              | 19,020 |      |  | $ | 21,608 | 
|                                           |  |                |        |      |  |   |        | 

Note 8.     Debt

Debt consisted of the following:

|              |                      |                |       |      |  |   |       |       | 
|------------- | -------------------- | -------------- | ----- | ---- |  | - | ----- | ----- | 
|              |                      |               
|              |                      | December 31,  
|              |                      |               
|              |                      | 2003           |       | 2002
|              |                      |                |       |     
|              |                      |               
|              |                      | (In thousands)
|(A) Term loan |                      | $              | 722   |      |  | $ | 2,556 |      
|(A) Revolver  |                      |                |      |      |  |   |      |      
|(B) MELF      |                      |                | 438   |      |  |   |      |      
|              | Other                |                |       |     |  |   |       | 274   | 
|              |                      |                |       |      |  |   |       |      
|              |                      |                | 1,160 |      |  |   | 2,830 |      
|              | Less current portion |                |       | 818  |  |   |       | 1,502 | 
|              |                      |                |       |      |  |   |       |      
|              |                      | $              | 342   |      |  | $ | 1,328 |      
|              |                      |                |       |      |  |   |       |      



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(A) | In October 2001, the Company entered into a
    third amendment to its bank credit facility agreement,
    consisting of a one-year Revolving Credit Facility with a
    maximum principal amount of $20.0 million and a
    $4.0 million Term Loan to be paid in 36 monthly
    installments. Proceeds from the Term Loan were used to retire
    the $3.7 million outstanding under the old Revolving Credit
    Facility. In October 2002 and December 2002, the
    Company entered into a fourth and fifth amendment, respectively,
    which extended the maturity date of the Revolving Credit
    Facility through December 2002 and February 2003,
    respectively. The Company entered into the sixth amendment to
    the Revolving Credit facility in February 2003, which
    reduced the availability under the revolving credit facility
    from $20.0 million to $15.0 million and extended the
    maturity date through February 2004. In December 2003,
    the Company entered into the seventh amendment, which modified
    the financial covenant on minimum earnings to exclude
    non-recurring restructuring charges relating to its facilities
    reduction plan and the European Restructuring Plan for the
    quarter ended December 31, 2003. Funds borrowed under the
    line of credit may be used for working capital requirements and
    general corporate purposes. At December 31, 2003,
    $11.3 million was available under the Revolving Credit
    Facility based on eligible accounts receivable, which is reduced
    by $771,000 in outstanding letters of credit. The Revolving
    Credit Facility bears interest at the lenders prime rate,
    which was 4.0% at December 31, 2003. The Term Loan bears
    interest at the lenders prime rate +0.50%.



|    |                                                                                                                                                                                                                                                                                                  
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(B) | In March 2003, the Company entered into a loan
    agreement (MELF) with the Commonwealth of
    Pennsylvania, acting by and through the Department of Community
    and Economic Development. Proceeds from the loan agreement in
    the amount of $500,000 were for the purchase of computer

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FREEMARKETS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)



| |                                                                                                          
| | ---------------------------------------------------------------------------------------------------------
| | equipment. Repayments under the MELF are made
    monthly through April 2008 at an interest rate of 3.0%.

The Revolving Credit Facility and the Term Loan
contain restrictive covenants, including a limitation on
incurring additional indebtedness and paying dividends. The
Company is also required to satisfy monthly minimum tangible net
worth, minimum earnings and minimum quick ratios, as defined in
the underlying agreement. The Company has pledged substantially
all of its tangible assets as collateral for the Revolving
Credit Facility.

Interest expense was $102,000 in 2003, $228,000
in 2002 and $300,000 in 2001. The weighted average interest rate
was 5.2% in 2003, 6.6% in 2002 and 6.9% in 2001.

Scheduled maturities of debt for each of the
years ending December 31 are as follows (in thousands):

|     |  |   |       | 
|---- |  | - | ----- | 
|2004 |  | $ | 818   | 
|2005 |  |   | 99    | 
|2006 |  |   | 102   | 
|2007 |  |   | 105   | 
|2008 |  |   | 36    | 
|     |  |   |       | 
|     |  | $ | 1,160 | 
|     |  |   |       | 

Note 9.     Commitments
and Contingencies

The Company leases office space and equipment
under operating leases expiring through 2010. In
October 1998, the Company entered into an Office Lease
Agreement (the Lease), as amended in March and
June 1999 and March 2000, that significantly expanded
the Companys office space within the City of Pittsburgh,
Pennsylvania. The Lease, which currently provides for 182,000
square feet and the option for additional expansion within the
same building, expires in May 2010.

Operating lease rental expense amounted to
$7.0 million in 2003, $7.3 million in 2002 and
$7.5 million in 2001. The following is a schedule of future
minimum lease payments under all operating leases through
December 31 of each of the following years (in thousands):

|           |  |   |        | 
|---------- |  | - | ------ | 
|2004       |  | $ | 6,741  | 
|2005       |  |   | 6,164  | 
|2006       |  |   | 5,083  | 
|2007       |  |   | 5,024  | 
|2008       |  |   | 5,152  | 
|Thereafter |  |   | 7,518  | 
|           |  |   |        | 
|           |  | $ | 35,682 | 
|           |  |   |        | 




Since April 27, 2001, eleven securities
fraud class action complaints have been filed against the
Company and two executive officers in federal court in
Pittsburgh, Pennsylvania. The complaints, all of which assert
the same claims, stem from the Companys announcement on
April 23, 2001 that, as a result of discussions with the
SEC, the Company was considering amending its 2000 financial
statements for the purpose of reclassifying fees earned by the
Company under a service contract with Visteon. All of the cases
have been consolidated into a single proceeding. On
October 30, 2001, the Company filed a motion seeking to
dismiss all of the cases in their entirety. On January 17,
2003, the Court denied the motion to dismiss. On March 10,
2004, the Court certified the case as a class action. The case
is now in the discovery phase. In addition, on
September 24, 2001, an individual claiming to be a
FreeMarkets




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FREEMARKETS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

shareholder filed a shareholders derivative
action, nominally on behalf of FreeMarkets, against all of the
Companys directors and certain of its executive officers.
FreeMarkets is also named as a nominal defendant. The suit is
based on the same facts alleged in the foregoing securities
fraud class actions. The Company believes that the
plaintiffs allegations are without merit and it intends to
defend these claims vigorously.

Since July 31, 2001, several securities
fraud class action complaints have been filed in the United
States District Court for the Southern District of New York
alleging violations of the securities laws in connection with
the Companys December 1999 initial public offering
(IPO). In four of the complaints, the Company and
certain of its officers are named as defendants, together with
the underwriters that are the subject of the plaintiffs
allegations. Each of these cases has been consolidated for
pretrial purposes into an earlier lawsuit against the
underwriters of the Companys IPO. In addition, the cases
have been consolidated for pretrial purposes with approximately
1,000 other lawsuits filed against other issuers, their
officers, and underwriters of their initial public offerings. On
April 19, 2002, a consolidated amended class action
complaint (the Consolidated Complaint) was filed.
The Consolidated Complaint alleges claims against the Company
and seven of its officers and/or directors, as well as seven
investment banking firms who either served as underwriters or
are successors in interest to underwriters of the Companys
IPO. The Consolidated Complaint alleges that the prospectus used
in the Companys IPO contained material misstatements or
omissions regarding the underwriters allocation practices
and compensation in connection with the IPO and also alleges
that the underwriters manipulated the aftermarket for the
Companys stock. Damages in an unspecified amount are
sought, together with interest, costs and attorneys fees.
The defendants filed a motion to dismiss the Consolidated
Complaint. On February 19, 2003, the court denied the
Companys motion to dismiss. On June 25, 2003, a
Special Committee of the Board of Directors of the company
approved a proposed settlement of the litigation under terms set
forth in a memorandum of understanding, and authorized the
Company to enter into a definitive settlement agreement to be
prepared in accordance with the memorandum of understanding. The
anticipated settlement will be subject to court approval
following notice to class members and a fairness hearing. Based
on the memorandum of understanding, the Company believes that
the anticipated settlement will have no material effect on the
Company.

The Company is also subject to various other
legal proceedings and claims, either asserted or unasserted,
which arise in the ordinary course of business. While the
outcome of these claims cannot be predicted with certainty,
management does not believe that the outcome of any of these
legal matters will have a material adverse effect on the
Companys consolidated results of operations or financial
position.

Note 10.     Income
Taxes

The provision for income taxes consisted of the
following:

|        |  |                |       |      |  |      |     |  |  |   |     | 
|------- |  | -------------- | ----- | ---- |  | ---- | --- |  |  | - | --- | 
|        |  |               
|        |  | December 31,  
|        |  |               
|        |  | 2003           |       | 2002 |  | 2001
|        |  |                |       |      |  |     
|        |  |               
|        |  | (In thousands)
|Foreign |  | $              | 1,188 |      |  | $    | 712 |  |  | $ | 782 | 

There has been no provision for U.S. federal
or state income taxes as the Company has incurred a net taxable
loss in each of these periods. The Company recorded foreign
income tax provisions relating to taxes withheld from customer
payments and remitted to foreign taxing jurisdictions on the
Companys behalf, as well as income taxes generated in
certain foreign jurisdictions.

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FREEMARKETS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Deferred income taxes reflect the net tax effects
of temporary differences between the carrying amounts of assets
and liabilities for financial reporting purposes and the amounts
used for income tax purposes. Significant components of the
Companys deferred tax assets are as follows:

|                                                  |                          |                |        |         |   |   |        |         |  
|------------------------------------------------- | ------------------------ | -------------- | ------ | ------- | - | - | ------ | ------- | -
|                                                  |                          |               
|                                                  |                          | December 31,  
|                                                  |                          |               
|                                                  |                          | 2003           |        | 2002   
|                                                  |                          |                |        |        
|                                                  |                          |               
|                                                  |                          | (In thousands)
|Net operating losses                              |                          | $              | 58,475 |         |   | $ | 58,125 |        
|Capitalized research and experimentation costs    |                          |                | 8,334  |         |   |   | 9,608  |        
|Accrued expenses                                  |                          |                | 2,535  |         |   |   | 2,810  |        
|Accrued restructuring charges                     |                          |                | 2,832  |         |   |   |       |        
|Goodwill                                          |                          |                | 4,490  |         |   |   | 4,963  |        
|Research and experimentation credit carryforwards |                          |                | 4,692  |         |   |   | 3,546  |        
|Depreciation                                      |                          |                | 5,655  |         |   |   | 4,655  |        
|Capital loss carryforward                         |                          |                | 2,160  |         |   |   | 2,044  |        
|Deferred stock-based expense                      |                          |                | 631    |         |   |   | 600    |        
|Other                                             |                          |                | 3,414  |         |   |   | 1,948  |        
|                                                  |                          |                |        |         |   |   |        |        
|                                                  | Net deferred tax assets  |                |        | 93,218  |   |   |        | 88,299  |  
|                                                  | Less valuation allowance |                |        | (93,218 | ) |   |        | (88,299 | )
|                                                  |                          |                |        |         |   |   |        |        
|                                                  |                          | $              |       |         |   | $ |       |        
|                                                  |                          |                |        |         |   |   |        |        

The realization of deferred tax assets is
dependent upon future earnings, if any, while the timing and
amount of which are uncertain. Accordingly, the net deferred tax
assets have been fully offset by a valuation allowance. The
valuation allowance increased by approximately $4.9 million
during 2003.

As of December 31, 2003, the Company had net
operating loss carryforwards for federal and state income tax
purposes of approximately $146.2 million, which will expire
beginning in years 2010 and 2005, respectively. Included in the
deferred tax asset related to net operating loss carryforwards
is a tax benefit attributable to employee stock options of
approximately $21.1 million at December 31, 2003,
which, when realized, will be a credit to additional capital. In
addition, the Company had federal tax credit carryforwards of
approximately $4.7 million, which expire beginning 2010.

Utilization of the Companys net operating
loss and tax credit carryforwards may be subject to a
substantial annual limitation due to the ownership change
limitations imposed by Internal Revenue Code Section 382
and similar state provisions. Such an annual limitation could
result in the expiration of the net operating loss and tax
credit carryforwards before utilization.

Note 11.     Stockholders
Equity

The following is a summary of share activity for
all classes of stock:

|                                 |                                                |        |        |                |  |  |       |      |  
|-------------------------------- | ---------------------------------------------- | ------ | ------ | -------------- |  |  | ----- | ---- | -
|                                 |                                                | Common |        | Stock Purchase
|                                 |                                                | Stock  |        | Warrants      
|                                 |                                                |        |        |               
|Outstanding at December 31, 2000 |                                                |        | 38,788 |                |  |  | 1,750 |     
|                                 | Shares issued to Mitsubishi                    |        |        | 194            |  |  |       |     |  
|                                 | Shares issued for Employee Stock Purchase Plan |        |        | 227            |  |  |       |     |  
|                                 | Stock purchase warrants exercised by Visteon   |        |        | 350            |  |  |       | (350 | )
|                                 | Options exercised by employees                 |        |        | 1,172          |  |  |       |     |  
|                                 |                                                |        |        |                |  |  |       |     

56



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FREEMARKETS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

|                                 |                                                |        |        |                |   |  |       |   | 
|-------------------------------- | ---------------------------------------------- | ------ | ------ | -------------- | - |  | ----- | - | 
|                                 |                                                | Common |        | Stock Purchase
|                                 |                                                | Stock  |        | Warrants      
|                                 |                                                |        |        |               
|Outstanding at December 31, 2001 |                                                |        | 40,731 |                |   |  | 1,400 |  
|                                 | Shares issued for Employee Stock Purchase Plan |        |        | 337            |   |  |       |  | 
|                                 | Options exercised by employees                 |        |        | 1,308          |   |  |       |  | 
|                                 |                                                |        |        |                |   |  |       |  
|Outstanding at December 31, 2002 |                                                |        | 42,376 |                |   |  | 1,400 |  
|                                 | Shares purchased and retired                   |        |        | (1,299         | ) |  |       |  | 
|                                 | Shares issued for Employee Stock Purchase Plan |        |        | 390            |   |  |       |  | 
|                                 | Options exercised by employees                 |        |        | 870            |   |  |       |  | 
|                                 |                                                |        |        |                |   |  |       |  
|Outstanding at December 31, 2003 |                                                |        | 42,337 |                |   |  | 1,400 |  
|                                 |                                                |        |        |                |   |  |       |  



| |                
| | ---------------
| | Preferred Stock

The Companys Board of Directors has the
authority, without further action by the stockholders, to issue
up to 5.0 million shares of preferred stock in one or more
series and to designate the rights, preferences, privileges and
restrictions of each series.

In March 2003, the Board of Directors declared a
dividend of one right (collectively, Rights) to
purchase one one-hundredth of a share of a newly created class
of Series A Junior Participating Preferred Stock
(Series A Preferred Stock), payable to
stockholders of record at the close of business on
March 11, 2003. The Rights will not be exercisable until
10 days after the public announcement that a person or
group has become an Acquiring Person by obtaining
beneficial ownership of 15% or more of the Companys
outstanding common stock, or, if earlier, 10 business days
(or a later date determined by the Board before any person or
group becomes an Acquiring Person) after a person or group
begins a tender or exchange offer which, if consummated, would
result in that person or group becoming an Acquiring Person.
Each Right entitles the holder, upon certain specified events,
to purchase, at an exercise price of $42.00 per Right (subject
to adjustment), shares of common stock of the Company or an
Acquiring Person having a value equal to two times the exercise
price of the Right.



| |             
| | ------------
| | Common Stock

In December 2001, the Company sold
194,000 shares of common stock to Mitsubishi Corporation at
a price of $15.46 per share (based on the average of the
closing prices of our common stock over the 20 trading days
prior to the sale) for a total purchase price of
$3.0 million.

In January 2003, the Board of Directors of the
Company authorized the repurchase of up to an aggregate of 15%
of the Companys outstanding common stock from time to time
on the open market or in one or more negotiated transactions. In
2003, the Company purchased and retired 1,298,500 shares at
a weighted average share price of $4.93.



| |                        
| | -----------------------
| | Stock Purchase Warrants

In April 2000, the Company entered into a
five-year service contract with Visteon. Under the terms of the
contract, Visteon pays the Company a fixed monthly fee for
access to the Companys sourcing technology and services,
and may pay the Company variable fees if specified volume
thresholds are exceeded. At the time the Company entered into
the service contract, the Company granted a warrant to Visteon,
with an exercise price of $.01 per share, to purchase
1.75 million shares of the Companys common stock. The
Company receives ongoing marketing and public relations benefits
as a result of its relationship with Visteon. The warrant was
valued at $95.5 million using the Black-Scholes pricing
model. This value is being amortized on a straight-line basis
over the five-year term of the contract, of which

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FREEMARKETS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

$19.1 million was amortized in each of 2003,
2002 and 2001. This amortization has been reclassified as a
reduction to revenues to the extent of the $12.4 million,
$11.3 million and $11.3 million in fees earned from
Visteon in 2003, 2002 and 2001, respectively, and the remaining
$6.7 million, $7.8 million and $7.8 million as
stock compensation and warrant costs in 2003, 2002 and 2001,
respectively. Visteon exercised 350,000 warrants in July 2001,
resulting in total proceeds of $3,000 and a $19.1 million
transfer from stock purchase warrants to additional capital.



| |                                           
| | ------------------------------------------
| | Accumulated Other Comprehensive
    (Loss)

The following is a summary of the components of
accumulated other comprehensive income (loss), net of income
taxes:

|                                                     |  |                |     |      |  |      |     |   |  |   |     | 
|---------------------------------------------------- |  | -------------- | --- | ---- |  | ---- | --- | - |  | - | --- | 
|                                                     |  |               
|                                                     |  | December 31,  
|                                                     |  |               
|                                                     |  | 2003           |     | 2002 |  | 2001
|                                                     |  |                |     |      |  |     
|                                                     |  |               
|                                                     |  | (In thousands)
|Foreign currency translation adjustments             |  | $              | 301 |      |  | $    | (49 | ) |  | $ | 354 | 
|Unrealized (loss) gain on marketable
    investments |  |                | (81 | )    |  |      | 48  |   |  |   | 197 | 
|                                                     |  |                |     |      |  |      |     |   |  |   |     | 
|                                                     |  | $              | 220 |      |  | $    | (1  | ) |  | $ | 551 | 
|                                                     |  |                |     |      |  |      |     |   |  |   |     | 

Note 12.     Employee
Benefit Plans



| |                    
| | -------------------
| | 401(k) Savings Plan

The Company maintains a savings plan (the
Savings Plan) that qualifies as a deferred salary
arrangement under Section 401(k) of the Internal Revenue
Code. Under the Savings Plan, eligible employees may contribute
a certain percentage of their pre-tax earnings up to the annual
limit set by the Internal Revenue Service. The Company is not
required to contribute to the Savings Plan, and prior to 2002
had made no contributions since its inception. In each of 2003
and 2002, the Company expensed approximately $500,000 as a
discretionary contribution to the Plan. The Companys
contributions to the Savings Plan vest 100% upon completion of
one year of service. The current investment options under the
Savings Plan do not include the Companys common stock.



| |                             
| | ----------------------------
| | Employee Stock Purchase Plan

The Company maintains an employee stock purchase
plan (ESPP), under which 500,000 shares were
initially reserved for issuance. The number of shares reserved
under the ESPP automatically increases on January 1 each year by
the number of shares purchased under the ESPP the preceding
year, provided that the aggregate number of shares reserved
under the ESPP does not exceed 2,000,000 shares. The ESPP
is intended to qualify under Section 423 of the Internal
Revenue Code. Under the ESPP, eligible employees may purchase
common stock each year in an amount not to exceed 20% of the
employees annual cash compensation. The purchase price per
share is 85% of the lowest fair value at certain dates defined
in the ESPP. The Company issued approximately 390,000, 337,000
and 227,000 shares of common stock in 2003, 2002 and 2001,
respectively, under the ESPP.



| |                   
| | ------------------
| | Stock Option Plans

Prior to March 1998, the Company maintained a
stock incentive plan (the 1996 Option Plan), which
provided for the issuance of stock options and stock
appreciation rights to employees. Under the 1996 Option Plan,
options were granted at prices determined by the Board of
Directors. The options granted are exercisable in accordance
with a vesting schedule, not to exceed 10 years. No further
stock options may be granted under the 1996 Option Plan.

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FREEMARKETS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

In March 1998, the Company adopted the 1998 Stock
Option Plan (the 1998 Option Plan). All available
options in the 1996 Option Plan were transferred into the 1998
Option Plan. All options outstanding under the 1996 Option Plan
as of the termination date continue in effect under their
original terms. The 1998 Option Plan provides for the issuance
of stock options to employees, directors, consultants and
advisors, which are granted at prices determined by the Board of
Directors. The options granted are exercisable in accordance
with a vesting schedule, not to exceed 10 years. Options
held by certain executives immediately vested 30% in connection
with the IPO.

In June 1999, the Company adopted an Amended
and Restated Stock Incentive Plan (the Stock Incentive
Plan). The Stock Incentive Plan amended the 1998 Option
Plan to increase the amount of shares reserved for the future
issuance of stock options and added certain change-of-control
provisions, as well as made other minor modifications. In
January 2001, the Companys Board of Directors amended
and restated the Stock Incentive Plan to eliminate certain
change-of-control provisions. The amendment did not affect
options previously granted under the plan.

In May 2001, the Board adopted the 2001
Broad Based Equity Incentive Plan (the 2001 Option
Plan). The 2001 Option Plan provides for the issuance of
stock options to employees who are not directors or officers of
the Company.

As of December 31, 2003, a total of
21.6 million stock options were authorized under all of the
Companys stock option plans, of which 13.1 million
were outstanding and 2.6 million remained available for
future grants.

The following is a summary of stock option
activity:

|                                           |           |            |        |                  |   |  |       |       | 
|------------------------------------------ | --------- | ---------- | ------ | ---------------- | - |  | ----- | ----- | 
|                                           |           | Number     |        | Weighted Average
|                                           |           | of Options |        | Exercise Price  
|                                           |           |            |        |                 
|Outstanding at December 31, 2000           |           |            | 10,605 |                  |   |  | 17.36 |      
|                                           | Granted   |            |        | 5,262            |   |  |       | 16.87 | 
|                                           | Forfeited |            |        | (2,271           | ) |  |       | 34.99 | 
|                                           | Exercised |            |        | (1,169           | ) |  |       | 2.21  | 
|                                           |           |            |        |                  |   |  |       |      
|Outstanding at December 31, 2001           |           |            | 12,427 |                  |   |  | 14.90 |      
|                                           | Granted   |            |        | 1,250            |   |  |       | 12.59 | 
|                                           | Forfeited |            |        | (1,427           | ) |  |       | 17.97 | 
|                                           | Exercised |            |        | (1,308           | ) |  |       | 2.79  | 
|                                           |           |            |        |                  |   |  |       |      
|Outstanding at December 31, 2002           |           |            | 10,942 |                  |   |  | 15.67 |      
|                                           | Granted   |            |        | 5,046            |   |  |       | 4.37  | 
|                                           | Forfeited |            |        | (1,971           | ) |  |       | 13.19 | 
|                                           | Exercised |            |        | (870             | ) |  |       | 2.81  | 
|                                           |           |            |        |                  |   |  |       |      
|Outstanding at December 31, 2003           |           |            | 13,147 |                  |   |  | 12.55 |      
|                                           |           |            |        |                  |   |  |       |      
|Shares exercisable as of December 31, 2003 |           |            | 6,615  |                  |   |  | 15.04 |      
|                                           |           |            |        |                  |   |  |       |      

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FREEMARKETS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

The following is a summary of the options
outstanding as of December 31, 2003 (in thousands):

|                                                           |  |         |            |         |  |         |       |         |  |         |             |         |  |       |              |  |  |   |              |  |  |   |               |  |  |   |              | 
|---------------------------------------------------------- |  | ------- | ---------- | ------- |  | ------- | ----- | ------- |  | ------- | ----------- | ------- |  | ----- | ------------ |  |  | - | ------------ |  |  | - | ------------- |  |  | - | ------------ | 
|                                                           |  | Range 1 |            | Range 2 |  | Range 3 |       | Range 4 |  | Range 5 |             | Range 6 |  | Total
|                                                           |  |         |            |         |  |         |       |         |  |         |             |         |  |      
|Range of exercise Prices                                   |  | $       | 0.54-$2.50 |         |  | $       | 4.03  |         |  | $       | 4.04-$12.50 |         |  | $     | 12.80-$14.80 |  |  | $ | 14.85-$19.75 |  |  | $ | 19.88-$234.25 |  |  | $ | 0.54-$234.25 | 
|Weighted average exercise price                            |  |         | 1.15       |         |  |         | 4.03  |         |  |         | 8.06        |         |  |       | 14.09        |  |  |   | 18.88        |  |  |   | 47.47         |  |  |   | 12.55        | 
|Weighted average remaining contractual life (in
    years) |  |         | 4.5        |         |  |         | 9.1   |         |  |         | 7.8         |         |  |       | 6.1          |  |  |   | 6.9          |  |  |   | 6.6           |  |  |   | 7.1          | 
|Exercisable                                                |  |         | 1,237      |         |  |         | 498   |         |  |         | 714         |         |  |       | 1,670        |  |  |   | 1,858        |  |  |   | 638           |  |  |   | 6,615        | 
|Outstanding                                                |  |         | 1,568      |         |  |         | 3,493 |         |  |         | 2,040       |         |  |       | 2,773        |  |  |   | 2,156        |  |  |   | 1,117         |  |  |   | 13,147       | 

All options were granted at exercise prices
determined by the Board of Directors. In 1999, the Company
recorded $2.0 million of unearned stock compensation
related to employee stock option grants with exercise prices
lower than the deemed fair value of the underlying shares at the
time of grant, of which $80,000, $150,000 and $253,000 was
amortized in 2003, 2002 and 2001, respectively.

In July 2001, the Company offered option
holders who were current employees (excluding the Board of
Directors, executive officers and employees located outside of
the United States) the opportunity to exchange outstanding
options with an exercise price of $20.00 per share or more for
new options. The number of shares subject to new options would
be determined by application of an exchange ratio based upon the
exercise price of the options. The offer expired on
August 3, 2001. The exchange resulted in the voluntary
cancellation of employee stock options to purchase 181,000
shares of common stock in exchange for the granting of 37,000
employee stock options in February 2002 with an exercise
price of $21.62, which was the fair market value of the
Companys common stock on the grant date. There was no
compensation expense recorded as a result of this exchange.




Note 13.     Selected
Quarterly Financial Data (unaudited)




The Companys quarterly results for 2003 and
2002 are as follows:

|                    |                   |                                          |         |         |   |         |        |         |   |       |        |       |   |   |        |       |   |   |         |       |  
|------------------- | ----------------- | ---------------------------------------- | ------- | ------- | - | ------- | ------ | ------- | - | ----- | ------ | ----- | - | - | ------ | ----- | - | - | ------- | ----- | -
|                    |                   | First                                    |         | Second  |   | Third   |        | Fourth  |   |      
|2003:               |                   | Quarter                                  |         | Quarter |   | Quarter |        | Quarter |   | Total
|                    |                   |                                          |         |         |   |         |        |         |   |      
|                    |                   |                                         
|                    |                   | (In thousands, except per share amounts)
|Revenues            |                   | $                                        | 34,520  |         |   | $       | 34,633 |         |   | $     | 36,022 |       |   | $ | 33,541 |       |   | $ | 138,716 |      
|Net loss            |                   |                                          | (11,799 | )       |   |         | (5,963 | )       |   |       | (4,554 | )     |   |   | (8,578 | )     |   |   | (30,894 | )    
|Earnings per share: |                   |                                          |         |         |   |         |        |         |   |       |        |       |   |   |        |       |   |   |         |      
|                    | Basic and diluted |                                          |         | (0.28   | ) |         |        | (0.14   | ) |       |        | (0.11 | ) |   |        | (0.20 | ) |   |         | (0.74 | )

|                                     |                                               |                                          |         |         |   |         |        |         |   |       |        |       |   |   |        |       |   |   |         |       |  
|------------------------------------ | --------------------------------------------- | ---------------------------------------- | ------- | ------- | - | ------- | ------ | ------- | - | ----- | ------ | ----- | - | - | ------ | ----- | - | - | ------- | ----- | -
|                                     |                                               | First                                    |         | Second  |   | Third   |        | Fourth  |   |      
|2002:                                |                                               | Quarter                                  |         | Quarter |   | Quarter |        | Quarter |   | Total
|                                     |                                               |                                          |         |         |   |         |        |         |   |      
|                                     |                                               |                                         
|                                     |                                               | (In thousands, except per share amounts)
|Revenues                             |                                               | $                                        | 43,173  |         |   | $       | 44,604 |         |   | $     | 40,388 |       |   | $ | 42,276 |       |   | $ | 170,441 |      
|Net loss before change in accounting |                                               |                                          | (6,191  | )       |   |         | (87    | )       |   |       | (3,024 | )     |   |   | (2,966 | )     |   |   | (12,268 | )    
|Net loss after change in accounting  |                                               |                                          | (11,518 | )       |   |         | (87    | )       |   |       | (3,024 | )     |   |   | (2,966 | )     |   |   | (17,595 | )    
|Earnings per share:                  |                                               |                                          |         |         |   |         |        |         |   |       |        |       |   |   |        |       |   |   |         |      
|                                     | Basic and diluted before change in accounting |                                          |         | (0.15   | ) |         |        | (0.00   | ) |       |        | (0.07 | ) |   |        | (0.07 | ) |   |         | (0.30 | )
|                                     | Basic and diluted after change in accounting  |                                          |         | (0.28   | ) |         |        | (0.00   | ) |       |        | (0.07 | ) |   |        | (0.07 | ) |   |         | (0.42 | )

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FREEMARKETS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)




Note 14.     Subsequent
Events




In January 2004, the Company announced a
definitive agreement to merge with Ariba, Inc.
(Ariba), a provider of Enterprise Spend Management
products and services. Under terms of the agreement,
shareholders of the Companys common stock will receive
2.25 Ariba common shares and $2.00 in cash for each
outstanding share of FreeMarkets. The transaction is subject to
customary closing conditions, including regulatory review and
approval by the stockholders of each company, and is expected to
close in the latter part of the second quarter.




Also, in January 2004, the Company acquired
the auction and services business of Covisint, an independent
e-business service provider for the global automotive industry,
for $16.3 million.







Also in January 2004, the Company executed a
restructuring plan resulting in the elimination of 65 positions
in its global workforce. Additionally, in February 2004,
the Company evaluated its office space in Pittsburgh,
Pennsylvania, and determined that it will cease using one of the
floors it currently leases in its global headquarters, as well
as closed two domestic offices. In accordance with SFAS
No. 146, the Company will record a restructuring charge of
approximately $4.4 million in the first quarter of 2004,
covering these severance and lease costs.




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|        |                                                                                         
|------- | ----------------------------------------------------------------------------------------
|Item 9. | Changes in and Disagreements with
    Accountants on Accounting and Financial Disclosure

Not applicable.






|         |                        
|-------- | -----------------------
|Item 9A. | Controls and Procedures

As of the end of the period covered by this
report, the Company carried out an evaluation, under the
supervision and with the participation of the Companys
management, including the Chief Executive Officer and the acting
Chief Financial Officer, of the effectiveness of the
Companys disclosure controls and procedures. Based on that
evaluation, the Chief Executive Officer and acting Chief
Financial Officer concluded that the Companys disclosure
controls and procedures as of the end of the period covered by
this report have been designed and are functioning effectively
to provide reasonable assurance that the information required to
be disclosed by the Company in reports filed under the
Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in the
SECs rules and forms. A controls system, no matter how
well designed and operated, cannot provide absolute assurance
that the objectives of the controls systems are met, and no
evaluation of controls can provide absolute assurance that all
control issues and instances of fraud, if any, within a company
have been detected.

No change in the Companys internal control
over financial reporting occurred during the Companys most
recent fiscal quarter that has materially affected or is
reasonable likely to materially affect, the Companys
internal control over financial reporting.







PART III












|         |                                                       
|-------- | ------------------------------------------------------
|Item 10. | Directors and Executive Officers of the
    Registrant







Glen T. Meakemco-founded FreeMarkets in 1995 and has
served as its Chairman of the Board of Directors and a director
since inception. Mr. Meakem also held the offices of
President and Chief Executive Officer from FreeMarkets
inception until June 2000 and January 2003, respectively. Prior
to co-founding FreeMarkets, from May 1994 to February 1995,
Mr. Meakem was employed as a manager in the Corporate
Business Development Group of General Electric Co. From January
1992 through April 1994, he was employed as a consultant with
McKinsey & Company. Mr. Meakem earned his B.A
degree cum laude from Harvard College and his M.B.A. from
Harvard Business School. Age 40







David H. McCormickhas served as President and Director
since October 2002 and as Chief Executive Officer since January
2003. Before becoming President, Mr. McCormick served as an
Executive Vice President since May 2001, as Senior Vice
President and General Manager of Core Business Markets since
June 2000 and as Vice President and General Manager of Core
Business Markets since December 1999. Prior to joining
FreeMarkets, Mr. McCormick was a consultant with
McKinsey & Company, Inc. Mr. McCormick holds a
B.S. in Mechanical Engineering from the United States Military
Academy and a Ph.D. in Public and International Affairs from
Princeton University. Age 38







Sean M. Rollmanhas
served as Vice President, Treasurer and acting Chief Financial
Officer since October 2003 and as Controller since January 2000.
Before becoming Controller, Mr. Rollman served as Manager
of Financial Planning and Assistant Controller since April 1998.
Prior to joining FreeMarkets, from 1992 to 1998,
Mr. Rollman worked for Coopers & Lybrand as a
Manager in Assurance Services serving clients in the technology
and real estate industries. Mr. Rollman holds a B.S. in
Accounting and Economics from Indiana University of
Pennsylvania. Age 34







Jared Cohonhas
served as a member of the FreeMarkets Board since 2003.
Dr. Cohon was elected president of Carnegie Mellon
University in 1997 and was also appointed Professor of Civil and
Environmental Engineering and Professor of Engineering and
Public Policy. Prior to joining Carnegie Mellon, Dr. Cohon
was Dean and Professor of Environmental Systems Analysis in the
School of Forestry and Environmental Studies at Yale University.
Previously, he was a professor of Geography and Environmental
Engineering at John Hopkins University, where he also served as
Vice Provost for Research




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from 1986 to 1992, Associate Dean of Engineering
from 1983 to 1986, and Assistant Dean of Engineering from 1981
to 1983. Dr. Cohon was appointed chairman of the Nuclear
Waste Technical Review Board by President Clinton in 1997 and
served in that capacity until 2002. He also served as
Legislative Assistant for Energy and Environment on the staff of
U.S. Senator Moynihan from 1977 to 1978. President George W.
Bush appointed him in 2002 to serve on the Homeland Security
Advisory Council. He is a director of Mellon Financial Services
Corporation and American Standard Corporation. Dr. Cohon
earned his B.S. in Civil Engineering from the University of
Pennsylvania, and his Masters and Ph.D. in Civil Engineering
from the Massachusetts Institute of Technology. Age 56








Thomas J. Gillhas
served as a member of the FreeMarkets Board since 2003.
Mr. Gill has been the Managing Partner of G4 Partners, LLC,
a private investment management firm since May 2000 and is also
Chairman and Director of Helium Networks, Inc., a wireless data
solutions provider. From January 1998 until November 1999,
Mr. Gill served as a director and President and Chief
Executive Officer of FORE Systems, Inc., a developer and
manufacturer of high-speed networking equipment, which was
acquired by GEC, p.l.c., now called Marconi Communications. He
served as FORE Systems Chief Operating Officer from
January 1997 to January 1998 and as its Vice President of
Finance, Chief Financial Officer and Treasurer from December
1993 to January 1998. Mr. Gill received his B.S. in
Business Administration from the University of Pittsburgh.
Age 45







Raymond J. Lanehas
served as a member of the FreeMarkets Board since 2001.
Mr. Lane has been a General Partner of Kleiner Perkins
Caufield & Byers (a private venture firm) since 2000.
Prior to joining Kleiner Perkins Caufield & Byers,
Mr. Lane was President and Chief Operating Officer of
Oracle Corporation (an enterprise software and services company)
from 1996 to 2000, and was Executive Vice President of Oracle
and President of Worldwide Operations from 1993 to 1996.
Mr. Lane serves as a Director of SeeBeyond Technology
Corporation, Marimba, Quest Software and several private
portfolio companies. Mr. Lane received his B.S. degree in
Mathematics from West Virginia University. Age 57.







Thomas J. Meredithhas served as a member of the
FreeMarkets Board since 1999. Mr. Meredith is the Chief
Executive Officer of MFI Capital (the Meredith familys
private investment firm). He served as the Managing Director of
Dell Ventures and Senior Vice President of Business Development
and Strategy for Dell Computer Corporation from 2000 to 2001 and
was Senior Vice President and Chief Financial Officer for Dell
from 1992 to 2000. Mr. Meredith is a Director of several
private portfolio companies. Mr. Meredith received his
Master of Law degree in Taxation from Georgetown University, his
Juris Doctor degree from Duquesne University School of Law and
his Bachelors degree in political science from
St. Francis College. Age 53







Karl Newkirkhas
served as a member of the FreeMarkets Board since 2003. From
June 1963 to December 2001, Mr. Newkirk was employed at
Accenture, Ltd (formerly known as Andersen Consulting), where he
was a partner from 1972 until July 2001, the time that Andersen
Consulting became a public company. Mr. Newkirk held a
number of leadership roles throughout his career at Accenture,
most recently serving as the Managing Partner of the Global ERP
practice and of the Microsoft Alliance. He also serves as a
director of I-Many, Inc. and SeeBeyond Technology Corporation.
Mr. Newkirk holds an undergraduate degree in industrial
engineering from Case Institute of Technology, and an M.B.A.
from Case Western Reserve University. Age 63







Section 16 Reporting Compliance







Section 16(a) of the Securities Exchange Act
of 1934, as amended, requires our directors and executive
officers and persons who own more than ten percent of a
registered class of our equity securities to file with the SEC
within specified due dates reports of ownership and reports of
changes in ownership of the Common Stock and our other equity
securities. These persons are required by SEC regulations to
furnish us with copies of all Section 16(a) reports they
file. Based on reports and written representations furnished to
us by these persons, we believe that all of our directors and
executive officers complied with these filing requirements in
2003, except for: Mr. Meakem who filed late one Form 4
with respect to the grant of 100,000 options on
January 28th; Mr. McCormick who filed late one
Form 4 with respect to the




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grant of 600,000 options on January 28th;
Mr. Becker who filed late one Form 4 with respect to
the grant of 150,000 options on January 28th;
Ms. Hooper who filed late one Form 4 with respect to
the grant of 300,000 options on January 28th; Mr. Lane
who filed late one Form 4 with respect to the grant of
100,000 options on January 28th; Mr. Meredith who
filed late one Form 4 with respect to the grant of 100,000
options on January 28th and Mr. Newkirk who filed late
one Form 4 with respect to the grant of 100,000 options on
August 11.








Code of Ethics







The Company has adopted a Code of Business
Conduct which applies to all directors, officers and employees.
The Companys Code of Ethics will be provided free of
charge upon request in writing to FreeMarkets, Inc.
210 Sixth Avenue, Pittsburgh, PA 15222, Attention:
Investor Relations, or by telephone at (412) 434-0500.












|          |                       
|--------- | ----------------------
|Item  11. | Executive Compensation







Compensation of Executive Officers







The following table sets forth the compensation
earned by our Chief Executive Officer and the four other
individuals who served as executive officers during 2003 for
services rendered in all capacities to the Company and its
subsidiaries for each of the last three fiscal years. The
individuals included in the table are collectively referred to
as the Named Executive Officers.







Summary Compensation Table







|                            |                                 |                     |      |            |  |           |         |              |  |              |         |         |  |  |         |           |  |   |         |     |    
|--------------------------- | ------------------------------- | ------------------- | ---- | ---------- |  | --------- | ------- | ------------ |  | ------------ | ------- | ------- |  |  | ------- | --------- |  | - | ------- | --- | ---
|                            |                                 |                     |      |            |  |           |         | Long-Term    |  |             
|                            |                                 |                     |      |            |  |           |         | Compensation |  |             
|                            |                                 |                     |      |            |  |          
|                            |                                 | Annual Compensation |      | Securities |  |          
|                            |                                 |                     |      | Underlying |  | All Other
|Name and Principal Position |                                 | Year                |      | Salary     |  | Bonus     |         | Options      |  | Compensation
|                            |                                 |                     |      |            |  |           |         |              |  |             
|Glen T. Meakem              |                                 |                     | 2003 |            |  | $         | 362,500 |              |  | $            | 75,000  | (6)     |  |  | 100,000 |           |  | $ |        |    
|                            | Chairman of the
    Board(1)    |                     |      | 2002       |  |           | $       | 393,750      |  |              | $       | 100,000 |  |  |         |          |  |   | $       |    |    
|                            |                                 |                     | 2001 |            |  | $         | 356,250 |              |  | $            | 225,000 |         |  |  | 100,000 |           |  | $ |        |    
|David H. McCormick          |                                 |                     | 2003 |            |  | $         | 350,000 |              |  | $            | 190,000 | (6      |  |  |         | ) 600,000 |  | $ |        |    
|                            | Chief Executive Officer and     |                     |      | 2002       |  |           | $       | 287,500      |  |              | $       | 125,000 |  |  |         | 80,000    |  |   | $       |    |    
|                            | President(2)                    |                     |      | 2001       |  |           | $       | 243,750      |  |              | $       | 150,000 |  |  |         | 280,000   |  |   | $       |    |    
|Sean M. Rollman             |                                 |                     | 2003 |            |  | $         | 136,250 |              |  | $            | 70,000  | (6)     |  |  | 35,000  |           |  | $ |        |    
|                            | Vice President, Controller,     |                     |      | 2002       |  |           | $       | 117,500      |  |              | $       | 38,000  |  |  |         | 10,000    |  |   | $       |    |    
|                            | Treasurer and Acting
    CFO(3) |                     |      | 2001       |  |           | $       | 107,231      |  |              | $       | 40,000  |  |  |         | 10,000    |  |   | $       |    |    
|David J. Becker             |                                 |                     | 2003 |            |  | $         | 216,667 |              |  | $            |        |         |  |  | 150,000 |           |  | $ | 325,000 | (7)
|                            | Executive Vice President and    |                     |      | 2002       |  |           | $       | 325,000      |  |              | $       | 50,000  |  |  |         |          |  |   | $       |    |    
|                            | Chief Operating
    Officer(4)  |                     |      | 2001       |  |           | $       | 307,000      |  |              | $       | 195,000 |  |  |         | 100,000   |  |   | $       | 750 | (8)
|Joan S. Hooper              |                                 |                     | 2003 |            |  | $         | 283,334 |              |  | $            |        |         |  |  | 300,000 |           |  | $ |        |    
|                            | Executive Vice President,       |                     |      | 2002       |  |           | $       | 287,500      |  |              | $       | 100,000 |  |  |         | 80,000    |  |   | $       |    |    
|                            | Chief Financial Officer,        |                     |      | 2001       |  |           | $       | 268,750      |  |              | $       | 165,000 |  |  |         | 180,000   |  |   | $       |    |    
|                            | Secretary and
    Treasurer(5)  |                     |      |            |  |           |         |              |  |              |         |         |  |  |         |           |  |   |         |     |    






---



|    |                                                                                                                                                                                                             
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(1) | Mr. Meakem ceased to serve as the
    Companys Chief Executive Officer on January 24, 2003.                                                                                                                
|   
|   
|   
|(2) | Mr. McCormick was elected President on
    October 3, 2002 and assumed the role of Chief Executive
    Officer on January 24, 2003.                                                                         
|   
|   
|   
|(3) | Mr. Rollman was elected Treasurer and Acting
    Chief Financial Officer of the Company on October 23, 2003.                                                                                                
|   
|   
|   
|(4) | Mr. Becker was elected Executive Vice
    President and Chief Operating Officer on October 3, 2002.
    Prior to October 3, 2002, Mr. Becker served as
    President and Chief Operating Officer. Mr. Becker
|   

64



---



##### Table of Contents



|    |                                                                                                                                                                      
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|    | ceased to be an executive officer of the Company
    within the meaning of Rule 3b-7 promulgated under the
    Securities Act of 1934 on September 1, 2003.          
|   
|   
|   
|(5) | Ms. Hooper ceased to be an executive officer
    of the Company within the meaning of Rule 3b-7 promulgated
    under the Securities Act of 1934 on October 31, 2003.
|   
|   
|   
|(6) | Represents a performance bonus paid in March 2004
    for services rendered in 2003.                                                                                 
|   
|   
|   
|(7) | Represents a severance payment made to
    Mr. Becker in 2003 in connection with the termination of
    his employment.                                              
|   
|   
|   
|(8) | Represents a patent bonus.                                                                                                                                           
|   




Option Grants







The following table sets forth certain
information regarding options granted during 2003 to the Named
Executive Officers. No stock appreciation rights were granted in
2003.







Option Grants During 2003







|                   |  |            |         |               |  |           |       |            |  |                      |      |     |  |  |          |  |  |  |           |  |  |  |           | 
|------------------ |  | ---------- | ------- | ------------- |  | --------- | ----- | ---------- |  | -------------------- | ---- | --- |  |  | -------- |  |  |  | --------- |  |  |  | --------- | 
|                   |  |            |         |               |  |           |       |            |  |                     
|                   |  |            |         |               |  |           |       |            |  | Potential Realizable
|                   |  |            |         |               |  |           |       |            |  | Value at Assumed    
|                   |  |            |         |               |  |           |       |            |  | Annual Rates of     
|                   |  | Number of  |         | Percentage of |  |           |       |            |  | Stock Price         
|                   |  | Securities |         | Total Options |  |           |       |            |  | Appreciation for    
|                   |  | Underlying |         | Granted to    |  | Exercise  |       |            |  | Option Term($)(2)   
|                   |  | Options    |         | Employees in  |  | Price     |       | Expiration |  |                     
|Name               |  | Granted    |         | 2003(1)       |  | Per Share |       | Date       |  | 5%                   |      | 10%
|                   |  |            |         |               |  |           |       |            |  |                      |      |    
|Glen T. Meakem     |  |            | 100,000 |               |  |           | 1.98  | %          |  | $                    | 4.03 |     |  |  | 1/28/13  |  |  |  | 253,445   |  |  |  | 642,278   | 
|David H. McCormick |  |            | 600,000 |               |  |           | 11.89 | %          |  | $                    | 4.03 |     |  |  | 1/28/13  |  |  |  | 1,520,667 |  |  |  | 3,853,669 | 
|David J. Becker    |  |            | 150,000 |               |  |           | 2.97  | %          |  | $                    | 4.03 |     |  |  | 10/30/03 |  |  |  |          |  |  |  |          | 
|Joan S. Hooper     |  |            | 300,000 |               |  |           | 5.95  | %          |  | $                    | 4.03 |     |  |  | 12/30/03 |  |  |  |          |  |  |  |          | 
|Sean M. Rollman    |  |            | 35,000  |               |  |           | 0.69  | %          |  | $                    | 4.03 |     |  |  | 1/28/13  |  |  |  | 88,706    |  |  |  | 224,797   | 






---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                         
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(1) | Based on 5,079,650 options granted to all
    employees during 2003.                                                                                                                                                                                                                                                                                                                                                    
|   
|   
|   
|(2) | The 5% and 10% assumed annual rates of compounded
    stock price appreciation are mandated by rules of the SEC. Our
    actual stock price appreciation over the 10-year option term
    will likely differ from these assumed annual rates. Unless the
    market price of the Common Stock appreciates over the option
    term, no value will be realized from the option grants made to
    the executive officers.
|   




Option Exercises







The following table sets forth as to the Named
Executive Officers information with respect to (i) the
number of shares received upon the exercise of options,
(ii) the aggregate dollar value realized upon exercise,
(iii) the total number of shares underlying unexercised
options held at the end of 2003, and (iv) the aggregate
dollar value of in-the-money unexercised options held at the end
of 2003.







Option Exercises in 2003 and Year End Option
Values







|                   |  |             |         |             |  |                        |         |                         |  |             |           |               |  |  |         |  |  |  |           |  |  |  |           | 
|------------------ |  | ----------- | ------- | ----------- |  | ---------------------- | ------- | ----------------------- |  | ----------- | --------- | ------------- |  |  | ------- |  |  |  | --------- |  |  |  | --------- | 
|                   |  |             |         |             |  |                        |         |                        
|                   |  |             |         |             |  | Number of Securities   |         | Value of Unexercised   
|                   |  |             |         |             |  | Underlying Unexercised |         | In-the-Money Options at
|                   |  | Shares      |         |             |  | Options at Year End(#) |         | Year End($)(1)         
|                   |  | Acquired on |         | Value       |  |                        |         |                        
|Name               |  | Exercise(#) |         | Realized($) |  | Exercisable            |         | Unexercisable           |  | Exercisable |           | Unexercisable
|                   |  |             |         |             |  |                        |         |                         |  |             |           |              
|Glen T. Meakem     |  |             |        |             |  |                        |        |                         |  |             | 1,494,750 |               |  |  | 533,250 |  |  |  | 4,408,855 |  |  |  | 1,632,422 | 
|David H. McCormick |  |             |        |             |  |                        |        |                         |  |             | 356,000   |               |  |  | 776,000 |  |  |  | 300,375   |  |  |  | 1,301,625 | 
|David J. Becker    |  |             | 102,750 |             |  |                        | 660,681 |                         |  |             |          |               |  |  |        |  |  |  |          |  |  |  |          | 
|Joan S. Hooper     |  |             | 56,250  |             |  |                        | 237,320 |                         |  |             |          |               |  |  |        |  |  |  |          |  |  |  |          | 
|Sean M. Rollman    |  |             | 9,175   |             |  |                        | 55,899  |                         |  |             | 12,003    |               |  |  | 46,222  |  |  |  | 5,839     |  |  |  | 77,087    | 




65



---



##### Table of Contents





---






|    |                                                                                                                                                        
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Based on the closing price per share of the
    Common Stock on the Nasdaq National Market on December 31,
    2003, less the exercise price per share.







Compensation of Directors







We reimburse our directors for travel and lodging
expenses in connection with attendance at Board and committee
meetings. All of our directors, including non-employee
directors, are eligible to receive options under our Amended and
Restated Stock Incentive Plan.







In February 2001, we granted options to purchase
1,000,000 shares of Common Stock to each of Mr. Lane and
Mr. Meredith. These options vest in 24 equal monthly
installments, provided that Mr. Lane or Mr. Meredith,
as applicable, is serving as a member of the Board of Directors
on the applicable vesting dates. We granted the option to
Mr. Lane in consideration of his service on the Board and
his agreement to stand for reelection at the Annual Meeting and,
if reelected, to serve as a Class II director with a term
expiring at the 2004 Annual Meeting. We granted the option to
Mr. Meredith in consideration of his agreement to stand for
reelection at the 2003 Annual Meeting and, if reelected, to
serve for a term expiring at the 2006 Annual Meeting, and to
continue in his capacity as chairman of the Audit Committee
during his entire term of service on the Board if requested to
do so. In January 2002, Mr. Meredith voluntarily returned
to the Company 541,671 options, which constituted all of the
options granted to him in 2001 which were unvested as of
January 30, 2002. Mr. Merediths agreement to
continue as a member of the Board and as Chairman of the Audit
Committee remains unchanged.







In July 2003, we granted options to purchase
100,000 shares of common stock to Dr. Cohon in
consideration of his Board Service. In August 2003, we granted
options to purchase 100,000 shares of common stock to
Mr. Newkirk in consideration of his Board Service. In
February 2003, we granted options to purchase 100,000 shares of
common stock to Mr. Gill in consideration of his Board
service. The exercise price of all such options is the fair
market value on the date of grant.







Commencing in the first quarter of 2003, each
non-employee director of the Company (other than the chair of
the audit committee) will be paid a $12,500 quarterly cash
retainer on the last day of each calendar quarter provided that
the non-employee director is serving on the Board throughout the
entire calendar quarter. The chair of the audit committee will
be paid an $18,750 quarterly cash retainer provided the
non-employee director is serving as the audit committee chair
throughout the entire calendar quarter. The quarterly cash
retainer will be paid on a pro rated basis in the event of a
non-employees resignation or dismissal from the Board.







In the event that any non-employee director is
prohibited by the terms of a partnership agreement or otherwise
from receiving the quarterly cash retainer, then, in lieu of a
quarterly cash retainer, the Company will grant to such
non-employee director an immediately exercisable option to
purchase shares of the Companys Common Stock, at an
exercise price per share equal to the Fair Market Value (as
defined in the Amended and Restated Stock Incentive Plan) on the
date of grant. The number of shares subject to the option will
equal the number of shares of Common Stock as will cause such
option to have a dollar value, based on the
Black-Scholes method or such other reasonable option
valuation method as the Board may from time to time determine,
substantially equal to the quarterly cash retainer that would
otherwise have been payable to such non-employee director.




66



---



##### Table of Contents






Employment and Change in Control
Arrangements







All of our executive officers serve at the
discretion of the Board of Directors.







If we experience a change of control, our Named
Executive Officers are entitled to accelerated vesting of
options and benefits under our Change of Control Separation
Plan, as more fully described below. Under our option plans and
our Change of Control Separation Plan, a change of control
generally includes:






| |   |                                                                                                                                                                                                       
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | an acquisition of more than 50% of the combined
    voting power of all our outstanding securities;                                                                                                   
|
|
|
| |  | a reorganization, merger, consolidation, or
    recapitalization where, following the transaction, our
    stockholders own 50% or less of the voting securities of the
    surviving corporation;    
|
|
|
| |  | our liquidation or dissolution, or the sale of
    substantially all of our assets; or                                                                                                                
|
|
|
| |  | individuals who currently form a majority of our
    Board of Directors ceasing to be a majority, unless the new
    directors are approved by a vote of at least a majority of our
    current Board.
|




Upon a change of control, certain of the
outstanding options held by the Named Executive Officers that
were not previously vested will immediately vest. In addition,
if the acquiror in any change in control fails to provide
substitute options to replace the outstanding options held by
these executive officers, then all outstanding options not
previously vested would vest upon the change in control.







On January 2, 2001, the Board of Directors
amended and restated the stock incentive plan to eliminate the
provision which provided for the automatic acceleration of 50%
of unvested options and the lapse of restrictions with respect
to 50% of shares of restricted stock upon a change of control.
The amendment does not affect options granted under the plan
prior to January 2, 2001.







In November 2003, our Board of Directors approved
a Change of Control Separation Plan. Under this plan, certain
officers, including each of our Named Executive Officers who is
currently serving as such, would receive separation benefits if
they are terminated within eighteen months of a change of
control, as defined in the plan. These separation benefits
consist of (a) a lump sum cash payment equal to 150% of the
Named Executive Officers annual salary at the rate in
effect on his termination date plus 150% of the average of the
Named Executive Officers annual bonuses for 2001, 2002,
and 2003 (300% of annual salary and average bonus for David H.
McCormick), (b) a lump sum payment equal to the average of
the Named Executive Officers annual bonuses for 2001,
2002, and 2003, prorated to reflect the number of days that the
Named Executive Officer worked in the year of termination,
(c) continued employer-subsidized medical and dental
coverage for the Named Executive Officer and the Named Executive
Officers dependents for eighteen months (except in the
case of David H. McCormick where such coverage will be provided
for three years) following the Named Executive Officers
termination, and (d) vesting of all stock options granted
to the Named Executive Officer by FreeMarkets in accordance with
a vesting schedule based upon the Named Executive Officers
years of service with FreeMarkets.







Compensation Committee Interlocks and Insider
Participation







Neither of the members of our Compensation
Committee has ever been an officer or employee of FreeMarkets.
None of our executive officers serves as a member of the board
of directors or compensation committee of any entity that has
one or more executive officers serving on our Board of Directors
or Compensation Committee.












|         |                                                                                                       
|-------- | ------------------------------------------------------------------------------------------------------
|Item 12. | Security Ownership of Certain Beneficial
    Owners and Management and Related Stockholder
    Matters







Beneficial Ownership Table







The following table sets forth information
regarding the beneficial ownership of the Companys Common
Stock as of February 29, 2004 held by each person who is
known by the Company to have been the beneficial owner of more
than five percent of the Companys Common Stock on such
date, by our Chief Executive Officer and the other Named
Executive Officers listed in the Summary Compensation




67



---



##### Table of Contents






Table below, our directors and by all directors
and executive officers of the Company as a group (based on
42,928,327 shares of Common Stock outstanding as of such date).








|                                                                  |  |                      |           |          |  |  |       |  
|----------------------------------------------------------------- |  | -------------------- | --------- | -------- |  |  | ----- | -
|                                                                  |  |                     
|                                                                  |  | Beneficial Ownership
|                                                                  |  | of Common Stock     
|                                                                  |  |                     
|                                                                  |  | Number               |           | Percent 
|Beneficial Owner                                                  |  | of Shares            |           | of Class
|                                                                  |  |                      |           |         
|Directors and Executive Officers                                  |  |                      |           |          |  |  |       |  
|Glen T. Meakem                                                    |  |                      | 3,028,250 | (1)      |  |  | 6.81  | %
|David H. McCormick                                                |  |                      | 443,800   | (2)      |  |  | 1.02  | %
|Sean M. Rollman                                                   |  |                      | 20,481    | (3)      |  |  | *     |  
|Jared Cohon                                                       |  |                      | 25,000    | (4)      |  |  | *     |  
|Thomas J. Gill                                                    |  |                      | 33,333    | (5)      |  |  | *     |  
|Raymond J. Lane                                                   |  |                      | 1,741,666 | (6)      |  |  | 3.96  | %
|Thomas J. Meredith                                                |  |                      | 558,995   | (7)      |  |  | 1.29  | %
|Karl Newkirk                                                      |  |                      | 16,666    | (8)      |  |  | *     |  
|All directors and executive officers as a group                   |  |                      | 5,868,191 | (9)      |  |  | 12.62 | %
|5% Stockholders                                                   |  |                      |           |          |  |  |       |  
|Strong Capital Management, Inc. and Richard S.
    Strong         |  |                      | 2,177,720 | (10)     |  |  | 5.07  | %
|100 Hundred Heritage Reserve
    Menomonee Falls, Wisconsin 53051 |  |                      |           |          |  |  |       |  






---






|  |              
|- | -------------
|* | Less than 1%.






|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(1) | Includes 874,000 shares held by a limited
    partnership controlled by Mr. Meakem, 212,200 shares held
    by a charitable foundation controlled by Mr. Meakem, and
    1,512,250 shares which may be acquired by April 29, 2004 (i.e.,
    within 60 days of February 29, 2004) pursuant to the
    exercise of options.                                                                                                                               
|   
|   
|   
|(2) | Includes 440,000 shares which may be acquired by
    April 29, 2004 pursuant to the exercise of options.                                                                                                                                                                                                                                                                                                                                                 
|   
|   
|   
|(3) | Includes 18,053 shares which may be acquired by
    April 29, 2004 pursuant to the exercise of options.                                                                                                                                                                                                                                                                                                                                                  
|   
|   
|   
|(4) | Consists of 25,000 shares which may be acquired
    by April 29, 2004 pursuant to the exercise of options.                                                                                                                                                                                                                                                                                                                                               
|   
|   
|   
|(5) | Consists of 33,333 shares which may be acquired
    by April 29, 2004 pursuant to the exercise of options.                                                                                                                                                                                                                                                                                                                                               
|   
|   
|   
|(6) | Consists of 1,041,666 shares which may be
    acquired by April 29, 2004 pursuant to the exercise of
    options and 700,000 shares held by limited partnerships for
    which KPCB IX Associates, LLC is the general partner.
    Mr. Lane is a managing director of KPCB IX Associates, LLC.
    Mr. Lane disclaims beneficial ownership of the shares held
    by the limited partnerships except to the extent of his
    pecuniary interest therein.
|   
|   
|   
|(7) | Includes 499,995 shares which may be acquired by
    April 29, 2004 pursuant to the exercise of options.                                                                                                                                                                                                                                                                                                                                                 
|   
|   
|   
|(8) | Consists of 16,666 shares which may be acquired
    by April 29, 2004 pursuant to the exercise of options.                                                                                                                                                                                                                                                                                                                                               
|   
|   
|   
|(9) | See notes (1) through (8).                                                                                                                                                                                                                                                                                                                                                                                                                               
|   






|     |                                                                                                                                                                                                                                                                                                        
|---- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(10) | Based solely on information contained in a
    Schedule 13G filed with the SEC by Strong Capital
    Management, Inc. on March 2, 2004. Strong Capital
    Management, Inc. and Mr. Richard S. Strong have shared
    voting power to dispose of and to direct the disposition of
    2,177,720 shares.












|         |                                                   
|-------- | --------------------------------------------------
|Item 13. | Certain Relationships and Related
    Transactions







None.




68



---



##### Table of Contents











|         |                                           
|-------- | ------------------------------------------
|Item 14. | Principal Accountant Fees and
    Services







Aggregate fees for professional services rendered
for the Company by PricewaterhouseCoopers LLP
(PricewaterhouseCoopers) for the years ended
December 31, 2003 and 2002 were as follows:







|              |  |      |         |      |  |   |         | 
|------------- |  | ---- | ------- | ---- |  | - | ------- | 
|              |  | 2003 |         | 2002
|              |  |      |         |     
|Audit         |  | $    | 288,300 |      |  | $ | 269,200 | 
|Audit related |  |      | 12,400  |      |  |   | 39,100  | 
|Tax           |  |      | 415,000 |      |  |   | 527,300 | 
|              |  |      |         |      |  |   |         | 
|              |  | $    | 715,700 |      |  | $ | 835,600 | 
|              |  |      |         |      |  |   |         | 







The audit fees for the years ended
December 31, 2003 and 2002, respectively, were for
professional services rendered for the audits of the
consolidated financial statements of the Company, reviews of the
Companys quarterly consolidated financial statements and
statutory audits.







The audit related fees for the year ended
December 31, 2003 were for assurance and related services
related to employee benefit plan audits and assistance related
to the internal control reporting requirements of the
Sarbanes-Oxley Act. The audit related fees for the year ended
December 31, 2002 were for assurance and related services
related to employee benefit plan audits and other audit related
services.







Tax fees for the years ended December 31,
2003 and 2002, respectively, were for services related to tax
compliance in the United States and foreign jurisdictions, and
tax planning and advice.







During the years ended December 31, 2003 and
2002, PricewaterhouseCoopers rendered no professional services
to the Company in connection with the design and implementation
of financial information systems.







The Audit Committee has implemented policies and
procedures that require Audit Committee pre-approval of all
audit and non-audit services performed by the Companys
independent accounting firm. Pre-approval is generally provided
early in the year and includes a specific budget as to each
category of services to be provided and the specific services
within each category. The Companys management and
independent accountants periodically report to the Audit
Committee at its regular meetings regarding the nature, scope
and cost of services provided up to the date of each such
report. Audit Committee pre-approval is required for any
engagements that may arise during that year that are outside the
scope and budget that have been pre-approved at the beginning of
the year.







PART IV






|         |                                                                    
|-------- | -------------------------------------------------------------------
|Item 15. | Exhibits, Financial Statement Schedules and
    Reports on Form 8-K

(a) Documents filed as part of this
report:






| |                                                                                                                                           
| | ------------------------------------------------------------------------------------------------------------------------------------------
| | 1. Financial Statements and Supplementary
    Data. The following Financial Statements of the Company are
    filed with this Form 10-K/A:




|                                                                                                                          |  |  |  | 
|------------------------------------------------------------------------------------------------------------------------- |  |  |  | 
|Report of Independent Auditors                                                                                            |  |  |  | 
|Consolidated Balance Sheets as of
    December 31, 2003 and 2002                                                          |  |  |  | 
|Consolidated Statements of Operations for each of
    the three years in the period ended December 31, 2003               |  |  |  | 
|Consolidated Statements of Stockholders
    Equity for each of the three years in the period ended
    December 31, 2003 |  |  |  | 
|Consolidated Statements of Cash Flows for each of
    the three years in the period ended December 31, 2003               |  |  |  | 
|Notes to Consolidated Financial Statements                                                                                |  |  |  | 

69



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##### Table of Contents





| |                                                                                                                                                                                                                           
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | 2. Financial Statement Schedules. The
    following financial statement schedule is filed as part of this
    Annual Report on Form 10-K/A:                                                                               
|
|
| | Schedule II  Valuation and
    Qualifying Accounts                                                                                                                                                                       
|
|
| | 3. Exhibits. The Exhibits listed
    below are filed or incorporated by reference as part of this
    Form 10-K/A. Where so indicated by footnote, exhibits which
    were previously filed are incorporated by reference.
|




|        |    |             |  |                                                                                                                                                                                                                                                                                                                                                                                                                     
|------- | -- | ----------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|Number  |    | Description
|        |    |            
|        | 3  | .1          |  | Registrants Amended and Restated
    Certificate of Incorporation, as amended by Certificate of
    Amendment dated May 12, 2000.(1)                                                                                                                                                                                                                                                                               
|        | 3  | .2          |  | Registrants Amended and Restated Bylaws.(2)                                                                                                                                                                                                                                                                                                                                                                        
|        | 10 | .1         |  | Service and Market Access Agreement made as of
    October 19, 2000 and effective as of January 1, 2001
    by and between the registrant and United Technologies
    Corporation.(3)                                                                                                                                                                                                                               
|        | 10 | .2(a)       |  | Lease Agreement between the registrant and One
    Oliver Associates Limited Partnership dated October 21,
    1998.(4)                                                                                                                                                                                                                                                                                             
|        | 10 | .2(b)       |  | First Amendment to Lease between the registrant
    and One Oliver Associates Limited Partnership dated
    March 30, 1999.(4)                                                                                                                                                                                                                                                                                      
|        | 10 | .2(c)       |  | Second Amendment to Lease between the registrant
    and One Oliver Associates Limited Partnership dated June 1999.(5)                                                                                                                                                                                                                                                                                              
|        | 10 | .2(d)       |  | Third Amendment to Lease between the registrant
    and One Oliver Associates Limited Partnership dated March
    2000.(13)                                                                                                                                                                                                                                                                                         
|        | 10 | .3(a)       |  | Credit Agreement dated as of November 3,
    2000 by and among the registrant and the banks party thereto and
    PNC Bank, National Association, as administrative agent, and
    Silicon Valley Bank, as syndication agent, as amended by the
    First Amendment dated as of December 2, 2000, the Second
    Amendment dated as of February 7, 2001 and the Third
    Amendment dated as of October 31, 2001.(6)
|        | 10 | .3(b)       |  | Fourth Amendment to Credit Agreement between the
    registrant and the banks party thereto and PNC Bank, National
    Association, as administrative agent, and Silicon Valley Bank,
    as syndication agent, dated as of October 10, 2002.(13)                                                                                                                                                                   
|        | 10 | .3(c)       |  | Fifth Amendment to Credit Agreement between the
    registrant and the banks party thereto and PNC Bank, National
    Association, as administrative agent, and Silicon ValleyBank, as
    syndication agent, dated as of December 26, 2002.(13)                                                                                                                                                                    
|        | 10 | .3(d)       |  | Sixth Amendment to Credit Agreement between the
    registrant and the banks party thereto and PNC Bank, National
    Association, as administrative agent, and Silicon Valley Bank,
    as syndication agent, dated as of February 28, 2003.                                                                                                                                                                       
|        | 10 | .3(e)       |  | Seventh Amendment to Credit Agreement between the
    registrant and the banks party thereto and PNC Bank, National
    Association, as administrative agent, and Silicon Valley Bank,
    as syndication agent, dated as of December 18, 2003.                                                                                                                                                                     
|        | 10 | .4          |  | Registrants 1996 Stock Incentive Plan.(4)                                                                                                                                                                                                                                                                                                                                                                          
|        | 10 | .5          |  | Registrants Second Amended and Restated
    Stock Incentive Plan.(7)                                                                                                                                                                                                                                                                                                                                               
|        | 10 | .6          |  | Registrants Amended and Restated Employee
    Stock Purchase Plan.(8)                                                                                                                                                                                                                                                                                                                                              
|        | 10 | .7          |  | Form of Indemnification Agreement between the
    registrant and each of its directors and officers.(9)                                                                                                                                                                                                                                                                                                             
|        | 10 | .8*         |  | Restricted Stock Purchase Agreement between
    Thomas J. Meredith and the registrant dated as of
    November 23, 1999.(10)                                                                                                                                                                                                                                                                                        
|        | 10 | .9         |  | Long Term Access and Services Agreement dated as
    of April 17, 2000 by and between the registrant and Visteon
    Corporation.(11)                                                                                                                                                                                                                                                                               
|        | 10 | .10        |  | Common Stock Purchase Warrant of the registrant
    issued to Visteon Corporation dated April 17, 2000.(11)                                                                                                                                                                                                                                                                                                         
|        | 10 | .11(a)      |  | 1998 Stock Option Grant Certificate (Raymond L.
    Lane).(12)                                                                                                                                                                                                                                                                                                                                                      




70



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##### Table of Contents






|        |    |             |  |                                                                                                                                               
|------- | -- | ----------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|Number  |    | Description
|        |    |            
|        | 10 | .11(b)      |  | 1998 Stock Option Grant Certificate (Thomas J.
    Meredith).(12)                                                                             
|        | 10 | .12         |  | 2001 Broad Based Equity Incentive Plan.                                                                                                       
|        | 10 | .13         |  | 2002 Bonus Plan.                                                                                                                              
|        | 10 | .14*        |  | Change of Control Separation Plan.                                                                                                            
|        | 21 | .1          |  | Subsidiaries of the registrant.(8)                                                                                                            
|        | 23 | .1          |  | Consent of PricewaterhouseCoopers LLP                                                                                                         
|        | 31 | .1          |  | Certification of Chief Executive Officer pursuant
    to Section 302 of the Sarbanes-Oxley Act of 2002                                        
|        | 31 | .2          |  | Certification of acting Chief Financial Officer
    pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                 
|        | 32 |             |  | Certification by the Chief Executive Officer and
    Chief Financial Officer Relating to a Periodic Report Containing
    Financial Statements






---






| |   |                                                                        
| | - | -----------------------------------------------------------------------
| | * | Indicates management contract or compensatory
    plan or arrangements.






| |   |                                                                                                                                                                                                      
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Portions of this exhibit have been omitted based
    on a request for confidential treatment filed with the SEC. The
    omitted portions of the exhibit have been filed separately with
    the SEC.

| |     |                                                                                                                                                                                       
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (1) | Incorporated by reference to exhibit filed with
    the registrants Registration Statement on Form S-8,
    as filed with the SEC on May 26, 2000.                                   
| | (2) | Incorporated by reference to exhibit filed with
    the registrants Registration Statement on Form S-8,
    as filed with the SEC on July 10, 2001.                                  
| | (3) | Incorporated by reference to exhibit filed with
    the registrants Form 10-K for the year ended
    December 31, 2000, as filed with the SEC on
    February 23, 2001.              
| | (4) | Incorporated by reference to exhibit filed with
    the Registration Statement as filed with the SEC on
    September 8, 1999.                                                        
| | (5) | Incorporated by reference to exhibit filed with
    Amendment No. 2 to the Registration Statement, as filed
    with the SEC on November 1, 1999.                                     
| | (6) | Incorporated by reference to exhibit filed with
    the registrants Form 10-K for the year ended
    December 31, 2001, as filed with the SEC on March 12,
    2002.                 
| | (7) | Incorporated by reference to exhibit filed with
    the registrants Registration Statement on Form S-4,
    as filed with the SEC on February 23, 2001.                              
| | (8) | Incorporated by reference to exhibit filed with
    the registrants Annual Report on Form 10-K for the
    year ended December 31, 1999, as filed with the SEC on
    March 16, 2000.
| | (9) | Incorporated by reference to exhibit filed with
    Amendment No. 5 to the Registration Statement, as filed
    with the SEC on November 18, 1999.                                    

|     |                                                                                                                                                                                         
|---- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(10) | Incorporated by reference to exhibit filed with
    Amendment No. 6 to the Registration Statement, as filed
    with the SEC on November 23, 1999.                                      
|(11) | Incorporated by reference to exhibit filed with
    the registrants Quarterly Report on Form 10-Q for the
    quarter ended June 30, 2000, as filed with the SEC in
    August 2, 2000.
|(12) | Incorporated by reference to exhibit filed with
    the registrants Registration Statement on Form S-4/A,
    as filed with the SEC on May 10, 2001.                                   
|(13) | Incorporated by reference to exhibit filed with
    the registrants Form 10-K for the year ended
    December 31, 2002, as filed with the SEC on March 14,
    2003.                   

(b) Reports on Form 8-K

Form 8-K furnished on October 27, 2003
under Item 12, Results of Operations and Financial
Condition (with respect to a press release relating to the
Companys performance in the third quarter of 2003).

* * * * * *

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##### Table of Contents






SIGNATURES

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



| |                  
| | -----------------
| | FREEMARKETS, INC.



| |     |                    
| | --- | -------------------
| | BY: | /s/ SEAN M. ROLLMAN

| |                                                                             
| | ----------------------------------------------------------------------------
| |                                                                             
| | Sean M. Rollman                                                             
| | Vice President, Controller, Treasurer and
    acting Chief Financial Officer




Dated: April 29, 2004







Pursuant to the requirements of the Securities
Exchange Act of 1934, this report has been signed below by the
following persons on behalf of the Registrant and in the
capacities and on the dates indicated.







|                                            |  |                                                                                   |  |      |                |  |  | 
|------------------------------------------- |  | --------------------------------------------------------------------------------- |  | ---- | -------------- |  |  | 
|                                            |  |                                                                                   |  |     
|Signature                                   |  | Capacity                                                                          |  | Date
|                                            |  |                                                                                   |  |     
|                                           
|/s/ GLEN T. MEAKEM*Glen T. Meakem           |  | Chairman of the Board and Director                                                |  |      | April 29, 2004 | 
|                                           
|/s/ DAVID H. MCCORMICKDavid H. McCormick    |  | President, Chief Executive Officer and Director
    (Principal Executive Officer) |  |      | April 29, 2004 | 
|                                           
|/s/ SEAN M. ROLLMANSean M. Rollman          |  | Vice President, Controller, Treasurer and acting
    Chief Financial Officer      |  |      | April 29, 2004 | 
|                                           
|/s/ DR. JARED L. COHON*Dr. Jared L. Cohon   |  | Director                                                                          |  |      | April 29, 2004 | 
|                                           
|/s/ THOMAS J. GILL*Thomas J. Gill           |  | Director                                                                          |  |      | April 29, 2004 | 
|                                           
|/s/ RAYMOND J. LANE*Raymond J. Lane         |  | Director                                                                          |  |      | April 29, 2004 | 
|                                           
|/s/ THOMAS J. MEREDITH*Thomas J. Meredith   |  | Director                                                                          |  |      | April 29, 2004 | 
|                                           
|/s/ KARL E. NEWKIRK*Karl E. Newkirk         |  | Director                                                                          |  |      | April 29, 2004 | 
|                                           
|*By: /s/ DAVID H. MCCORMICKAttorney-in-fact |  |                                                                                   |  |      |                | 




72



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##### Table of Contents



EXHIBIT INDEX




|        |    |             |  |                                                                                                                                               
|------- | -- | ----------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|Number  |    | Description
|        |    |            
|        | 10 | .14         |  | Change of Control Separation Plan.                                                                                                            
|        | 23 | .1          |  | Consent of PricewaterhouseCoopers LLP                                                                                                         
|        | 31 | .1          |  | Certification of Chief Executive Officer pursuant
    to Section 302 of the Sarbanes-Oxley Act of 2002                                        
|        | 31 | .2          |  | Certification of acting Chief Financial Officer
    pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                 
|        | 32 |             |  | Certification by the Chief Executive Officer and
    Chief Financial Officer Relating to a Periodic Report Containing
    Financial Statements




73



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##### Table of Contents



REPORT OF INDEPENDENT AUDITORS ON

FINANCIAL STATEMENT SCHEDULE


To the Board of Directors and Stockholders

of FreeMarkets, Inc. and Subsidiaries:





Our audits of the consolidated financial
statements referred to in our report dated February 6, 2004
appearing in this Form 10-K/A also included an audit of the
financial statement schedule listed in Item 15(a)(2) of
this Form 10-K/A. In our opinion, this financial statement
schedule presents fairly, in all material respects, the
information set forth therein when read in conjunction with the
related consolidated financial statements.






| |                               
| | ------------------------------
| | /s/ PricewaterhouseCoopers LLP

Pittsburgh, Pennsylvania

February 6, 2004


74



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##### Table of Contents



SCHEDULE II  VALUATION AND
QUALIFYING ACCOUNTS

|                                   |                              |              |   |            |  |             |   |            |  |               |   |           |  |  |   |            |   |  |   |            | 
|---------------------------------- | ---------------------------- | ------------ | - | ---------- |  | ----------- | - | ---------- |  | ------------- | - | --------- |  |  | - | ---------- | - |  | - | ---------- | 
|                                   |                              |              |   |            |  |             |   |           
|Column A                           |                              | Column B     |   | Column C   |  | Column D    |   | Column E  
|                                   |                              |              |   |            |  |             |   |           
|                                   |                              |              |   |            |  |             |   |           
|                                   |                              |              |   | Additions  |  |             |   |           
|                                   |                              |              |   |            |  |             |   |           
|                                   |                              | Balance at   |   |            |  | Charged to  |   |            |  |              
|                                   |                              | Beginning of |   | Charged to |  | Other       |   |            |  | Balance at   
|                                   |                              | Period       |   | Expense    |  | Accounts(1) |   | Deductions |  | End of Period
|                                   |                              |              |   |            |  |             |   |            |  |              
|Allowance for doubtful accounts:   |                              |              |   |            |  |             |   |            |  |               |   |           |  |  |   |            |   |  |   |           
|                                   | Year ended December 31, 2003 |              | $ | 1,915,000  |  |             | $ | 1,501,000  |  |               | $ |          |  |  | $ | (1,296,000 | ) |  | $ | 2,120,000  | 
|                                   | Year ended December 31, 2002 |              |   | 1,015,000  |  |             |   | 1,555,000  |  |               |   |          |  |  |   | (655,000   | ) |  |   | 1,915,000  | 
|                                   | Year ended December 31, 2001 |              |   | 903,000    |  |             |   | 3,123,000  |  |               |   |          |  |  |   | (3,011,000 | ) |  |   | 1,015,000  | 
|Allowance for deferred tax assets: |                              |              |   |            |  |             |   |            |  |               |   |           |  |  |   |            |   |  |   |           
|                                   | Year ended December 31, 2003 |              |   | 88,299,000 |  |             |   | 3,825,000  |  |               |   | 1,094,000 |  |  |   |           |   |  |   | 93,218,000 | 
|                                   | Year ended December 31, 2002 |              |   | 76,490,000 |  |             |   | 10,173,000 |  |               |   | 1,636,000 |  |  |   |           |   |  |   | 88,299,000 | 
|                                   | Year ended December 31, 2001 |              |   | 38,271,000 |  |             |   | 36,459,000 |  |               |   | 1,760,000 |  |  |   |           |   |  |   | 76,490,000 | 



---



|    |                                                                                                                                             
|--- | --------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Represents the valuation allowance related to the
    exercise of non-qualified stock options which is recorded in
    stockholders equity.

75