##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
   FORM 10-K [X]
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2003
OR [  ]
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the transition period from            to Commission File Number 000-25781   NET PERCEPTIONS, INC. (Exact Name of Registrant as Specified in its Charter)
 Delaware
    
    41-1844584(State or Other Jurisdiction
    
    (I.R.S. Employer Identification No.)of Incorporation or Organization)7700 France Avenue South, Edina, Minnesota
    
    55435(Address of Principal Executive Offices)
    
    (Zip Code)
 (952) 842-5000
(Registrants telephone number, including area code)   Securities registered pursuant to Section 12(b) of the Act: Title of each class
    
    Name of each exchange on which registeredNone
    
    Not applicable
 Securities registered Pursuant to Section 12(g) of the Act: Common Stock, par value $.0001 per share
(Title of class) Preferred Stock Purchase Rights
(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 [X] No [  ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of 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. [X] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [  ] No [X] The aggregate market value of voting and non-voting stock held by
non-affiliates of the registrant, based upon the last sale price of the
registrants Common Stock, par value $0.0001 per share, reported on the Nasdaq
National Market on June 30, 2003 was $40,976,733. As of March 31, 2004, there were outstanding 28,270,918 shares of the
registrants Common Stock, $0.0001 par value.




---



NET PERCEPTIONS, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2003 TABLE OF CONTENTS PagePART I
    
    
    
    
    1ITEM 1.
    
    BUSINESS
    
    
    1ITEM 2.
    
    PROPERTIES
    
    
    7ITEM 3.
    
    LEGAL PROCEEDINGS
    
    
    7ITEM 4.
    
    SUBMISSION OF
MATTERS TO A VOTE OF SECURITY HOLDERS
    
    
    8PART II
    
    
    
    
    9ITEM 5.
    
    MARKET FOR
REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES
    
    
    9ITEM 6.
    
    SELECTED CONSOLIDATED FINANCIAL DATA
    
    
    10ITEM 7.
    
    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
    
    
    11ITEM 7A.
    
    QUANTITATIVE AND
QUALITATIVE DISCLOSURES ABOUT MARKET RISK
    
    
    26ITEM 8.
    
    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
    
    
    26ITEM 9.
    
    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
    
    
    26ITEM 9A.
    
    CONTROLS AND PROCEDURES
    
    
    26PART III
    
    
    
    
    28ITEM 10.
    
    DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
    
    
    28ITEM 11.
    
    EXECUTIVE COMPENSATION
    
    
    29ITEM 12.
    
    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
    
    
    32ITEM 13.
    
    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
    
    
    34ITEM 14.
    
    PRINCIPAL ACCOUNTANT FEES AND SERVICES
    
    
    35PART IV
    
    
    
    
    36ITEM 15.
    
    EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
    
    
    36ITEM 8.
    
    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
    
    
    F-1List of SubsidiariesConsent of PricewaterhouseCoopers LLPCertification of CEO and CFOCertification of CEO and CFO




---



##### Table of Contents



SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS This Annual Report on Form 10-K (including exhibits and information
incorporated by reference herein) contains forward-looking statements that
involve risks, uncertainties and assumptions. The statements contained in this
report that are not purely historical are forward-looking statements within the
meaning of Section 21E of the Securities Exchange Act of 1934, as amended,
including statements regarding our expectations, beliefs, intentions or
strategies for the future. All forward-looking statements included in this
Annual Report on Form 10-K (including exhibits and information incorporated by
reference herein) are based on information available to us on the date hereof,
and we assume no obligation to update any such forward-looking statements.
Events and actual results could differ materially from those described in our
forward-looking statements. Factors that could cause or contribute to such
differences include, but are not limited to, those discussed below in Item 7 of
this report (Managements Discussion and Analysis of Financial Condition and
Results of Operations) under the heading CERTAIN RISK FACTORS and those
described in our previous filings with the Securities and Exchange Commission.
Readers are cautioned not to place undue reliance on these forward-looking
statements, which speak only as of the date that they were made. We undertake
no obligation to publicly release any revisions to these forward-looking
statements to reflect events or circumstances after the date of this Annual
Report on Form 10-K or to reflect the occurrence of unanticipated events. References in this Annual Report on Form 10-K to Net Perceptions, the
Company, we, our and us refer to Net Perceptions, Inc. and, if so
indicated or the context so requires, includes our wholly owned subsidiary
Knowledge Discovery One, Inc. (which we refer to in this report as KD1),
prior to its merger with and into the Company on September 9, 2003.




---



##### Table of Contents



PART I 
 ITEM 1. BUSINESS Summary Net Perceptions was incorporated in Delaware in 1996 and our initial
product was shipped in January 1997. Our principal executive offices are
located at 7700 France Avenue South, Edina, Minnesota 55435. Our Web site
address is www.netperceptions.com. The information on our Web site is not
incorporated by reference into this Annual Report on Form 10-K and should not
be considered a part of this report. We have sustained losses on a quarterly and annual basis since inception.
As of December 31, 2003, we had an accumulated deficit of $222 million. Our net
loss was $5.3 million for the twelve months ended December 31, 2003, compared
to a net loss of $16.7 million in the same period of the prior year. These
losses resulted from costs incurred in the development and marketing of our
products and services, significant costs incurred related to restructuring
activities, significant costs for outside professional services related to the
exploration of various strategic alternatives for the Company and responding to
an unsolicited exchange offer by Obsidian Enterprises, Inc. which has since
been withdrawn, as well as a decline in our revenues since the third quarter of
2000. On October 21, 2003, the Company announced that our board of directors had
unanimously approved a Plan of Complete Liquidation and Dissolution, referred
to as the plan of liquidation. The plan of liquidation was submitted to the
Companys stockholders for approval and adoption at a special meeting of
stockholders originally scheduled for March 12, 2004, which was adjourned and
was reconvened on March 23, 2004. At the reconvened special meeting, the
proposal to approve and adopt the plan of liquidation did not receive the
affirmative vote of a majority of the total number of shares of common stock
outstanding as of the record date for the special meeting required to approve
the proposal. We have now substantially curtailed our operations. We anticipate that
our board of directors will continue to review and consider possible actions or
transactions which might be available to resolve the Companys future in the
near term in the best interest of all stockholders. These could include, among
other actions or transactions, further sales or licenses of assets, an
acquisition of or investment in the Company or other extraordinary transaction,
adopting a new plan of complete liquidation and dissolution and seeking
stockholder approval therefor, and/or changes in the composition of our board
of directors. Background We developed and marketed software solutions designed to enable our
customers to interact more intelligently with their customers. Our solutions
integrated and analyzed information about customers, products and transaction
activity to generate specific actions our customers could take to improve their
marketing, selling, and merchandising effectiveness. We combined our software
products with industry expertise and professional services to create
industry-specific solutions that were designed to integrate with and add value
to existing custom or purchased systems, including customer relationship
management, or CRM, systems and processes. Our software solutions extracted data from our customers existing
business applications, including electronic commerce, call center, campaign
management, merchandise management, enterprise resource planning and
point-of-sale systems. Sophisticated and proprietary analytical and reporting
techniques then generated intelligence about customers and products that could
be inserted into operational processes and systems to drive actions such as
cross-selling and up-selling or personalized promotions. Our software solutions
were particularly well suited to environments with large numbers of customers,
a large product assortment and large quantities of transaction data. 1




---



##### Table of Contents



We sold and marketed our solutions primarily through a direct sales force.
We licensed our products under various pricing plans, such as per user, per
CPU, per site and per enterprise. We generally granted licenses on a perpetual
basis. License fees for our products ranged from $50,000 to in excess of $1.0
million. We provided product maintenance pursuant to service agreements, the
pricing of which was typically based on a percentage of the related product
license fee and was generally paid in advance. Professional service fees for
business consulting, implementation support, data processing and educational
services were generally priced on a time and materials basis. In February 2000, we completed our acquisition of Knowledge Discovery One,
Inc., or KD1, an Austin, Texas-based private company which supplied advanced
data analysis solutions for retailers, pursuant to a stock-for-stock merger
whereby KD1 became our wholly owned subsidiary. On September 9, 2003, KD1 was
merged with and into the Company and its separate existence ceased. Following our acquisition of KD1, we experienced two quarters of
increasing revenue and thus continued to expand our sales force and other
personnel. However, commencing in the third quarter of 2000, the market for our
products deteriorated precipitously as Internet retailers, our principal
customers, substantially reduced their spending for our products. Accordingly,
we experienced declining revenues and increased net losses. We began 2001 with approximately 315 employees. In 2001, we instituted two
separate restructuring plans to better align our cost structure with our
business outlook and general economic conditions and, in particular, the
continuing deterioration in the financial condition of Internet retailers.
During 2001, we reduced our workforce by 169 positions, and recorded total
charges of $15.6 million to reorganize the Company and exit certain facilities
in various United States and international locations. However, our revenues
continued to erode as the market for our products continued to decline due to
the continued weakness of the technology industry and Internet-based companies
generally, and as the software market began to consolidate, with customers
increasingly purchasing software solutions from fewer independent vendors. In
April 2001, we retained J.P. Morgan Securities, Inc. as our financial advisor
to explore strategic alternatives and solicit proposals from parties with an
interest in pursuing a business combination with us. This activity did not
result in a strategic transaction on acceptable terms. In June 2001, Steven
Snyder resigned as president and chief executive officer and Donald Peterson
became our president and chief executive officer. In the first quarter of 2002, in light of our continued declining revenues
and net losses, the continued weakness of the technology industry and
Internet-based companies and our deteriorating prospects as a small public
company as industry consolidation continued, we further reduced our workforce
by 15 positions, and recorded $367,000 in related employee termination costs.
In June 2002, we reduced our workforce by an additional 18 positions, and
recorded an additional $401,000 charge. As of December 31, 2002, we had 52
employees. In January 2003, we closed satellite offices in San Francisco, California,
London, England and Austin, Texas, and reduced headcount by 22 positions. In
August 2003, we reduced headcount by an additional 12 positions, including
Donald Peterson, then our president and chief executive officer. At December
31, 2003, we had nine full-time employees, and had, and currently have, only
limited business operations. As of April 13, 2004, we have two employees, both
of whom are executive officers. While we expect to continue to service our existing customers, principally
through external contractors, and may continue to derive a declining level of
revenues from software licenses and royalties, software maintenance and
professional services relating to existing customers, we are no longer actively
marketing our products and have not retained any employees to do so. We expect
that the size of our customer base will decline and we do not expect that
future product or service revenues, if any, will be significant. We anticipate
that our operating expenses will continue to decline in 2004, but will continue
to constitute a material use of our cash resources. We expect to incur
additional losses and continued negative cash flow for the foreseeable future.
We do not expect to generate an operating profit for 2004 or the foreseeable future. 2




---



##### Table of Contents



Developments Relating to Possible Strategic Transactions and the Plan of Liquidation In February 2003, in response to continued uncertainties in the
marketplace and the difficulties we were likely to continue facing as a
relatively small public company, we engaged U.S. Bancorp Piper Jaffray, Inc.,
or Piper Jaffray, to act as our financial advisor in connection with the
potential sale of the Company. From March 2003 through October 2003, the
Company pursued discussions with a number of companies regarding possible
transactions and compared potential transactions to each other as well as to an
orderly liquidation of the Company. In August 2003, our board of directors determined that, in light of the
Companys extensive, but unsuccessful, efforts to achieve for stockholders a
transaction with a third party that would provide certainty of closing and the
maximum value reasonably available in the near term, and the fact that the
downsizing and limited operations of the Company meant that the Company would
not require a significant portion of its current cash and short-term
investments to continue to operate, it was appropriate and in the best
interests of the Companys stockholders to provide immediate value and
liquidity to the Companys stockholders through a cash distribution.
Accordingly, the board (i) authorized and directed management to effect a
reduction in the Companys workforce to approximately 10 employees, which was
determined to be the minimum number necessary at that time to serve customers,
preserve the value of our intellectual property and administer our limited
ongoing business affairs; (ii) determined that in the near term management
should continue to operate the Companys business on this scaled-back basis,
and that it should seek to settle or otherwise resolve, as soon and to the
extent reasonably practicable, its existing obligations and liabilities, while
continuing to explore asset sale transactions or the sale of the Company in its
entirety, with a view to resolving the Companys future and providing maximum
additional value to our stockholders; and (iii) declared a cash distribution of
$1.50 per share, or an aggregate of approximately $42.2 million. This cash
distribution was made on September 2, 2003 to stockholders of record as of
August 18, 2003. In September 2003, we announced that we had settled our remaining
obligations under our leases for our office facilities in Edina, Minnesota,
Roseland, New Jersey and Austin, Texas for an aggregate cash payment of
approximately $5.4 million, which cancelled approximately $21.7 million of the
gross obligation, and approximately $9.6 million of the obligations net of
anticipated sublease income, under such leases when measured from June 30,
2003. In October 2003, the board of directors met to consider the Companys
alternatives, including adopting a plan of liquidation. It was determined that
none of the available strategic transaction proposals appeared to be more
favorable than liquidation, and thus on October 21, 2003 the board unanimously
adopted the plan of liquidation and resolved to submit it to stockholders for
approval and recommend that stockholders vote in favor of the plan of
liquidation. Following adoption by the board of directors of the plan of liquidation,
the Company continued to receive, and the board of directors reviewed and
carefully considered, various proposals to acquire the Company. On December
30, 2003, we entered into a patent purchase agreement with Thalveg Data Flow
LLC, or Thalveg, to sell to Thalveg our patent portfolio for $1.8 million in
cash. The agreement included a royalty-free license back to the Company under
the transferred patents, patent licenses and pending patent applications, and
provided that the closing thereunder was subject to stockholder approval
thereof as part of the plan of liquidation or otherwise. We also granted to a
software company a non-exclusive source code license to a portion of our
intellectual property for cash payments of $325,000. Under the license
agreement, we will also provide certain consulting services to the licensee for
additional cash payments of $75,000. On December 30, 2003, the board of
directors also determined that, in the absence of a definitive agreement to
acquire the Company on terms which the board believed would provide substantial
transaction certainty and higher realizable value to stockholders than
liquidation and dissolution in accordance with the plan of liquidation, we
should proceed with the plan of liquidation. Accordingly, the board reaffirmed
the plan of liquidation and its recommendation that stockholders vote in favor
of the plan. 3




---



##### Table of Contents



In light of the continuing interest expressed by various
parties in a possible acquisition of the Company, on January 9, 2004, we publicly announced
procedures for the submission of best and final acquisition proposals. Our board of directors carefully considered and
reviewed various proposals that were submitted in response to this announcement
and determined that implementation of the plan of liquidation, rather than
pursuing and entering into any of such transactions, was the course most likely
to obtain the highest value reasonably available to stockholders. Accordingly,
the board authorized the Company to continue to proceed expeditiously to seek
stockholder approval of, and implement, the plan of liquidation. Recent Events At a special meeting of the Companys stockholders held on March 12, 2004,
which was reconvened on March 23, 2004, the proposal to approve and adopt the
plan of liquidation did not receive the affirmative vote of a majority of the
total number of shares of common stock outstanding as of the record date for
the special meeting required to approve the proposal. As noted above, by the terms of the patent purchase agreement with
Thalveg, the closing thereunder was conditioned on stockholder approval
thereof, as part of the plan of liquidation or otherwise, and thus the failure
of the plan of liquidation to obtain stockholder approval resulted in this
closing condition remaining unsatisfied. Accordingly, following the vote at
the reconvened special meeting on March 23, 2004, we and Thalveg entered into
discussions regarding amending the patent purchase agreement to remove this
closing condition and completing the transaction. In the course of these
discussions, Thalveg indicated to us that it was prepared to execute an
amendment removing this condition if we agreed to close by March 31, 2004, and
that if we would not agree to close by that time, Thalveg would require that
the escrow of half of the purchase price be terminated and its deposit
returned. At a meeting on March 30, 2004, after considering the value to the
Company of the Thalveg transaction and the risks to the Company of losing the
benefit of this transaction, the impact of closing the Thalveg transaction on
possible actions or transactions the Company might seek to pursue as a result
of the plan of liquidation not receiving the required stockholder approval, and
other relevant factors, the board concluded that it was in the best interest of
our stockholders to execute the amendment to the Thalveg agreement and promptly
close the transaction. On March 31, 2004, we and Thalveg executed the
amendment to the Thalveg agreement and completed the sale of the patent
portfolio to Thalveg for $1.8 million. Under the agreement, we received a
royalty-free license back under the transferred patents, patent licenses and
pending patent applications. This license is transferable, subject to certain
restrictions applicable to the transferee relating to revenues which can be
generated by products covered by the license. This transaction did not involve
any of our other intellectual property rights or assets, including our
proprietary software products. In addition, on March 31, 2004, we announced
that we had granted to a software company a non-exclusive source code license
to a portion of our intellectual property and sold certain technology related
to a product discontinued in 2002. The aggregate consideration for this sale
and license was $325,000. On April 1, 2004, we entered into an agreement with Tornago, Inc., or
Tornago, a corporation formed by three non-officer former employees, to fulfill
existing prepaid customer support obligations in exchange for future cash
payments of approximately $60,000. This amount represents approximately 60% of
the remaining prepaid deferred maintenance revenue amounts under the existing
end user contracts when measured from April 1, 2004. Under the terms of the
agreement, Tornago received a non-transferable license to relevant intellectual
property solely to provide support and consulting services to end users of our
products. Under the agreement, we will receive a 15% royalty on any follow-on
services sold by Tornago through April 1, 2006. In connection with the agreement with Tornago, we terminated the
employment of the remaining members of our engineering staff, effective March
31, 2004, and will pay severance to these employees in accordance with existing
agreements. We anticipate that our board of directors will continue to review and
consider possible actions or transactions which might be available to resolve
the Companys future in the near term in the best interest of all stockholders.
These could include, among other actions or transactions, further sales or
licenses of assets, an acquisition of or investment in the Company or other
extraordinary transaction, adopting a new plan of complete liquidation and
dissolution and seeking stockholder approval therefor and/or changes in the
composition of our board of directors. 4




---



##### Table of Contents



Products We have one principal product, NetP 7,which is comprised of two
principal components, Intelligence Manager, the analytical hub, and Channel
Injectors, which deliver the analytical results of Intelligence Managerinto
multiple operational systems that our customers use. NetP 7enables
multi-channel retailers, distributors and manufacturers to harness the power of
predictive analytics to convert customer, product and transaction data into
actionable insight companies can use to generate higher sales, increased
revenues and improved customer loyalty. The following figure is a graphical
representation of our NetP 7product suite. (PICTURE) Intelligence Manager, the core of NetP 7, includes sophisticated analytics
to aggregate and analyze data about customers, products and transactions to
generate actionable sales and marketing intelligence, while Channel Injectors
automatically inject that intelligence in real time at various points of
customer interaction. Intelligence Managerallows companies to create and
manage highly personalized campaigns in in-bound, interactive selling
situations, such as Web sites and inbound customer contact centers, as well as
outbound selling situations, such as email and outbound telemarketing.
Intelligence Managerintegrates with a companys existing infrastructure to
deliver these campaigns in real time. Companies can use Intelligence Managerto
increase the likelihood that the products they market to customers will be
products the customer will value. Intelligence Managerutilizes advanced
one-to-one recommendation technology combined with business rules to produce
product offerings targeted directly to individual customers. It provides
marketers with the ability to create unique marketing strategies for different
groups of customers, interact with those customers on an individualized basis,
and closely track the impact that different strategies are having on sales and
profit by customer segment, product group and promotional effort. Intelligence
Managermakes it possible for marketers to rapidly modify their marketing
strategy and deploy new marketing campaigns. NetP 7s Channel Injectorsautomatically deliver the output of
Intelligence Manager, such as real time product recommendations, targeted
customer lists, and other forms of sales intelligence, directly into the
selling process. Channel Injectorscan be utilized at many customer touch
points - inbound and outbound telesales, field sales, Internet, e-mail and
direct mail channels as represented by the following channel specific modules: 5




---



##### Table of Contents




    
    NetP 7 Telesales Channel Injector allows catalogers, manufacturers and
distributors to inject sales intelligence into inbound and outbound call
centers, enabling call center representatives to deliver highly targeted,
personalized product recommendations in real time.
    
    NetP 7 Field Sales Channel Injector provides inside and
outside direct field sales representatives with a Sales
Playbook for building sales with each of their customers. The
Sales Playbookidentifies the products that customers are likely
using but purchasing from competitors, revealing previously
hidden sales opportunities. The Sales Playbookalso identifies
products that customers purchase on a periodic basis and when
they will likely repurchase them.
    
    NetP 7 E-Commerce Channel Injector interacts with customers
on a companys Web site much like a best sales representative.
Working one-to-one in real time via the Web, E-Commerce Channel
Injectordelivers highly targeted, personalized product
recommendations.
    
    NetP 7 Direct Marketing Channel Injector enables companies
to provide product recommendations and content for outbound
catalogs, direct mail, fax and e-mail marketing campaigns.
Direct Marketing Channel Injectorimproves the selection process
for direct marketing campaigns by choosing the right products
for the right customer or the right customers for a targeted
group of products. NetP 7is an installed software solution that is the culmination of our
history of product recommendation systems for assisted marketing. Predecessor
products include Personalization Manager, Insight Manager, Distribution
Analyst, Net Perceptions for E-Commerce, Net Perceptions for Call Centers, Net
Perceptions for Marketing Campaigns, and the Net Perceptions Recommendation
Engine. NetP 7(or its predecessor products) has accounted for a substantial
majority of all historical company revenue since inception. Intellectual Property and Other Proprietary Rights We rely on a combination of trademark, copyright, patent and trade secret
laws to protect our rights in our technology. We have licensed our software and
required our customers to enter into license agreements, which impose
restrictions on our customers ability to utilize the software. In addition, we
seek to avoid disclosure of our trade secrets, including but not limited to
requiring those persons with access to our proprietary information to execute
confidentiality agreements with us and restricting access to the source code
for our software. As of December 31, 2003, we had four pending United States patent
applications and four issued United States patents, as well as exclusive
license rights to three issued United States patents from the University of
Minnesota. These patents have expiration dates from 2016 through 2019. As
described above, on March 31, 2004, we sold our patent portfolio of pending and
issued patents to Thalveg for $1.8 million in cash. The patent purchase
agreement includes a royalty-free, non-exclusive license back to us of the
transferred patents, patent licenses and pending patent applications. We own a number of trademarks. These include Net Perceptions and
NetP. The Net Perceptions mark is federally registered for a term of ten
years. Employees As of December 31, 2003, we had nine full-time employees. As described
above under Recent Events, on April 1, 2004, we entered into an agreement
with Tornago to fulfill existing prepaid customer obligations. In connection
with this agreement, we terminated the employment of the remaining members of
our engineering staff, effective March 31, 2004, and will pay severance to
these employees in accordance with existing agreements. As of April 13, 2004,
we have two employees, both of whom are executive officers. None of our
employees is represented by a collective bargaining agreement, nor have we
experienced any work stoppage. Financial
Information About Geographic Areas For certain
geographic financial information, see Note 13 to the Consolidated Financial Statements. 6




---



##### Table of Contents



ITEM 2. PROPERTIES On September 12, 2003, we announced that we had entered into lease
termination agreements for our office facilities located in Edina, Minnesota,
Roseland, New Jersey and Austin, Texas. Net Perceptions current activities are
conducted in 1,500 square feet of leased space in Edina, Minnesota pursuant to
a month-to-month lease. The Company remains obligated under one office lease
for its vacated San Francisco, California location which expires in August
2004. The majority of this space is sublet and the Company is seeking to
sublease the remaining vacant portion. The Company believes that its current
facilities are suitable and adequate for its present and anticipated near-term
needs. 
 ITEM 3. LEGAL PROCEEDINGS Initial and Follow-On Public Offering Securities Litigation On November 2, 2001, Timothy J. Fox filed a purported class action lawsuit
against us, FleetBoston Robertson Stephens, Inc., the lead underwriter of our
April 1999 initial public offering, several other underwriters who participated
in our initial public offering, Steven J. Snyder, our then president and chief
executive officer, and Thomas M. Donnelly, our then chief financial officer.
The lawsuit was filed in the United States District Court for the Southern
District of New York and has been assigned to the judge who is also the
pretrial coordinating judge for substantially similar lawsuits involving more
than 300 other issuers. An amended class action complaint, captioned In re Net
Perceptions, Inc. Initial Public Offering Securities Litigation,01 Civ. 9675
(SAS), was filed on April 22, 2002, expanding the basis for the action to
include allegations relating to our March 2000 follow-on public offering in
addition to those relating to our initial public offering. The amended complaint generally alleges that the defendants violated
federal securities laws by not disclosing certain actions taken by the
underwriter defendants in connection with our initial public offering and our
follow-on public offering. The amended complaint alleges specifically that the
underwriter defendants, with our direct participation and agreement and without
disclosure thereof, conspired to and did raise and increase their underwriters
compensation and the market prices of our common stock following our initial
public offering and in our follow-on public offering by requiring their
customers, in exchange for receiving allocations of shares of our common stock
sold in our initial public offering, to pay excessive commissions on
transactions in other securities, to purchase additional shares of our common
stock in the initial public offering aftermarket at pre-determined prices above
the initial public offering price, and to purchase shares of our common stock
in our follow-on public offering. The amended complaint seeks unspecified
monetary damages and certification of a plaintiff class consisting of all
persons who acquired our common stock between April 22, 1999 and December 6,
2000. The plaintiffs have since agreed to dismiss the claims against Mr. Snyder
and Mr. Donnelly without prejudice, in return for their agreement to toll any
statute of limitations applicable to those claims; and those claims have been
dismissed without prejudice. On July 15, 2002, all of the issuer defendants
filed a joint motion to dismiss the plaintiffs claims in all of the related
cases. On February 19, 2003, the Court ruled against the Company on this
motion. A special committee of our board of directors has authorized the Company
to negotiate a settlement of the pending claims substantially consistent with a
memorandum of understanding negotiated among class plaintiffs, issuer
defendants and their insurers. Any such settlement would be subject to approval
by the Court. We believe that the allegations against the Company are without merit.
However, we are unable to predict the outcome or ultimate effect of this
litigation. Blakstad Litigation On October 29, 2003, a purported class action lawsuit was filed against
the Company, its current directors and unnamed defendants in the District
Court, Fourth Judicial District, of the State of Minnesota, County of Hennepin
captioned Don Blakstad, on Behalf of Himself and All 7




---



##### Table of Contents



others Similarly Situated,
vs. Net Perceptions, Inc., John F. Kennedy, Ann L. Winblad, John T. Riedl and
Does 1-25, inclusive,File No. 03-17820. The complaint alleged, among other
things, that defendants breached their fiduciary duties of loyalty, due care,
independence, good faith and fair dealing and sought to enjoin the proposed
liquidation of the Company and to recover reasonable attorneys and experts
fees. On November 24, 2003, defendants filed a motion to dismiss the lawsuit,
and, by order dated March 8, 2004, the court dismissed the plaintiffs
complaint with prejudice. By letter dated March 9, 2004, the plaintiff
requested the courts permission to file a motion to reconsider the decision
dismissing the complaint with prejudice. On March 18, 2004, the court denied
plaintiffs request. On April 9, 2004, defendants filed a notice of appeal
with the Court of Appeals of the State of Minnesota. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year covered by this report. 8




---



##### Table of Contents



PART II 
 ITEM 5. MARKET FOR
REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES Our common stock has been quoted on the NASDAQ National Market under the
symbol NETP since April 23, 1999. The following table sets forth, for the
periods indicated, the high and low sale prices per share of our common stock
as reported on the NASDAQ National Market. Price Range ofCommon StockHigh
    
    Low2003First Quarter
    
    
    1.56
    
    
    
    1.22Second Quarter
    
    
    1.68
    
    
    
    1.41Third Quarter(1)
    
    
    1.88
    
    
    
    .36Fourth Quarter(1)
    
    
    .51
    
    
    
    .322002First Quarter
    
    
    2.28
    
    
    
    1.32Second Quarter
    
    
    1.63
    
    
    
    1.02Third Quarter
    
    
    1.19
    
    
    
    .76Fourth Quarter
    
    
    1.47
    
    
    
    .78
  (1)
    
    See discussion below regarding a $1.50 per share cash distribution
paid to stockholders on September 2, 2003, which impacted stock prices
in the third and fourth quarters of 2003 As of March 31, 2004, there were 235 stockholders of record registered
with our transfer agent, Wells Fargo Bank Minnesota, N.A. Because many of
these shares are held by brokers and other institutions on behalf of
stockholders, we are unable to estimate the total number of stockholders
represented by the record holders. As described in Item 1 under Developments Relating to Possible Strategic
Transactions and the Plan of Liquidation, on September 2, 2003 we paid a
return of capital cash distribution to stockholders of record as of August 18,
2003 in the amount of $1.50 per share, or an aggregate of approximately $42.2
million. Other than this special distribution, we have not declared or paid
any cash dividends on our capital stock since our inception. Our board of
directors will determine future dividends, if any, based upon our financial
condition, results of operations, capital requirements, general business
condition and other factors that the board deems relevant. Stockholders should
not expect to receive any future dividend payments. On October 15, 2003, the Nasdaq Stock Market notified us by letter that we
had failed to maintain the $1.00 minimum bid price requirement for continued
listing on the Nasdaq National Market and that, if compliance with this
requirement could not be demonstrated by April 12, 2004, we would be notified
that our common stock would be delisted from the Nasdaq National Market.
Nasdaq subsequently informed us that any such delisting notification will be
deferred until after Nasdaq completes its review of our application to transfer
to the Nasdaq SmallCap Market referred to below. Since September 2, 2003, the
payment date for the special cash distribution to our stockholders of $1.50 per
share, our common stock has not closed at a price exceeding $0.54 per share,
and we do not expect to be able to meet the $1.00 minimum bid price requirement
for continued inclusion on the Nasdaq National Market. We may also be delisted
if we fail to meet Nasdaq National Markets other quantitative listing
requirements or its qualitative standards. On April 5, 2004, we submitted an
application to the Nasdaq Stock Market to transfer to the Nasdaq SmallCap
Market. If our common stock is accepted for listing on the Nasdaq SmallCap
Market, we will have until approximately October 10, 2004 to demonstrate
compliance with the $1.00 minimum bid price requirement. 9




---



##### Table of Contents



ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA In the tables below we provide you with selected historical financial data
of Net Perceptions, which should be read in conjunction with the financial
statements and the notes to the financial statements and Managements
Discussion and Analysis of Financial Condition and Results of Operations,
which are included elsewhere in this report. The statement of operations data
for each of the years in the periods ended December 31, 2003, 2002, and 2001,
and the balance sheet data at December 31, 2003 and 2002, are derived from, and
are qualified by reference to, the audited financial statements included
elsewhere in this report. The statement of operations data for the years ended
December 31, 2000 and 1999 and the balance sheet data at December 31, 2001,
2000, and 1999 are derived from audited financial statements not included in
this report, and have been reclassified to conform with current period
presentation relating to reimbursable expenses that were previously recorded
net to cost of revenue. FIVE YEAR CONSOLIDATED FINANCIAL DATA(1) Year Ended December 31,2003
    
    2002
    
    2001
    
    2000
    
    1999(in thousands, except per share amounts)Statement of Operations DataRevenues:Product
    
    $
    962
    
    
    $
    1,703
    
    
    $
    2,979
    
    
    $
    25,087
    
    
    $
    11,408Service and maintenance
    
    
    1,622
    
    
    
    3,541
    
    
    
    7,535
    
    
    
    12,342
    
    
    
    3,922Total revenues
    
    
    2,584

    
    
    
    5,244
    
    
    
    10,514
    
    
    
    37,429
    
    
    
    15,330Cost of revenues:Product
    
    
    12
    
    
    
    292
    
    
    
    943
    
    
    
    1,807
    
    
    
    286Service and maintenance
    
    
    755
    
    
    
    2,101
    
    
    
    5,143
    
    
    
    11,532
    
    
    
    2,936Total cost of revenues
    
    
    767
    
    
    
    2,393
    
    
    
    6,086
    
    
    
    13,339
    
    
    
    3,222Gross margin
    
    
    1,817
    
    
    
    2,851
    
    
    
    4,428
    
    
    
    24,090
    
    
    
    12,108Operating expenses:Sales and marketing
    
    
    1,347
    
    
    
    4,550
    
    
    
    15,215
    
    
    
    25,589
    
    
    
    12,883Research and development
    
    
    2,112
    
    
    
    5,933
    
    
    
    10,572
    
    
    
    19,354
    
    
    
    8,625General and administrative
    
    
    2,261
    
    
    
    2,819
    
    
    
    6,198
    
    
    
    11,146
    
    
    
    4,005Lease abandonment expense
    
    
    
    
    
    
    
    
    
    
    225
    
    
    
    1,250
    
    
    
    Restructuring related
charges and impairments(2)
    
    
    2,251
    
    
    
    768
    
    
    
    15,551
    
    
    
    
    
    
    
    Amortization of intangibles
    
    
    
    
    
    
    110
    
    
    
    9,650
    
    
    
    25,394
    
    
    
    Impairment of goodwill and
other
intangibles(3)
    
    
    
    
    
    
    6,546
    
    
    
    75,298
    
    
    
    
    
    
    
    Total operating expenses
    
    
    7,971
    
    
    
    20,726
    
    
    
    132,709
    
    
    
    82,733
    
    
    
    25,513Loss from operations
    
    
    (6,154
    )
    
    
    (17,875
    )
    
    
    (128,281
    )
    
    
    (58,643
    )
    
    
    (13,405
    )Other income, net
    
    
    861
    
    
    
    1,141
    
    
    
    4,483
    
    
    
    5,096
    
    
    
    1,366Net loss
    
    $
    (5,293
    )
    
    $
    (16,734
    )
    
    $
    (123,798
    )
    
    $
    (53,547
    )
    
    $
    (12,039
    )Basic and diluted net loss per
share
    
    $
    (0.19
    )
    
    $
    (0.61
    )
    
    $
    (4.59
    )
    
    $
    (2.12
    )
    
    $
    (0.78
    )Shares used in computing
basic and
diluted net loss per share
    
    
    27,683
    
    
    
    27,216
    
    
    
    26,951
    
    
    
    25,209
    
    
    
    15,402Cash distributions paid (4)
    
    $
    1.50
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Balance Sheet DataCash, cash equivalents and
short-term
investments
    
    $
    11,932
    
    
    $
    62,959
    
    
    $
    73,605
    
    
    $
    68,880
    
    
    $
    36,854Working capital
    
    
    11,600
    
    
    
    57,031
    
    
    
    64,321
    
    
    
    66,364
    
    
    
    37,372Total assets
    
    
    12,803
    
    
    
    65,796
    
    
    
    88,878
    
    
    
    211,834
    
    
    
    58,748Long-term liabilities, net of
current portion
    
    
    
    
    
    
    510
    
    
    
    577
    
    
    
    1,951
    
    
    
    707Total stockholders equity
    
    
    11,635
    
    
    
    58,342
    
    
    
    75,407
    
    
    
    198,518
    
    
    
    48,388
 10




---



##### Table of Contents



(1)
    
    The selected consolidated financial data for the years ended December 31,
2003, 2002, 2001 and 2000 include the effects of the acquisition of KD1 in
February 2000, which was accounted for under the purchase method of
accounting. See Note 4 to the Consolidated Financial Statements.(2)
    
    In 2001, we incurred a restructuring related charge of $15.6 million,
consisting of charges relating to facility consolidation and employee
terminations, losses and estimated losses on the disposal of assets and
other restructuring related charges. In 2002, we incurred a restructuring
related charge of $768,000 consisting primarily of charges relating to
employee terminations. In 2003, we incurred a restructuring related
charge of $2.3 million, consisting of charges relating to facility
consolidation, lease terminations and employee terminations. See Note 6
to the Consolidated Financial Statements.(3)
    
    At March 31, 2001, we performed an impairment assessment of the goodwill
and other intangible assets recorded in connection with the acquisition of
KD1. As a result of our review, we recorded a $75.3 million impairment
charge to reduce goodwill and other intangible assets to their estimated
fair values. At December 31, 2002, we performed an additional impairment
assessment of the remaining goodwill and other intangible assets recorded
in connection with the acquisition of KD1. As a result of our review, we
recorded a $6.5 million impairment charge to reduce goodwill and other
intangible assets to zero value. See Note 4 to the Consolidated Financial
Statements.(4)
    
    On September 2, 2003, we paid a return of capital cash distribution to

stockholders of record as of August 18, 2003 in the amount of $1.50 per
share. See Note 9 to the Consolidated Financial Statements. 
 ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The following discussion and analysis should be read in conjunction with
the consolidated financial statements and notes thereto appearing elsewhere in
this report. We were incorporated in Delaware in July 1996, and our initial product was
shipped in January 1997. From inception through late 2000, we expanded our
organization by hiring personnel in key areas, particularly marketing, sales
and research and development. Our total number of employees was 315 on December
31, 2000. During 2001, 2002 and 2003, we instituted certain restructuring plans
to align our cost structure with our business outlook and general economic
conditions. In connection with our restructuring activities, our total number
of employees was reduced to 98 as of December 31, 2001, 52 as of December 31,
2002, and 9 as of December 31, 2003. As of April 13, 2004, the Company has two
employees, both of whom are executive officers. We have sustained losses on a quarterly and annual basis since inception.
As of December 31, 2003, we had an accumulated deficit of $222 million. Our net
loss was $5.3 million for the twelve months ended December 31, 2003, compared
to a net loss of $16.7 million in the same period of the prior year. These
losses resulted from costs incurred in the development and marketing of our
products and services, significant costs incurred related to restructuring
activities, significant costs for outside professional services related to the
exploration of various strategic alternatives for the Company, as well as a
decline in our revenues since the third quarter of 2000. In February 2003, we engaged Piper Jaffray to act as our financial advisor
in connection with the potential sale of the Company. On September 2, 2003, we
paid a return of capital cash distribution to stockholders of record as of
August 18, 2003 in the amount of $1.50 per share or a total of approximately
$42.2 million, which was reflected as a reduction to additional paid-in
capital. We also reduced our workforce by 12 positions to 10 full-time
employees. In addition, as a result of the cash distribution paid on September
2, 2003, our board of directors 11




---



##### Table of Contents



approved an adjustment to our outstanding
options to take effect on the close of business on September 3, 2003. The adjustment was
to in no event reduce the exercise price of any options to less than $0.01 per
share or increase the number of shares subject to such options to a number
exceeding the number of shares of common stock that are registered and
available for issuance. In accordance with FIN 44, Accounting for Certain
Transactions Involving Stock Compensation and interpretation of APB No. 25,
there was no accounting consequence due to the changes made to the exercise
price or the number of shares other than future potential dilution to
stockholders because the aggregate intrinsic value of each award immediately
after the change was not greater than the aggregate intrinsic value of the
award immediately before the change and the ratio of the exercise price per
share to the market value per share was not reduced. On October 21, 2003, we announced that our board of directors had
unanimously approved a Plan of Complete Liquidation and Dissolution, referred
to as the plan of liquidation. The plan of liquidation was submitted to the
Companys stockholders for approval and adoption at a special meeting of
stockholders originally scheduled for March 12, 2004, which was adjourned and
was reconvened on March 23, 2004. At the reconvened special meeting, the
proposal to approve and adopt the plan of liquidation did not receive the
affirmative vote of a majority of the 28,145,338 shares of common stock
outstanding as of the record date for the special meeting required to approve
the proposal. Of the 15,773,134 shares represented in person or by proxy at
the reconvened special meeting, 13,810,233 shares voted in favor of the
proposal, 1,925,694 shares voted against and 37,207 shares abstained. On March 31, 2004, we and Thalveg executed an amendment to the patent
purchase agreement which had been entered into on December 30, 2003, and we
completed the sale of our patent portfolio provided for therein for a purchase
price of $1.8 million in cash. The patent purchase agreement, as amended,
includes a royalty-free, non-exclusive license back to us. The license is
transferable, subject to certain restrictions applicable to the transferee
relating to revenues that can be generated by products covered by the license.
This transaction did not involve any of our other intellectual property rights
or assets, including our proprietary software products. In addition, on March
31, 2004 we announced that we had granted to a software company a non-exclusive
source code license to a portion of the Companys had intellectual property and
sold certain technology related to a product discontinued in 2002. The
aggregate consideration for this sale and license was $325,000. On April 1, 2004, we entered into an agreement with Tornago, Inc., or
Tornago, a corporation formed by three non-officer former employees, to fulfill
existing prepaid customer support obligations in exchange for future cash
payments of approximately $60,000. This amount represents approximately 60% of
the remaining prepaid deferred maintenance revenue amounts under the existing
end user contracts when measured from April 1, 2004. The Company will continue
to recognize the deferred revenue as earned and the $60,000 will be reflected
as cost of revenue. Under the terms of the agreement, Tornago received a
non-transferable license to relevant intellectual property solely to provide
support and consulting services to end users of our products. Under the
agreement, we will receive a 15% royalty on any follow-on services sold by
Tornago through April 1, 2006. In connection with the agreement with Tornago, we terminated the
employment of the remaining members of our engineering staff, effective March
31, 2004, and will pay severance to these employees in accordance with existing
agreements. As of April 13, 2004, the Company has two employees, both of whom
are executive officers. While we expect to continue to service our existing customers through
Tornago and may continue to derive a declining level of revenues from software
licenses and royalties, software maintenance and professional services relating
to existing customers, we are no longer actively marketing or directly
supporting our products and have not retained any employees to do so. We
expect that the size of our customer base will decline and we do not expect
that future product or service revenues, if any, will be significant. We
anticipate that our operating expenses will continue to decline in 2004, but
will continue to constitute a material use of our cash resources. We expect to
incur additional losses and continued negative cash flow for the foreseeable
future. While we expect to report a net profit for the first quarter of 2004
due to the Thalveg transaction, we do not expect to generate an operating
profit for 2004 or the foreseeable future. 12




---



##### Table of Contents



We anticipate that our board of directors will continue to review and
consider possible actions or transactions which might be available to resolve
the Companys future in the near term in the best interest of all stockholders.
These could include, among other actions or transactions, further sales or
licenses of assets, an acquisition of or investment in the Company or other
extraordinary transaction, adopting a new plan of complete liquidation and
dissolution and seeking shareholder approval therefor, and/or changes in the
composition of our board of directors. Period-to-period comparisons of our operating results should not be relied
upon as predictive of future performance. Our prospects must be considered in
light of the foregoing and the risks identified below under the heading Risks
That May Affect Future Results. We may not be successful in addressing these
risks. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Our discussion and analysis of financial condition and results of
operations is based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. On an on-going basis, we evaluate our estimates, including
those related to bad debts, investments, intangible assets, restructuring
liabilities, contingencies and litigation. We base our estimates on historical
experience and on various other assumptions that are believed to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions. We believe the following critical accounting policies affect significant
judgments and estimates used in the preparation of our consolidated financial
statements. Events occurring subsequent to the preparation of the consolidated
financial statements, such as those described in the section of this report
entitled Managements Discussion and Analysis of Financial Condition and
Results of Operations  Overview, may cause us to re-evaluate these policies. Revenue Recognition.Our revenues are recognized in accordance with the
American Institute of Certified Public Accountants Statement of Position
(SOP) 97-2, Software Revenue Recognition, as amended by SOP 98-4 and SOP
98-9, as well as Technical Practice Aids issued from time to time by the
American Institute of Certified Public Accountants and in accordance with the
Securities and Exchange Commission Staff Accounting Bulletin (SAB) No. 104,
Revenue Recognition in Financial Statements. We derive revenues from software
licenses, software maintenance and professional services. Maintenance includes
telephone and Web-based technical support, bug fixes and rights to unspecified
upgrades on a when-and-if available basis. Professional services include
project planning, implementation and testing, consulting, and ongoing customer
support. For software arrangements that include multiple software products,
maintenance or services, we allocate the total arrangement fee using the
residual method. Under the residual method, the fair value of the undelivered
maintenance and services elements, as determined by vendor-specific objective
evidence, is deferred and the remaining (residual) arrangement fee is
recognized as software product revenue. For software arrangements in which we
do not have vendor-specific objective evidence of undelivered elements, revenue
is deferred until the earlier of when vendor-specific objective evidence is
determined for the undelivered elements or when all elements for which we do
not have vendor-specific objective evidence have been delivered. Revenues from license fees are recognized when a non-cancelable agreement
has been executed, the product has been shipped or electronically delivered,
there are no uncertainties surrounding product acceptance, the fee is fixed or
determinable and collection of the related receivable is considered probable.
If the fee due from the customer is not fixed or determinable, revenues are
recognized as payments become due from the customer. If we do not consider
collection to be probable, then revenues are recognized when the fee is
collected. 13




---



##### Table of Contents



License revenues related to license terms of less than twenty-four months
are recognized ratably over the term of the license period. When we offer
products and services on a hosted basis, up front set-up fees are deferred and
recognized ratably over the estimated service period. We recognize revenues allocable to maintenance ratably over the term of
the agreement. We evaluate arrangements that include professional and/or data
processing services to determine whether those services are essential to the
functionality of other elements of the arrangement. If services are considered
essential, revenues from the arrangement are recognized using contract
accounting, generally on a percentage-of-completion basis. When we do not
consider the professional services to be essential, we recognize the revenues
allocable to the services as they are performed. Revenue recognition rules for software companies are very complex. We
follow specific and detailed guidelines in determining the proper amount of
revenue to be recorded; however, certain judgments affect the application of
our revenue recognition policy. The most significant judgments for revenue recognition typically involve
whether there are any significant uncertainties regarding customer acceptance
and whether collectibility can be considered probable. In addition, our
transactions often consist of multiple element arrangements that must be
analyzed to determine the relative fair value of each element, the amount of
revenue to be recognized upon shipment, if any, and the period and conditions
under which deferred revenue should be recognized. Allowance for doubtful accounts.We maintain allowances for doubtful
accounts for estimated losses resulting from the inability of our customers to
make required payments. If the financial condition of our customers were to
deteriorate, resulting in an impairment of their ability to make payments,
additional allowances may be required. Actual collection results could differ
materially from those estimated and have a significant impact on our
consolidated financial statements. Litigation.We have not recorded an estimated liability related to the
pending class action lawsuit in which we are named. For a discussion of this
matter, see the section of this report entitled Legal Proceedings. Due to the
uncertainties related to both the likelihood and the amount of any potential
loss, no estimate was made of the liability that could result from an
unfavorable outcome. As additional information becomes available, we will
assess the potential liability and make or revise our estimate(s) accordingly,
which could materially impact our results of operations and financial position. RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001 The following table sets forth certain items in our statements of
operations as a percentage of total revenues for the periods indicated: Year Ended December 31,2003
    
    2002
    
    2001Revenues:Product
    
    
    37
    %
    
    
    32
    %
    
    
    28
    %Service and maintenance
    
    
    63
    
    
    
    68
    
    
    
    72Total revenues
    
    
    100
    
    
    
    100
    
    
    
    100Cost of revenues:Product
    
    
    1
    
    
    
    6
    
    
    
    9Service and maintenance
    
    
    29
    
    
    
    40
    
    
    
    49Total cost of revenues
    
    
    30
    
    
    
    46
    
    
    
    58Gross margin
    
    
    70
    
    
    
    54
    
    
    
    42Operating expenses:Sales and marketing
    
    
    52
    
    
    
    87
    
    
    
    145Research and development
    
    
    82
    
    
    
    113
    
    
    
    101General and administrative
    
    
    87
    
    
    
    54
    
    
    
    58
 14




---



##### Table of Contents



Year Ended December 31,2003
    
    2002
    
    2001Lease abandonment expense
    
    
    
    
    
    
    
    
    
    
    2Restructuring related charges and impairments
    
    
    87
    
    
    
    14
    
    
    
    148Amortization of intangibles
    
    
    
    
    
    
    2
    
    
    
    92Impairment of goodwill and other intangibles.
    
    
    
    
    
    
    125
    
    
    
    716Total operating expenses
    
    
    308
    
    
    
    395
    
    
    
    1,262Loss from operations
    
    
    (238
    )
    
    
    (341
    )
    
    
    (1,220
    )Other income, net
    
    
    33
    
    
    
    22
    
    
    
    43Net loss
    
    
    (205
    )%
    
    
    (319
    )%
    
    
    (1,177
    )%
 REVENUES Total revenues. Total revenues decreased 51% to $2.6 million for the year
ended December 31, 2003, from $5.2 million in 2002. Revenues declined 50% in
2002 from $10.5 million in 2001. Revenues from sales in the United States were
$2.3 million in 2003 compared to $4.5 million in 2002 and $8.5 million in 2001
representing 89%, 86% and 80% of total revenues respectively. Revenues from
international sales in 2003 were $284,000, or 11% of total revenues, compared
to $719,000, or 14% of total revenues, in 2002 and $2.0 million, or 20% of
total revenues, in 2001. As a result of the downsizing of our business and
operations, we no longer maintain a direct sales force. International sales
have generally been denominated in United States dollars. As described in this Item 7 under Overview, we are no longer actively
marketing our products, and we do not expect that future product or service
revenues, if any, will be significant. Product revenues. Product revenues decreased 44% to $962,000 for the year
ended December 31, 2003, compared to $1.7 million for the year ended December
31, 2002. Product revenues declined 43% in 2002 from $3.0 million in 2001.
Product revenues comprised 37% of total revenues for 2003 compared to 32% and
28% for 2002 and 2001 respectively. The decrease in product revenues in
absolute dollars is attributable in part to increased deferral of purchase
decisions by our then current and potential customers due to economic
conditions, concerns about our ability to support products in the future,
elections to utilize alternatives to our products and reduced selling
activities. We expect limited product revenues for the foreseeable future. Service and maintenance revenues.Service and maintenance revenues
consist primarily of professional and maintenance services. Our professional
service revenues include business consulting, implementation support, and
educational services and are generally offered on a time and materials basis.
Maintenance revenues are generally derived from annual service agreements and
are recognized ratably over the term of the agreement. Service and maintenance
revenues decreased 54% to $1.6 million for the year ended December 31, 2003
from $3.5 million for the year ended December 31, 2002. Service and
maintenance revenues decreased 53% in 2002 from $7.5 million in 2001. Service
and maintenance revenues comprised 63%, 68% and 72% of total revenues for the
years ended December 31, 2003, 2002 and 2001, respectively.The decrease in
service and maintenance revenues in absolute dollars reflected lower levels of
consulting and maintenance services due to the combined effect of fewer new
customer acquisitions and a decline in our customer base, as well as customer
perceptions about our ability to support our products in the future. As
described in this Item 7 under Overview, we entered into an agreement on
April 1, 2004 with Tornago, Inc. to fulfill our existing prepaid customer
support obligations. We do not anticipate entering into additional service and
maintenance agreements with customers. Therefore, we expect service and
maintenance revenues to continue to decline in 2004. COST OF REVENUES Cost of product revenues. Cost of product revenues consists primarily of
the cost of royalties paid to third-party vendors and amortization of acquired
technology costs. Cost of product revenues decreased 96% to $12,000 for the
year ended December 31, 2003 from $292,000 for the year ended December 31,
2002. Cost of product revenue decreased 69% in 2002 from $943,000 million in
2001. Cost of product 15




---



##### Table of Contents



revenue in 2003, 2002 and 2001 represented 1%, 17% and 32% of the product
revenues, respectively. The decrease in cost of product revenues in absolute
dollars is due to lower royalties payable to third parties and no amortization
expense related to intangible assets in the first nine months of 2003. Since
all internal development costs incurred in the research and development of new
software products and enhancements to existing software products have been
expensed as incurred, cost of product revenues includes no amortization of
capitalized software development costs. We do not expect any future costs of
product revenues to be significant. Cost of service and maintenance revenues. Cost of service and maintenance
revenues consists primarily of personnel-related and infrastructure costs
incurred in providing telephone and Web-based support of our software products,
as well as professional, consulting and educational related services to
customers. Cost of service and maintenance revenues decreased 64% to $755,000
for the year ended December 31, 2003 from $2.1 million for the year ended
December 31, 2002. Cost of service and maintenance revenue decreased 59% in
2002 from $5.1 million in 2001. Cost of service and maintenance revenue in
2003, 2002 and 2001 represented 47%, 59% and 68% of the related service and
maintenance revenues, respectively. The decrease in cost of services and
maintenance revenues in absolute dollars and as a percentage of revenues is
primarily due to continued headcount reductions in our technical organization
as a result of our restructuring efforts and significantly decreased use of
third-party consultants to staff consulting engagements. Due to the further
headcount reductions undertaken in August 2003 and thereafter, and, as
described above in this Item 7 under Overview, because we entered into a
contract with Tornago to fulfill certain prepaid support obligations and in
connection therewith terminated the employment of the remaining members of our
engineering staff, we expect that our cost of service and maintenance revenues
will decrease in 2004. OPERATING EXPENSES In the first quarter of 2003, we reduced our operating expenses through
the closure of three remote offices and a reduction in workforce affecting 22
employees. On August 6, 2003, we reduced our workforce by an additional 12
employees. At December 31, 2003 we had 9 full-time employees, which was
determined to be the minimum number necessary at that time to serve customers,
preserve the value of our intellectual property and administer our limited
ongoing business affairs. As described in this Item 7 under Overview, we are
no longer actively marketing our products and do not expect to incur
significant operating expenses in 2004 relating to sales and marketing. Also
as described above in this Item 7 under Overview, at a reconvened special
meeting of the Companys stockholders held on March 23, 2004, the proposal to
approve and adopt the plan of liquidation did not receive the affirmative vote
of a majority of the total number of shares outstanding as of the record date
for the special meeting required to approve the proposal. We anticipate that
our board of directors will continue to review and consider possible actions or
transactions which might be available to resolve the Companys future in the
near term in the best interest of all stockholders. These could include, among
other actions or transactions, further sales or licenses of assets, an
acquisition of or investment in the Company or other extraordinary transaction,
adopting a new plan of complete liquidation and dissolution and seeking
stockholder approval therefor, and/or changes in the composition of our board
of directors. We anticipate that this ongoing review and consideration may
entail significant expenses, consisting principally of professional fees and
expenses. Sales and marketing. Sales and marketing expenses consisted primarily of
salaries, other employee-related costs, commissions and other incentive
compensation, travel and entertainment and expenditures for marketing programs
such as collateral materials, trade shows, public relations and creative
services. Sales and marketing expenses decreased 70% to $1.3 million for the
year ended December 31, 2003 compared to $4.6 million recorded for the year
ended December 31, 2002. Sales and marketing expenses decreased 70% in 2002
compared to $15.2 million in 2001. Sales and marketing expenses were 52%, 87%
and 145% of total revenues for the years ended December 31, 2003, 2002 and
2001, respectively. The decrease in sales and marketing expenses in absolute
dollars is primarily due to headcount reductions as a result of our
restructuring efforts and our decision to no longer actively market our
products. We expect sales and marketing expenses will be minimal, if any, in
2004. 16




---



##### Table of Contents



Research and development. Research and development expenses consist
primarily of salaries, other employee-related costs and consulting fees related
to the development of our products. Research and development expenses decreased
64% to $2.1 million for the year ended December 31, 2003 compared to $5.9
million for the year ended December 31, 2002. Research and development expenses
decreased 44% in 2002 compared to $10.6 million in 2001. Research and
development expenses were 82%, 113 % and 101% of total revenues for the years
ended December 31, 2003, 2002 and 2001, respectively. The decrease in research
and development expenses in absolute dollars is primarily due to continued
headcount reductions as a result of our restructuring efforts. As described
above in this Item 7 under Overview, we terminated the employment of the
remaining members of our engineering staff effective March 31, 2004. We expect
to incur no further research and development expenses after that date. General and administrative. General and administrative expenses consist
primarily of salaries, other employee-related costs, provision for doubtful
accounts and professional service fees. General and administrative expenses
decreased 20% to $2.2 million for the year ended December 31, 2003 compared to
$2.8 million for the year ended December 31, 2002. General and administrative
expenses decreased 55% in 2002 compared to $6.2 million in 2001. General and
administrative expenses were 87%, 54% and 58% of total revenue for the years
ended December 31, 2003, 2002 and 2001, respectively. The decrease in general
and administrative expenses in absolute dollars during the year ended December
31, 2003 was primarily due to headcount reductions as part of our restructuring
efforts, offset by increased professional fees associated with the settlement
or other resolution of our existing obligations and liabilities, our continued
exploration of asset dispositions, and our continued consideration and
evaluation of strategic alternatives. Although we expect personnel-related and
other general and administrative expenses to decline in 2004, continued high
levels of outside professional fees, and other costs, such as directors and
officers liability insurance, associated with continuing as a public reporting
company, may offset any such decrease. Restructuring related charges and impairments.During 2003, 2002 and
2001, we instituted certain restructuring plans to better align our cost
structure with our business outlook and general economic conditions. Under the
restructuring plans, we recorded restructuring related charges totaling $2.3
million, $768,000 and $15.6 million during 2003, 2002 and 2001, respectively.
These amounts represented 87%, 14% and 148% of total revenues for the years
ended December 31, 2003, 2002 and 2001, respectively. Substantially all
restructuring related charges had been paid as of December 31, 2003. Amortization of intangibles.Amortization expense was $0 for the year
ended December 31, 2003. This is compared to $257,000 and $10.1 million
(including $147,000 and $443,000 of amortization and goodwill and other
intangibles included in cost of product revenues) for the years ended December
31, 2002 and 2001 respectively. These amounts represented 0%, 5% and 96% of
total revenues for the years ended December 31, 2003, 2002 and 2001,
respectively. Total amortization is expected to be $0 during 2004 due to the
$6.5 million impairment charge recorded in the fourth quarter of 2002 to reduce
goodwill and other intangible assets to zero value. Other income, net. Other income, net, consists of interest income,
interest expense, foreign currency transaction losses or gains and other
expense. Net other income decreased 25% in 2003 to $861,000 from $1.1 million
in 2002. Net other income decreased 75% in 2002 compared to $4.5 million in
2001. The decrease in net other income for the year ended December 31, 2003
compared to the same period in 2002 was primarily due to lower cash and
investment balances as a result of the special cash distribution to
stockholders on September 2, 2003 and lower interest rates. The decrease in
net other income for 2002 compared to 2001 was attributable to a decrease in
interest income earned and the $1.6 million loss on investment resulting from
our sale of $2.1 million in WorldCom bonds upon announcement of accounting
issues by WorldCom, offset against $200,000 received as a result of a related
dispute settlement. PROVISION FOR INCOME TAXES We have incurred significant operating losses for all periods from
inception through December 31, 2003. For income tax purposes, the Company has
available federal net operating loss carry-forwards of approximately $119
million and research and development credit 17




---



##### Table of Contents



carry-forwards of approximately $151,000 at December 31, 2003. The net operating loss and research and
development credit carry-forwards expire in 2011 through 2023 if not previously
utilized. The utilization of these carry-forwards may be subject to limitations
based on past and future changes in ownership of the Company pursuant to
Internal Revenue Code Section 382. If the Company were to be acquired at its
recent stock value such that Section 382 is applicable, this would eliminate
the ability to use a substantial majority of these carry-forwards. Further, if
our historic business were not substantially continued for two years after a
Section 382 change in ownership, the full amount of carry-forwards would be
eliminated. Future tax benefits have not been recognized in the financial
statements, as their utilization is not considered probable based on the weight
of available information. SELECTED CONSOLIDATED QUARTERLY OPERATING RESULTS The following table sets forth quarterly unaudited financial data for 2003
and 2002, as well as the percentage of our total revenues represented by each
item. This unaudited financial data has been prepared on the same basis as the
audited financial statements included in this report and includes all
adjustments, consisting only of normal recurring accruals that are considered
necessary for a fair presentation of such information when read in conjunction
with our audited financial statements and notes thereto appearing elsewhere in
this report. You should not draw any conclusions from the operating results for
any quarter. Dec. 31
    
    Sept. 30
    
    June 30
    
    March 31
    
    Dec. 31
    
    Sept. 30
    
    June 30
    
    March 312003
    
    2003
    
    2003
    
    2003
    
    2002
    
    2002
    
    2002
    
    2002(Amounts in thousands, except per share amounts)(Unaudited)Results of Operations:Revenues:Product
    
    $
    386
    
    
    $
    95
    
    
    $
    343
    
    
    $
    138
    
    
    $
    145
    
    
    $
    613
    
    
    $
    902
    
    
    $
    43Service and maintenance
    
    
    231
    
    
    
    343
    
    
    
    570
    
    
    
    478
    
    
    
    748
    
    
    
    999
    
    
    
    697
    
    
    
    1,097Total revenues
    
    
    617
    
    
    
    438
    
    
    
    913
    
    
    
    616
    
    
    
    893
    
    
    
    1,612
    
    
    
    1,599
    
    
    
    1,140Cost of revenues:Product
    
    
    4
    
    
    
    
    
    
    
    8
    
    
    
    
    
    
    
    38
    
    
    
    68
    
    
    
    63
    
    
    
    123Service and maintenance
    
    
    120
    
    
    
    164
    
    
    
    255
    
    
    
    216
    
    
    
    319
    
    
    
    473
    
    
    
    539
    
    
    
    770Total cost of revenues
    
    
    124
    
    
    
    164
    
    
    
    263
    
    
    
    216
    
    
    
    357
    
    
    
    541
    
    
    
    602
    
    
    
    893Gross margin
    
    
    493
    
    
    
    274
    
    
    
    650
    
    
    
    400
    
    
    
    536
    
    
    
    1,071
    
    
    
    997
    
    
    
    247Operating expenses:Sales and marketing
    
    
    3
    
    
    
    157
    
    
    
    481
    
    
    
    706
    
    
    
    940
    
    
    
    753
    
    
    
    1,376
    
    
    
    1,481Research and development
    
    
    496
    
    
    
    427
    
    
    
    524
    
    
    
    665
    
    
    
    1,136
    
    
    
    1,213
    
    
    
    1,624
    
    
    
    1,960General and administrative
    
    
    981
    
    
    
    568
    
    
    
    276
    
    
    
    436
    
    
    
    628
    
    
    
    514
    
    
    
    935
    
    
    
    742Lease abandonment expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Restructuring related charges and
impairments
    
    
    
    
    
    
    1,051
    
    
    
    
    
    
    
    1,200
    
    
    
    
    
    
    
    
    
    
    
    401
    
    
    
    367Amortization of intangibles
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    27
    
    
    
    28
    
    
    
    27
    
    
    
    28Impairment of goodwill and
other intangibles
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,546
    
    
    
    
    
    
    
    
    
    
    
    Total operating expenses
    
    
    1,480
    
    
    
    2,203
    
    
    
    1,281
    
    
    
    3,007
    
    
    
    9,277
    
    
    
    2,508
    
    
    
    4,363
    
    
    
    4,578Loss from operations
    
    
    (987
    )
    
    
    (1,929
    )
    
    
    (631
    )
    
    
    (2,607
    )
    
    
    (8,741
    )
    
    
    (1,437
    )
    
    
    (3,366
    )
    
    
    (4,331
    )Other income (expense), net
    
    
    22
    
    
    
    216
    
    
    
    415
    
    
    
    208
    
    
    
    443
    
    
    
    811
    
    
    
    (972
    )
    
    
    859Net loss
    
    $
    (965
    )
    
    $
    (1,713
    )
    
    $
    (216
    )
    
    $
    (2,399
    )
    
    $
    (8,298
    )
    
    $
    (626
    )
    
    $
    (4,338
    )
    
    $
    (3,472
    )Basic and diluted net loss per
share
    
    $
    (0.03
    )
    
    $
    (0.06
    )
    
    $
    (0.01
    )
    
    $
    (0.09
    )
    
    $
    (0.30
    )
    
    $
    (0.02
    )
    
    $
    (0.16
    )
    
    $
    (0.13
    )
 18




---



##### Table of Contents



Dec. 31
    
    Sept. 30
    
    June 30
    
    March 31
    
    Dec. 31
    
    Sept. 30
    
    June 30
    
    March 312003
    
    2003
    
    2003
    
    2003
    
    2002
    
    2002
    
    2002
    
    2002(Amounts in thousands, except per share amounts)(Unaudited)Percentage of Total RevenuesRevenues:Product
    
    
    62
    %
    
    
    22
    %
    
    
    38
    %
    
    
    22
    %
    
    
    16
    %
    
    
    38
    %
    
    
    56
    %
    
    
    4
    %Service and maintenance
    
    
    38
    
    
    
    78
    
    
    
    62
    
    
    
    78
    
    
    
    84
    
    
    
    62
    
    
    
    44
    
    
    
    96Total revenues
    
    
    100
    
    
    
    100
    
    
    
    100
    
    
    
    100
    
    
    
    100
    
    
    
    100
    
    
    
    100
    
    
    
    100Cost of revenues:Product
    
    
    1
    
    
    
    
    
    
    
    1
    
    
    
    
    
    
    
    4
    
    
    
    4
    
    
    
    4
    
    
    
    11Service and maintenance
    
    
    19
    
    
    
    37
    
    
    
    28
    
    
    
    35
    
    
    
    36
    
    
    
    30
    
    
    
    34
    
    
    
    67Total cost of revenues
    
    
    20
    
    
    
    37
    
    
    
    29
    
    
    
    35
    
    
    
    40
    
    
    
    34
    
    
    
    38
    
    
    
    78Gross margin
    
    
    80
    
    
    
    63
    
    
    
    71
    
    
    
    65
    
    
    
    60
    
    
    
    66
    
    
    
    62
    
    
    
    22Operating expenses:Sales and marketing
    
    
    
    
    
    
    36
    
    
    
    53
    
    
    
    115
    
    
    
    105
    
    
    
    47
    
    
    
    86
    
    
    
    130Research and development
    
    
    81
    
    
    
    97
    
    
    
    57
    
    
    
    108
    
    
    
    127
    
    
    
    75
    
    
    
    101
    
    
    
    172General and administrative
    
    
    159
    
    
    
    130
    
    
    
    30
    
    
    
    71
    
    
    
    71
    
    
    
    31
    
    
    
    58
    
    
    
    65Lease abandonment expense .
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Restructuring related charges and
impairments
    
    
    
    
    
    
    240
    
    
    
    
    
    
    
    194
    
    
    
    
    
    
    
    
    
    
    
    25
    
    
    
    32Amortization of intangibles
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3
    
    
    
    2
    
    
    
    2
    
    
    
    3Impairment of goodwill and
other intangibles
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    733
    
    
    
    
    
    
    
    
    
    
    
    Total operating expenses
    
    
    240
    
    
    
    503
    
    
    
    150
    
    
    
    488
    
    
    
    1,039
    
    
    
    155
    
    
    
    272
    
    
    
    402Loss from operations
    
    
    (160
    )
    
    
    (440
    )
    
    
    (69
    )
    
    
    (423
    )
    
    
    (979
    )
    
    
    (89
    )
    
    
    (210
    )
    
    
    (380
    )Other income (expense), net
    
    
    3
    
    
    
    49
    
    
    
    45
    
    
    
    34
    
    
    
    50
    
    
    
    50
    
    
    
    (61
    )
    
    
    75Net loss
    
    
    (157
    )%
    
    
    (391
    )%
    
    
    (24
    )%
    
    
    (389
    )%
    
    
    (929
    )%
    
    
    (39
    )%
    
    
    (271
    )%
    
    
    (305
    )%
 LIQUIDITY AND CAPITAL RESOURCES Since inception, we have financed our operations primarily through the
sale of equity securities. At December 31, 2003, we had $11.9 million of cash,
cash equivalents and short-term investments, compared to $63.0 million at
December 31, 2002. This significant reduction was primarily due to the special
cash distribution paid on September 2, 2003 to record holders of our common
stock on August 18, 2003 in the aggregate amount of approximately $42.2
million. Cash used in operations was $9.4 million for the twelve months ended
December 31, 2003, compared to $9.8 million for 2002 and $22.3 million for
2001. Cash used in operations for all periods resulted primarily from net
losses, as adjusted for non-cash expenses. In addition, in 2003 the Company
used $5.4 million to terminate its obligations under three real estate leases.
The decrease in cash used in operations in the twelve months of 2003 as
compared to the same period in 2002 is principally a function of the reduced
operating expenses and cost of revenues that have resulted from the
restructuring plans described below, as adjusted for non-cash expenses. We do
not expect to receive any significant amounts of cash from future operations,
and we expect that we will continue to incur legal fees, salary expenses and
other ongoing costs that will constitute a material use of cash. A total of $22.9 million in net cash was provided by investing activities
for the twelve months ended December 31, 2003, compared to $34.6 million of
cash provided from investing activities in the same period for 2002. Prior to
September 2003, our investing activities consisted primarily of net purchases
of short-term investments and marketable securities. Since the special cash
distribution paid on September 2, 2003, we have held all of our cash in money
market accounts and we plan to continue this policy. 19




---



##### Table of Contents



Net cash used in financing activities was $41.3 million for the twelve
months ended December 31, 2003, compared to net cash generated in investing
activities of $33,000 for 2002 and net cash used of $498,000 for 2001. Net
cash was used in financing activities during 2003 due to the $42.2 million cash
distribution paid on September 2, 2003, partially offset by proceeds from sales
of our common stock pursuant to the exercise of options. Net cash in financing
activities in 2002 and 2001 was primarily attributable to proceeds from sales
of our common stock pursuant to the exercise of options, offset by principal
payments on capital leases in 2001. As described in Item 1 under Developments Relating to Possible strategic
Transactions and Plan of Liquidation, on September 2, 2003, we paid a return
of capital cash distribution to stockholders of record as of August 18, 2003 in
the amount of $1.50 per share, or an aggregate amount of approximately $42.2
million. During 2003, 2002 and 2001, we instituted certain restructuring plans to
better align our cost structure with our business outlook and general economic
conditions. Under the restructuring plans, we recorded restructuring related
charges totaling $2.3 million, $768,000 and $15.6 million during 2003, 2002 and
2001, respectively. A total of approximately $6.9 million was charged against
the restructuring reserve during 2003, lowering the accrued restructuring
liability to approximately $37,000. Of the $37,000 restructuring reserve remaining as of December 31, 2003,
management estimates that approximately $30,000 will be a use of cash in 2004
for remaining rent commitments, less estimated sublease income, related to
facilities we have vacated. The remaining $7,000 relates to accrued severance
benefits for a former executive officer. Capital expenditures were $0 for the twelve months ended December 31, 2003
and 2002. Capital expenditures were higher in years prior to 2002 and
reflected a significantly larger employee base and level of operations. As of
December 31, 2003, we had no material long-term commitments for capital
expenditures and we do not anticipate entering into any further material
commitments for capital expenditures. Since 1999, we have purchased property
and equipment with cash. From inception through 1998, we generally funded the
purchase of property and equipment with capital leases. Our remaining commitments consist primarily of obligations under one
operating lease. The following summarizes this contractual lease obligation at
December 31, 2003. 2004
    
    Total(in thousands)Operating leases
    
    $
    89
    
    
    $
    89Executed sublease agreements
    
    
    (59
    )
    
    
    (59
    )Net contractual cash obligation
    
    $
    30
    
    
    $
    30
 The operating lease obligation relates to one remaining vacated facility
in San Francisco, California, the majority of which is sublet. We are actively
seeking to sublease the remaining vacant portion of this office space and are
also attempting to negotiate the termination of this lease. We currently
occupy approximately 1,500 square feet of office space pursuant to a
month-to-month lease in Edina, Minnesota. As of December 31, 2003, we
estimated total future sublease income of $59,000 pursuant to existing sublease
arrangements. We believe that existing cash and investments will be sufficient to meet
our expected working capital needs for the next twelve months. However,
uncertainties exist as to the amounts we will receive in connection with any
potential sales of assets and the precise value of our existing obligations and
liabilities, which may exceed our available cash and cash equivalents.
Furthermore, we may be unable to settle or 20




---



##### Table of Contents



otherwise resolve our remaining obligations and liabilities, and we may
incur or be subject to additional obligations and liabilities, which could
collectively exceed our available cash and cash equivalents. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS In January 2003, the FASB issued Interpretation No. (FIN) 46,
Consolidation of Variable Interest Entities, an Interpretation of Accounting
Research Bulletin No. 51. FIN No. 46 requires certain variable interest
entities, or VIEs, to be consolidated by the primary beneficiary of the entity
if the equity investors in the entity do not have the characteristics of a
controlling financial interest, or do not have sufficient equity at risk for
the entity to finance its activities without additional subordinated financial
support from other parties. In December 2003, the FASB issued FIN No. 46-R,
Consolidation of Variable Interest Entities, which represents a revision to
FIN No. 46. The provisions of FIN No. 46-R are effective for interests in VIEs
as of the first interim or annual period ending after December 15, 2003. The
Company currently has no contractual relationship or other business
relationship with a variable interest entity and therefore the adoption of FIN
No. 46 and FIN No. 46-R did not have a material effect on our consolidated
financial position, results of operations or cash flows. CERTAIN RISK FACTORS The risks and uncertainties described below are not the only ones we face.
Additional risks and uncertainties not presently known to us or which are
currently deemed immaterial may also impair our financial condition. If any of
these risks actually occur, our financial condition could be materially
adversely affected. We Have Significantly Curtailed Business Operations, But Our Future Course of
Action is Uncertain, and Accordingly, the Value of Your Shares May Decrease We have significantly curtailed our business operations. We anticipate
that our board of directors will continue to review and consider possible
actions or transactions which might be available to resolve the Companys
future in the near term in the best interest of all stockholders. These could
include, among other actions or transactions, further sales or licenses of assets, an
acquisition of or investment in the Company or other extraordinary transaction,
adopting a new plan of complete liquidation and dissolution and seeking
stockholder approval therefor, and/or changes in the composition of our board
of directors. We expect to continue to incur operating, legal
and other expenses, which will decrease
our net cash and thus the potential value of the Company. Even if we identify
such actions or one or more
transactions as an appropriate strategy to resolve the Companys future in the
near term in the best interests of our stockholders, we cannot assure you that
we will be able to take or complete such actions or transaction(s), especially any
transaction which would require stockholder approval. Nor can we assure you
that any such action or transaction would result in a positive return on your
investment, and may in fact result in a substantial decrease in the value of
your stock. These factors substantially increase the uncertainty, and thus the
risk, of investing in our shares. You should also not expect any further cash
distributions. We do not expect to
generate an operating profit for the foreseeable future. We had net losses of $5.0 million in 1998, $12.0 million in 1999, $53.5
million in 2000 (including $27.6 million of amortization of goodwill and other
intangibles related to the acquisition of KD1 and non-cash stock compensation
expense) and $123.8 million for the year ended December 31, 2001 (including
$15.6 million in restructuring related charges, $10.3 million of amortization
of goodwill and other intangibles and non-cash stock compensation expense and a
$75.3 million charge for the impairment of goodwill and other intangibles). Our
net loss was $16.7 million for the year ended December 31, 2002 (including
$768,000 in restructuring related charges, $299,000 of amortization of
intangibles and non-cash stock compensation expense and a $6.5 million charge
for the impairment of goodwill and other 21




---



##### Table of Contents



intangibles) and $5.3 million for
the
year ended December 31, 2003). As of December 31, 2003, we had an accumulated deficit of $222 million. As described in the section of this
report entitled Managements Discussion and Analysis of Financial Condition
and Results of Operations  Overview, we have ceased to actively market our
products and we do not expect to generate significant future operating
revenues. We do not expect to generate an operating profit for 2004 or the foreseeable future. Our Ability to Operate or Carry-Out Any Strategy To Resolve the Companys
Future Will Be Substantially Impaired If We Lose Our Employees. As of March 31, 2004, we had two remaining employees, each of
whom is an executive officer. The loss of the services of either of such
persons, in particular, the cessation of employment of our President and Chief
Financial Officer, Thomas M. Donnelly, would seriously harm our ability to
operate or implement any strategy to resolve the Companys future. We cannot
assure you that either or both of the Companys executive officers will remain
with the Company. Certain Transactions May Impair or Eliminate Utilization of our Net Operating
Loss Carryforwards As noted above under We Have Significantly Curtailed Business Operations
But Our Future Course of Action is Uncertain, and Accordingly, the Value of
Your Shares May Decrease, the possibilities for resolving the Companys future
in the near term may include an acquisition of the Company through a merger or
other business combination. If we effect a combination with a business that has operating
income, we cannot assure you that we will be able to utilize all or even a
portion of our existing net operating loss carry-forwards for federal tax
purposes following such a business combination. If the Company were to be
acquired at its recent stock value such that the limitations under Section 382
of the Internal Revenue Code of 1986, as amended, are applicable, this would
eliminate the ability to use a substantial majority of these carry-forwards.
Further, if our historic business were not substantially continued for two
years after a Section 382 change in ownership, the full amount of
carry-forwards would be eliminated. If we are unable to make use of our
existing net operating loss carry-forwards, the tax advantages of such a
combination may be limited, which could negatively impact the price of our
stock and the value of your investment. These factors substantially increase
the uncertainty, and thus the risk, of investing in our shares. We may be unable to realize additional proceeds from sale(s) of our remaining
assets. As described in Item 1 above under Recent Events, on March 31, 2004, we
sold our patent portfolio for a purchase price of $1.8 million in cash pursuant
to a patent purchase agreement entered into in December 2003 and amended as of
March 31, 2004. The patent purchase agreement includes a royalty-free
non-exclusive license back to the Company under the transferred patents, patent
licenses and pending patent applications. The license back to the Company is
transferable, subject to certain restrictions applicable to the transferee
relating to revenues which can be generated by products covered by the license.
This transaction did not involve any of our other intellectual property rights
or assets, including our proprietary software product NetP7. However, we are
unable to predict whether any such rights or assets will be sold or, if such
sale(s) occur, the terms of such sale(s). The price(s) at which we may be able
to sell these assets will depend largely on factors beyond our control,
including, without limitation, the extent of actual or perceived competition
between, and the availability of financing for, prospective purchasers of the
assets and such prospective purchasers plans for our intellectual property and
products as integrated into their existing businesses. In addition, because
some of these remaining assets may decline in value over time, we may not be
able to consummate the sale of these assets in time to generate meaningful
value. Investors should not assume that we will be able to realize additional
proceeds from sale(s) of our remaining assets. Our Common Stock may be Delisted from Nasdaq. On October 15, 2003, the Nasdaq Stock Market notified us by letter that we
had failed to maintain the $1.00 minimum bid price requirement for continued
listing on the Nasdaq National Market and that, if compliance with this
requirement could not be demonstrated by April 12, 2004, we would be notified
that our common stock would be delisted from the Nasdaq National Market.
Nasdaq subsequently informed us 22




---



##### Table of Contents



that any such delisting notification will be deferred until after Nasdaq
completes its review of our application to transfer to the Nasdaq SmallCap
Market referred to below. Since September 2, 2003, the date on which the
special cash distribution to our stockholders of $1.50 per share was paid, our
common stock has not closed over $0.54 per share, and we do not expect to be
able to again meet the $1.00 minimum bid price requirement for continued
inclusion on the Nasdaq National Market. We may also be delisted if we fail to
meet Nasdaq National Markets other quantitative listing requirements or its
qualitative standards. In addition, termination of the registration of our
common stock under the Securities Exchange Act of 1934, as described below under the caption Compliance with public company
reporting requirements is costly, and we may seek to terminate the
applicability of such requirements to us and our common stock, would result in
the delisting of our common stock, and our common stock would no longer be
authorized for Nasdaq trading and Nasdaq would cease to provide any
quotations. On April 5, 2004, we submitted an application to the Nasdaq Stock Market
to transfer to the Nasdaq SmallCap Market. If our common stock is accepted for
listing on the Nasdaq SmallCap Market, we will have until approximately October
10, 2004 to demonstrate compliance with the $1.00 minimum bid price
requirements. If our common stock is not accepted for listing on the Nasdaq SmallCap
Market, or is otherwise delisted from Nasdaq, trading of our common stock, if any, would then be conducted on the
over-the-counter market in automated quotation systems, called the Pink Sheets,
and/or on the OTC Bulletin Board of the National Association of Securities
Dealers, Inc. In this event, stockholders may find it more difficult to dispose
of, or to obtain accurate quotations as to the price of, our common stock, the
liquidity of our stock may be reduced, making it difficult for a stockholder to
buy or sell our stock at competitive market prices or at all, we may lose
support from institutional investors and/or market makers that currently buy and
sell our stock and the price of our common stock could decrease further. Investors should not assume that our common
stock will continue to be listed and traded on the Nasdaq National Market or
the Nasdaq SmallCap Market or traded on the OTC Bulletin Board. Stockholders May Be Liable to Our Creditors for Up to Amounts Received From Us
if Our Reserves Are Inadequate If our board of directors were to adopt a new plan of complete liquidation
and dissolution and such plan was approved by our stockholders, a Certificate
of Dissolution would be filed with the State of Delaware. Pursuant to the
Delaware General Corporation Law, we would continue to exist for three years
after the dissolution became effective or for such longer period as the
Delaware Court of Chancery directed, for the purpose of prosecuting and
defending suits against us and enabling us gradually to wind up our business,
dispose of our property, discharge our liabilities, and distribute any
remaining assets to our stockholders. In that event if we failed to create an
adequate contingency reserve for payment of our expenses and liabilities, or
if we otherwise were unable to pay our expenses and liabilities and we became
subject to bankruptcy or insolvency proceedings, each stockholder could be
held liable for payment to our creditors for such stockholders pro rata share
of unpaid amounts owed to creditors in excess of a contingency reserve, if any.
The liability of any stockholder would be limited, however, to the amounts
previously distributed to such stockholder by us (or any liquidating trust or
trusts), including, possibly, the return of capital cash distribution of $1.50
per share paid on September 2, 2003. Accordingly, in such event a stockholder
could be required to return all such distributions made to such stockholder.
Moreover, in the event taxes are payable, and a stockholder has paid taxes, on
amounts previously received as a distribution, a repayment of all or a portion
of such amount could result in a stockholder incurring a net tax cost if the
stockholders repayment of an amount previously distributed does not cause a
commensurate reduction in taxes payable. There can be no assurance that the
amount of a contingency reserve established by us would be adequate to cover
our expenses and liabilities or that, if our cash and cash equivalents continue
to be depleted, our obligations and liabilities will not exceed our cash and
cash equivalents. 23




---



##### Table of Contents



Securities Class Action Claims Have Been Filed Against Us and Certain of Our
Current and Former Officers and Directors. On November 2, 2001, Timothy J. Fox filed a purported class action lawsuit
against us, FleetBoston Robertson Stephens, Inc., the lead underwriter of our
April 1999 initial public offering, several other underwriters who participated
in our initial public offering, Steven J. Snyder, our then president and chief
executive officer, and Thomas M. Donnelly, our then chief financial officer and
currently our president and chief financial officer. The lawsuit was filed in
the United States District Court for the Southern District of New York and has
been assigned to the judge who is also the pretrial coordinating judge for
substantially similar lawsuits involving more than 300 other issuers. An
amended class action complaint, captioned In re Net Perceptions, Inc. Initial
Public Offering Securities Litigation,01 Civ. 9675 (SAS), was filed on April
22, 2002, expanding the basis for the action to include allegations relating to
our March 2000 follow-on public offering in addition to those relating to our
initial public offering. The amended complaint generally alleges that the defendants violated
federal securities laws by not disclosing certain actions taken by the
underwriter defendants in connection with our initial public offering and our
follow-on public offering. The amended complaint alleges specifically that the
underwriter defendants, with our direct participation and agreement and without
disclosure thereof, conspired to and did raise and increase their underwriters
compensation and the market prices of our common stock following our initial
public offering and in our follow-on public offering by requiring their
customers, in exchange for receiving allocations of shares of our common stock
sold in our initial public offering, to pay excessive commissions on
transactions in other securities, to purchase additional shares of our common
stock in the initial public offering aftermarket at pre-determined prices above
the initial public offering price, and to purchase shares of our common stock
in our follow-on public offering. The amended complaint seeks unspecified
monetary damages and certification of a plaintiff class consisting of all
persons who acquired our common stock between April 22, 1999 and December
6, 2000. The plaintiffs have since agreed to dismiss the claims against Mr.
Snyder and Mr. Donnelly without prejudice, in return for their agreement to
toll any statute of limitations applicable to those claims; and those claims
have been dismissed without prejudice. On July 15, 2002, all of the issuer
defendants filed a joint motion to dismiss the plaintiffs claims in all of the
related cases. On February 19, 2003, the Court ruled against the Company on
this motion. A special committee of our board of directors has authorized the Company
to negotiate a settlement of the pending claims substantially consistent with a
memorandum of understanding negotiated among class plaintiffs, issuer
defendants and their insurers. Any such settlement would be subject to approval
by the Court. We believe that the allegations against the Company are without
merit. However, we are unable to
predict the outcome or ultimate effect of this litigation. Compliance with public company reporting requirements is costly, and we may
seek to terminate the applicability of such requirements to us and our common
stock. Our common stock is currently registered under the Securities Exchange Act
of 1934, which requires that we, and our officers and directors with respect to
Section 16 of that Act, comply with certain public reporting and proxy
statement requirements thereunder. Compliance with these requirements is costly
and time-consuming, and we will likely continue, at least in the near term, to
be subject to these requirements. However, our board of directors may in the
future conclude that to curtail expenses thereby conserving cash to minimize
erosion of stockholder value, the registration of our common stock under the
Securities Exchange Act of 1934 should be terminated. Termination of such
registration may occur following our certification to the Securities and
Exchange Commission that there are fewer than 300 record holders of our common
stock. As of March 31, 2003, there were 235 record holders of our common stock,
and thus it is likely that our common stock will be eligible for
de-registration should the board of directors determine that such action is
necessary or otherwise in the best interests of the Company. Termination of such registration of our common stock would
reduce substantially the information required to be furnished by us to our
stockholders and to the Securities and Commission and would make certain
provisions of the Securities Exchange Act of 1934, such as the short-swing
profit recovery provisions of Section 16(b), the requirement of furnishing a
proxy statement in connection with 24




---



##### Table of Contents



stockholders meetings pursuant to Section 14(a) and the requirements of
Rule 13e-3 under that Act with respect to going private transactions no
longer applicable to us or our common stock. Furthermore, if the registration
of our common stock under the Securities Exchange Act of 1934 were to be
terminated, the ability of affiliates of the Company and persons holding
restricted securities of the Company to dispose of such securities pursuant
to Rule 144 or 144A under the Securities Act of 1933, as amended, may be
impaired or eliminated. Also, as noted above, if registration of our common
stock under the Securities Exchange Act of 1934 were terminated our common
stock would be delisted from the Nasdaq National Market and/or the Nasdaq Small
Cap Market, would no longer be eligible for Nasdaq trading and could not be
traded on the OTC Bulletin Board. Our inability to reach cash break-even could give rise to securities class
action claims against us, which could deplete the proceeds that could be
distributed to stockholders. Securities class action claims have been brought against companies in the
past where the market price of the companys securities has fallen due to an
inability of the company to achieve operational profitability. In addition, the
Company was named in a purported class action described in Item 3 of this
report. Any such litigation could be very costly
and divert our remaining resources from being available for distribution to our
stockholders. To the extent that we are unable to settle or resolve the
currently pending litigation, and we are not indemnified by
other parties, or in the absence of sufficient insurance coverage, any adverse
determination in this kind of litigation could deplete our cash position,
thereby reducing the cash available for distribution to stockholders if the
Company were liquidated and possibly making more difficult, or reducing the
price obtainable in, a sale of or investment in the Company. We may face intellectual property infringement claims that could be costly to
resolve. There has been a substantial amount of litigation in the software industry
regarding intellectual property rights. It is possible that third parties may
claim that our products infringe their intellectual property rights, including
under issued patents. Such claims may result in our being involved in
litigation. We could incur substantial costs to defend any claims relating to
proprietary rights, which would deplete our remaining cash. In addition, in all
of our paid software license agreements, we generally indemnify our customers
against losses attributable to intellectual property infringement by our
software. Should a third party bring a suit against a customer alleging that
the customers use of our software infringes its intellectual property rights,
we could incur substantial costs in defending and resolving the suit. If
someone asserts a claim against us relating to proprietary technology or
information, we might seek settlement of such claim. We might not be able to
agree to a settlement on reasonable terms, or at all. The failure to obtain a
settlement on acceptable terms could deplete our cash position, thereby
reducing the cash available for distribution to stockholders if the Company
were liquidated and possibly making more difficult, or reducing the price
obtainable in, a sale of or investment in the Company. We may be subject to potential product liability claims that could result in
costly and time-consuming litigation. Because our customers have used, and may continue to use, our products for
important applications, errors or defects in, or other performance problems
with, our products could result in financial or other damages to our customers.
Our customers could seek to recover from us for such damages and we no longer
maintain product liability insurance to cover such claims. Although our
license agreements typically contain provisions designed to limit our exposure
to product liability claims, existing or future laws or unfavorable judicial
decisions could negate these limitation of liability provisions. Any product
liability claim brought against us, even if unsuccessful, would likely be
time-consuming and costly. If someone asserts a claim against us relating to
product liability, we might seek settlement of such claim. We might not be
able to agree to a settlement on reasonable terms, or at all. The failure to
obtain a settlement on acceptable terms could have the effect of decreasing or
delaying cash distributions to stockholders if the Company were liquidated and
could make more difficult, or reduce the price obtainable in, a sale of or
investment in the Company. 25




---



##### Table of Contents



Provisions of our corporate organizational documents and rights agreement could
delay or prevent a change of control, even if it would be beneficial to our
stockholders. Various provisions of our certificate of incorporation and bylaws could
have the effect of delaying or preventing a change in control and make it more
difficult for a third party to acquire us, even if doing so would be beneficial
to our stockholders. In addition, the rights issued under our rights agreement,
as amended, may be a substantial deterrent to a person acquiring 15% or more of
our common stock without the approval of our board of directors. These
provisions in our certificate of incorporation, bylaws and rights agreement
could reduce the price that investors might be willing to pay for shares of our
common stock in the future and result in the market price being lower than it
would be without these provisions. 
 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Through December 31, 2003, the majority of our recognized revenues were
denominated in United States dollars and were primarily from customers in the
United States, and our exposure to foreign currency exchange rate changes has
been immaterial. As described elsewhere in this report, we are no longer
actively marketing our products. Accordingly, we do not consider significant
our exposure to foreign currency exchange rate changes arising from revenues
being denominated in foreign currencies. Our historical exposure to market risk was otherwise limited to interest
income sensitivity, which was affected by changes in the general level of
United States interest rates, particularly because the majority of our
investments were in debt securities issued by corporations and the United
States government. All of our investments are now held in money market
accounts in order to preserve principal. Therefore, due to the conservative
nature of our investments, our future interest income sensitivity is limited. We do not have any derivative financial instruments and do not hold any
instruments for trading purposes. 
 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements required by this item are included on pages F-1
through F-22 of this report. The supplementary financial information required
by this Item is included in the section of this report captioned Managements
Discussion and Analysis of Operating Results under the heading Selected
Consolidated Quarterly Operating Results. 
 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE None. 
 ITEM 9A. CONTROLS AND PROCEDURES (a) Evaluation of Disclosure Controls and Procedures. The Companys management, with the participation of our chief executive
officer and chief financial officer, has evaluated the effectiveness of the
Companys disclosure controls and procedures (as such term is defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended
(the Exchange Act)) as of the end of the period covered by this report.
Based on such evaluation, the Companys chief executive officer and chief
financial officer has concluded that, as of the end of such period, the
Companys disclosure controls and procedures are effective to provide
reasonable assurance that information required to be disclosed by us in reports
that we file or submit under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in applicable SEC
rules and forms. 26




---



##### Table of Contents



(b) Internal Control Over Financial Reporting. There have not been any changes in the Companys internal control over
financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f)
under the Exchange Act) during the quarter ended December 31, 2003 that have
materially affected, or are reasonably likely to materially affect, the
Companys internal control over financial reporting. 27




---



##### Table of Contents



PART III 
 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Board of Directors Set forth below is certain information concerning persons who serve on the
Companys board of directors. None of the corporations or other organizations
referred to below with which a director has been employed or otherwise
associated is a parent, subsidiary or other affiliate of the Company. John F. Kennedy, age 55, became a director of Net Perceptions in April
2001. Since July 2002, Mr. Kennedy has been the President of Nova Analytics
Corporation, a supplier and integrator of electrochemistry products. From
August 1999 through June 2002, Mr. Kennedy served as Chief Financial Officer of
RSA Security Inc., a leading provider of e-security solutions. From June 1998
to July 1999, he served as Chief Financial Officer and Vice President, Finance,
of Decalog, a provider of enterprise investment management software.
Previously, he served as Chief Financial Officer and Vice President, Finance,
of Natural MicroSystems Corporation, a provider of telecommunications equipment
and software, from 1993 to 1998, serving also as Treasurer from 1995 to 1998.
From 1991 to 1993, he served as Chief Financial Officer of Ultimap Corporation,
a developer of geographic information software. Mr. Kennedy also serves as a
director of Harvard Bioscience Inc. Mr. Kennedy holds a B.S. in Mathematics
from the University of Massachusetts/Lowell and a MSBA in Accounting from the
University of Massachusetts/Amherst. John T. Riedl, age 42, co-founded Net Perceptions in July 1996 and since
that time has served as a director. From November 1998 to March 2001, Dr. Riedl
served as our Chief Scientist on a part-time basis. From July 1996 until
November 1998, Dr. Riedl served as our Chief Technical Officer. Dr. Riedl has
been a professor in the computer science department at the University of
Minnesota since March 1990. Dr. Riedl holds a B.S. in Mathematics from the
University of Notre Dame and an M.S. and a Ph.D. in Computer Science from
Purdue University. Ann L. Winblad, age 53, became a director of Net Perceptions in August
1996. Ms. Winblad has been a General Partner of Hummer Winblad Venture
Partners, a venture capital investment firm, since 1989. Ms. Winblad is also a
director of The Knot, Inc. as well as other private companies and is a Trustee
of the University of St. Thomas. Ms. Winblad holds a B.A. in Mathematics and
Business Administration from the College of Saint Catherine and an M.A. in
Education with an Economics focus from the University of St. Thomas. Executive Officers Set forth below is certain information concerning non-director employees
who serve as executive officers of the Company. Our executive officers serve at
the discretion of the board of directors. There are no family relationships
between any of our directors and executive officers. None of the corporations
or other organizations referred to below with which an executive officer has
been employed or otherwise associated is a parent, subsidiary or other
affiliate of the Company. Thomas M. Donnelly, age 40, joined Net Perceptions in March 1997 as our
Corporate Controller and, in March 1998, became our Chief Financial Officer and
Treasurer. In February 1999, Mr. Donnelly was appointed Secretary. In July
1999, Mr. Donnelly also became Senior Vice President of Finance and
Administration and since October 2001, Mr. Donnelly also served as our Chief
Operating Officer. In August 2003, Mr. Donnelly became our President and also
retained the Chief Financial Officer position. From March 1995 to March 1997,
Mr. Donnelly served as a financial and management consultant in the capacity of
chief financial officer or corporate controller for various public and private
companies and partnerships, including for Net Perceptions, from September 1996
to March 1997. Prior to September 1996, Mr. Donnelly served as an analyst for
Marshall Financial Group, a merchant banking company, Chief Financial Officer
of Medical 28




---



##### Table of Contents



Documentation Systems, Inc., a medical software company and
Controller of Staats International, Inc., a defense subcontractor. Mr. Donnelly holds a
B.A. in Economics from St. Olaf College. Teresa J. Dery, age 37, joined the Company as Corporate Counsel in
November 1999 and also became Secretary in August 2003. Prior to joining the
Company, Ms. Dery served as Vice President, Finance and Legal at 1 Potato 2, a
national restaurant franchisor. Ms. Dery holds a B.A. in Business
Administration from the University of St. Thomas and a J.D. from Hamline
University School of Law. Audit Committee We have a separately-designated standing audit committee of our board of
directors established in accordance with Section 3(a)(58)(A) of the Securities
Exchange Act of 1934. The current members of the audit committee are Messrs.
Kennedy and Riedl and Ms. Winblad, each of whom is independent under Rule
10A-3(b)(1) of the Exchange Act and the applicable rules of the National
Association of Securities Dealers, Inc. The board of directors has reviewed the
qualifications and experience of each of the audit committee members, and has
determined that Mr. Kennedy qualifies as an audit committee financial expert,
as such term is defined in Item 401(h)(2) of Regulation S-K under the
Securities Act of 1933. Section 16(A) Beneficial Ownership Reporting Compliance Section 16(a) of the Securities Exchange Act of 1934, as amended, requires
the Companys directors and executive officers and stockholders who own more
than 10% of a registered class of the Companys equity securities to file
reports of ownership and changes in ownership with the Securities and Exchange
Commission. Based solely upon a review of Forms 3, 4 and 5 (and amendments
thereto) furnished to the Company during or in respect of the fiscal year ended
December 31, 2003, the Company is not aware of any director, executive officer
or beneficial owner of more than 10% of the outstanding common stock who or
which has not timely filed reports required by Section 16(a) of the Exchange
Act during or in respect of such fiscal year. Code Of Business Conduct And Ethics We have adopted a Code of Business Conduct and Ethics that applies to all
of our directors, officers and employees, including our principal executive
officer, principal financial officer and principal accounting officer. Our Code
of Business Conduct and Ethics will be posted on our website,
www.netperceptions.com, under the About Net Perceptions caption. We intend to
disclose on our website any amendment to, or waiver of, a provision of the Code
of Business Conduct and Ethics that applies to our principal executive officer,
principal financial officer or principal accounting officer. 
 ITEM 11. EXECUTIVE COMPENSATION Summary Compensation Table The following table sets forth information with respect to compensation we
awarded and/or paid in 2003, 2002 and 2001 (or such shorter period that the
listed person served as an executive officer of the Company) for services to us
by our current President, and our three other executive officers whose total
salary and bonus for 2003 exceeded $100,000. We refer to these officers as our
named executive officers in other parts of this report. 29




---



##### Table of Contents



Long-TermCompensationAwardsAnnual Compensation
    
    Number of Sharesof Common Stock
    
    All OtherName and Position(s)
    
    Year
    
    Salary($)
    
    Bonus($)
    
    Underlying Options
    
    Compensation($)Thomas M. Donnelly
    
    
    2003
    
    
    
    225,000
    
    
    
    210,000
    
    
    
    
    
    
    
    86,000
    (1)President and Chief
    
    
    2002
    
    
    
    180,000
    
    
    
    
    
    
    
    
    
    
    
    86,000
    (1)Financial Officer
    
    
    2001
    
    
    
    177,507
    
    
    
    50,000
    
    
    
    321,204
    
    
    
    James S. Hanlon (2)
    
    
    2003
    
    
    
    137,500
    
    
    
    
    
    
    
    
    
    
    
    Vice President Engineering
    
    
    2002
    
    
    
    150,000
    
    
    
    
    
    
    
    
    
    
    
    2001
    
    
    
    130,780
    
    
    
    31,273
    
    
    
    89,400
    
    
    
    Teresa J. Dery
    
    
    2003
    
    
    
    100,000
    
    
    
    12,500
    
    
    
    
    
    
    
    Corporate Counsel
SecretaryDonald C. Peterson (3)
    
    
    2003
    
    
    
    119,744
    
    
    
    
    
    
    
    
    
    
    
    200,000
    (3)President and Chief
    
    
    2002
    
    
    
    200,000
    
    
    
    
    
    
    
    
    
    
    
    Executive Officer
    
    
    2001
    
    
    
    121,282
    
    
    
    43,750
    
    
    
    750,000
    
    
    
    
  (1)
    
    Represents forgiveness of principal on a loan with the Company. See
Certain Relationships and Related Transactions beginning on page 34.(2)
    
    Mr. Hanlons employment with the Company terminated on January 15,
2004. Prior to this date, Mr. Hanlon served as Vice President of
Engineering. Mr. Hanlon received $37,500 of severance benefits in
2004 pursuant to an agreement with the Company.(3)
    
    Mr. Petersons employment with the Company terminated on August 5,
2003. Prior to this date, Mr. Peterson served as President and Chief
Executive Officer. Mr. Peterson also resigned as a director effective August
6, 2003. Mr. Peterson received $200,000 of severance benefits in 2003
pursuant to his employment agreement with the Company and we are
continuing to provide him with health insurance benefits through August
6, 2004, or until Mr. Peterson is eligible to receive such benefits
through a new employer. Option Grants in Last Year We did not make any grants of stock options or stock appreciation rights
to the named executive officers during 2003. Aggregated Option Exercises in Last Fiscal Year and Option Values at December
31, 2003 The following table provides information concerning option exercises by
the named executive officers during the year ended December 31, 2003 and the
number and value of unexercised options held by each of the named executive
officers at December 31, 2003. Number of
    
    Value of UnexercisedSecurities Underlying
    
    In-The-MoneyShares Acquired
    
    
    
    
    
    Unexercised Options at
    
    Options aton Exercise (#)
    
    Value Realized ($)(1)
    
    December 31, 2003(#)(2)
    
    December 31, 2003($)(3)Name
    
    
    
    
    
    
    
    
    
    Exercisable
    
    Unexercisable
    
    Exercisable
    
    UnexercisableThomas M. Donnelly
    
    
    212,368
    
    
    
    108,613
    
    
    
    126,285
    
    
    
    623,093
    
    
    
    13,212
    
    
    
    64,644James S. Hanlon
    
    
    48,235
    
    
    
    32,103
    
    
    
    35,150
    
    
    
    200,729
    
    
    
    5,975
    
    
    
    34,124Teresa J Dery
    
    
    5,031
    
    
    
    3,392
    
    
    
    3,873
    
    
    
    17,210
    
    
    
    658
    
    
    
    2,926Donald C. Peterson
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
  (1)
    
    The value realized on option exercises is calculated based on the fair
market value per share of common stock on the date of exercise less the
applicable exercise price.(2)
    
    Options granted under our 1996 Stock Plan are immediately exercisable for
all the option shares, but any shares purchased under those 30




---



##### Table of Contents



options will be subject to repurchase by us
at the original exercise price paid per share, upon the optionees cessation
of service, prior to the vesting of those shares. Options granted under our
1999 Equity Incentive Plan and 2000 Stock Plan may be exercised only when,
and to the extent, vested.(3)
    
    The value of unexercised in-the-money options held at December 31, 2003
represents the total gain which would be realized if all of the
in-the-money options held at December 31, 2003 were exercised, and is
determined by multiplying the number of shares of Common Stock underlying
the options by the difference between $.40, which was the closing price
per share of our Common Stock on the Nasdaq National Market on December
31, 2003, and the applicable per share option exercise price. An option is
in-the-money if the fair market value of the underlying shares exceeds
the exercise price of the option. Change in Control Arrangements/Employment Agreements Our 1999 Equity Incentive Plan, in which our named executive officers
participate, and our 2000 Stock Plan, under which certain of our current named
executive officers received options prior to becoming executive officers,
provide for accelerated vesting of options to purchase shares of common stock
granted under the plans in connection with certain changes in control of the
Company. In addition, in the event that options granted under the plans are
assumed by the acquiror in a change in control, the options may accelerate if
the optionees employment is involuntarily terminated within 18 months
following the change in control event or, subject to the limitations set forth
in the plans, the optionee resigns from a position with the acquiror. Our 1996
Stock Plan, in which some of our named executive officers participate, provides
for the accelerated lapsing of repurchase rights with respect to shares of
common stock acquired upon exercise of options granted under the plan in
connection with certain changes in control of the Company. Our named executive officers (other than those named executive officers
who are no longer employed by the Company), are eligible to participate in our
Change in Control Severance Plan. Under the Change in Control Severance Plan,
if, within 18 months after a change in control of the Company, an officers
employment is involuntarily terminated other than for cause or voluntarily or
involuntarily terminated following a material change in the officers
responsibilities, cash compensation or place of employment, we will pay the
officer severance benefits equal to six months of base salary. We have entered into a severance agreement with Thomas M. Donnelly, our
President and Chief Financial Officer. Pursuant to the terms of this agreement,
if Mr. Donnellys employment is terminated without cause, or due to his
inability to perform his duties due to illness for a period of 90 consecutive
days or more, we will pay Mr. Donnelly severance benefits equal to twelve
months of base salary. Also under the terms of this agreement, if, within 18
months after a change in control of the Company, Mr. Donnellys employment is
involuntarily terminated other than for cause or voluntarily or involuntarily
terminated following a material change in Mr. Donnellys responsibilities, cash
compensation or place of employment, we will pay Mr. Donnelly severance
benefits equal to twelve months of base salary. Pursuant to an employment agreement with Donald C. Peterson, our former
President and Chief Executive Officer, during 2003, we made severance payments
of $200,000 to Mr. Peterson in connection with the termination of his
employment on August 5, 2003. Compensation Committee Interlocks and Insider Participation Neither Messrs. Kennedy and Lansing nor Ms. Winblad, each of whom served
as a member of the compensation committee during 2003, is currently or has
been, at any time since our formation, one of our officers or employees. 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 as a member of our board of directors or compensation committee. 31




---



##### Table of Contents



Director Compensation We do not currently provide our directors with cash compensation for their
services as members of the board of directors, although directors are
reimbursed for some expenses in connection with attendance at board and
committee meetings. Directors who are also our employees are eligible to
participate in our 1999 Equity Incentive Plan. None of the members of our
current board of directors is an employee of the Company. Non-employee
directors are eligible to participate in our 1999 Non-Employee Director Option
Plan, which was amended in April 2001. Pursuant to the terms of the 1999
Non-Employee Director Option Plan, each non-employee director receives an
automatic option grant to purchase 50,000 shares of common stock upon his or
her initial election or appointment to the board, and, at each Annual Meeting
thereafter, receives an automatic option grant to purchase 15,000 shares of
common stock. From time to time, non-employee directors may also receive
discretionary option grants under our 1999 Non-Employee Director Option Plan.
During 2002, the board formed a special committee of directors to act with the
full authority of the board on matters concerning certain litigation brought
against the Company, among other defendants, related to its 1999 IPO and 2000
follow-on public offering. Mr. Kennedy is a member of the committee, and Mr.
Peterson was a member of this committee until he resigned from the board on
August 6, 2003. Mr. Kennedy is compensated at a rate of $1,500 per day for
specific activities involving this special committee. During 2003, Mr. Kennedy
received $3,000 of compensation related to this matter. 
 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS The following table sets forth information regarding the beneficial
ownership of our common stock as of March 31, 2004, except as otherwise noted,
by:  
    
    each person who is known by us to beneficially own more than five
percent of the outstanding shares of common stock;
    
    each of our directors and each named executive officer; and
    
    all of our directors and executive officers as a group. This information is based upon information received from or on behalf of
the individuals or entities named below, except as otherwise noted. We have determined beneficial ownership in accordance with the rules of
the SEC. Unless otherwise noted below, the address of each beneficial owner
listed in the table is c/o Net Perceptions, Inc., 7700 France Avenue South,
Edina, Minnesota 55435. Except as indicated in the footnotes below, we believe,
based on information furnished or otherwise available to us, that each person
or entity named in the table has sole voting and investment power with respect
to all shares of our common stock shown as beneficially owned by them, subject
to applicable community property laws. The percentage of beneficial ownership
set forth below is based upon 28,270,918 shares of common stock outstanding as
of the close of business on March 31, 2004. In computing the number of shares
of common stock beneficially owned by a person and the percentage ownership of
that person, shares of common stock that are subject to options held by that
person that are currently exercisable or exercisable within 60 days of March
31, 2004, were deemed outstanding. These shares were not, however, deemed
outstanding for the purpose of computing the percentage ownership of any other
person. 32




---



##### Table of Contents



Number ofSharesName and Address
    
    Number of
    
    Subject toof Beneficial Owner
    
    Shares
    
    Options(1)
    
    PercentS. Muoio & Co., LLC
    
    
    4,221,787
    
    
    
    
    
    
    
    14.93
    %509 Madison Ave.,Suite 406New York, NY 10022Austin W. Marxe, & David M. Greenhouse
    
    
    1,546,200
    
    
    
    
    
    
    
    5.47153 East 53rd St.,51st FloorNew York, NY 10022John F. Kennedy
    
    
    65,000
    
    
    
    65,806
    
    
    
    *Ann L. Winblad
    
    
    311,204
    
    
    
    218,388
    
    
    
    1.86John T. Riedl(2)
    
    
    915,704
    
    
    
    32,903
    
    
    
    3.35Thomas M. Donnelly
    
    
    303,951
    
    
    
    403,802
    
    
    
    2.47Teresa J. Dery
    
    
    6,091
    
    
    
    12,838
    
    
    
    *James S. Hanlon(3)
    
    
    65,149
    
    
    
    49,426
    
    
    
    *Donald C. Peterson(4)
    
    
    
    
    
    
    
    
    
    
    *All directors and executive officers as a group
(seven persons)(5)
    
    
    1,601,950
    
    
    
    733,737
    
    
    
    8.05
    %
   *
    
    Indicates less than 1% of the total number of outstanding shares of
common stock.  (1)
    
    Reflects the number of shares issuable upon the exercise of options
exercisable within 60 days of March 31, 2004 and gives effect to the
adjustment to outstanding options in connection with the cash distribution
paid to stockholders on September 2, 2003.(2)
    
    Includes 359,043 shares held by a revocable trust of which Mr. Reidl is
sole trustee, 78,375 shares held in three irrevocable trusts of which Mr.
Reidl and his spouse are the trustees and 463,286 shares held by a
revocable trust of which Mr. Reidls spouse is the sole trustee.(3)
    
    Mr. Hanlons employment with the Company was terminated on January 15,
2004.(4)
    
    Mr. Petersons employment with the Company terminated on August 5, 2003.
Mr. Peterson also resigned as a director effective August 6, 2003.(5)
    
    Does not include shares held by Mr. Hanlon, who is no longer serving as
an executive officer of the Company. 33




---



##### Table of Contents



Equity Compensation Plan Information The following table sets forth information regarding our equity
compensation plans as of December 31, 2003: Number of securities
    
    
    
    
    
    Number of securities remainingto be issued upon
    
    Weighted-average
    
    available for future issuanceexercise of
    
    exercise price of
    
    under equity compensationoutstanding options,
    
    outstanding options,
    
    plans (excluding securitiesPlan Category
    
    warrants and rights
    
    warrants and rights
    
    reflected in column (a))(a)
    
    (b)
    
    (c)Equity compensation
plans approved by
security holders
    
    
    1,985,594
    (1)
    
    $
    1.78
    
    
    
    3,890,059
    (2)Equity compensation
plans not approved
by security holders(3)
    
    
    43,319
    
    
    $
    4.40
    
    
    
    446,724Total
    
    
    2,028,913
    
    
    $
    1.83
    
    
    
    4,336,783
  (1)
    
    Excludes purchase rights accruing under the Employee Stock Purchase Plan
which was terminated on October 27, 2003.(2)
    
    Includes 2,524,253 shares of common stock available for future issuance
under our 1999 Equity Incentive Plan. In addition to stock options, awards
under our 1999 Equity Incentive Plan may take the form of restricted
stock, stock appreciation rights and stock units as specified in the Plan.
If such awards are granted, they will reduce the number of shares of
common stock available for issuance pursuant to future stock option
awards.(3)
    
    The Companys 2000 Stock Plan was adopted by the board of directors
effective April 20, 2000. The Company has reserved 500,000 shares of
common stock for issuance under the 2000 Stock Plan. Nonstatutory options
and restricted stock awards may be granted under the 2000 Stock Plan to
employees of the Company (or any parent or subsidiary corporation) who are
neither officers nor Board members at the time of grant or to consultants.
All option grants will have an exercise price per share equal to not less
than 85% of the fair market value per share of common stock on the grant
date. Each option will vest in installments over the optionees period of
service with the Company. The purchase price for newly issued restricted shares
awarded under the 2000 Stock Plan may be paid in cash, by
promissory note or by the rendering of past or future services. As of
December 31, 2003, options covering 43,319 shares of common stock were
outstanding under the 2000 Stock Plan, 496,724 shares remained available
for future option grants, and options covering 9,957 shares had been
exercised. Outstanding options will vest on an accelerated basis in the
event the Company is acquired and those options are not assumed or
replaced by the acquiring entity. An option or award will become fully
exercisable or fully vested if the holders employment or service is
involuntarily terminated within 18 months following the acquisition. The
Board may amend or terminate the 2000 Stock Plan at any time. The 2000
Stock Plan will continue in effect indefinitely unless the Board decides
to terminate it. 
 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS In December 2000, Thomas M. Donnelly, our President and Chief Financial
Officer, entered into a full recourse secured promissory note and security
agreement in favor of the Company in connection with a loan from the Company to
Mr. Donnelly of up to $300,000 to be made to Mr. Donnelly solely to pay federal
income tax owed by Mr. Donnelly as a result of his exercise in March 2000 of an
option to purchase shares 34




---



##### Table of Contents



of Common Stock. In April 2001, $258,000 was loaned
to Mr. Donnelly pursuant to the promissory note. The note accrued interest at 8% and was due and payable in 2004.
On April 1st of each year, commencing in 2002, that Mr. Donnelly remained
continuously employed by the Company, one-third of the original principal and
accrued interest was forgiven. The largest amount of indebtedness outstanding
under the note during 2003 was $107,500. As of April 1, 2004, the note was
completely forgiven. We have entered into a severance agreement with Thomas M. Donnelly, our
President and Chief Financial Officer. Pursuant to the terms of this agreement,
if Mr. Donnellys employment is terminated without cause, or due to his
inability to perform his duties due to illness for a period of 90 consecutive
days or more, we will pay Mr. Donnelly severance benefits equal to twelve
months of base salary. Also under the terms of this agreement, if, within 18
months after a change in control of the Company, Mr. Donnellys employment is
involuntarily terminated other than for cause or voluntarily or involuntarily
terminated following a material change in Mr. Donnellys responsibilities, cash
compensation or place of employment, we will pay Mr. Donnelly severance
benefits equal to twelve months of base salary. We have also entered into an indemnification agreement with all of our
officers and directors. 
 ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES The following is a summary of fees billed by PricewaterhouseCoopers LLP,
our independent accountants, for audit and other professional services during
the fiscal years ended December 31, 2003 and 2002: 2003
    
    2002Audit Fees:
    
    $
    172,000
    
    
    $
    244,000Consists of fees incurred for the audit of the
Companys consolidated financial statements for
such year, review of the Companys interim
financial statements, statutory and subsidiary
audits, and assistance with review of documents
filed with the SEC.Audit Related Fees:
    
    
    39,000
    
    
    
    98,000Consists of fees incurred for employee benefit plan
audits, due diligence related to mergers and
acquisitions, and consultations concerning
financial accounting and reporting standards.Tax Fees:
    
    
    55,000
    
    
    
    136,000Consists of fees incurred for tax advisory
services, including compliance and planning (and
includes, for 2003, costs of preparation of returns
for the Companys foreign subsidiaries for 2001 and
2002).All Other Fees:Consists of fees incurred for educational seminars.
    
    
    
    
    
    
    Total
    
    $
    266,000
    
    
    $
    478,000
 Pre-Approval Policies and Procedures. The Audit Committee has adopted a policy that requires advance approval of
all audit, audit-related, tax and other services performed by
PricewaterhouseCoopers LLP. The policy provides for pre-approval by the Audit
Committee of specifically defined audit and non-audit services. Unless the
specific service has been previously pre-approved with respect to that year,
the Audit Committee must approve the permitted service before the independent
accountant is engaged to perform it. The Audit Committee did not utilize the de minimis exception to the
pre-approval requirements to approve any services provided by
PricewaterhouseCoopers LLP during 2003. 35




---



##### Table of Contents



PART IV 
 ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) 1. Financial Statements The financial statements filed as part of this report are listed on the
Index to Consolidated Financial Statements on page F-1. 2. Financial Statement Schedules All schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are not required. The
information required to be set forth therein is not applicable or is shown in
the Consolidated Financial Statements or notes thereto included in this report. 3. Exhibits ExhibitNumber
    
    Description2.1
    
    
    Patent Purchase Agreement, dated December 30, 2003, between Thalveg Data Flow LLC and
Net Perceptions, Inc., as amended on March 31, 2004 (1)3.1
    (a)
    
    Amended and Restated Certificate of Incorporation (2).3.1
    (b)
    
    Certificate of Amendment to the Amended and Restated Certificate of Incorporation (3).3.2
    
    
    Amended and Restated Bylaws as amended through August 5, 2003 (4).4.1
    
    
    Amended and Restated Investors Rights Agreement, dated December 18, 1997, among Net
Perceptions, Inc. and the investors and founders named therein, as amended (2).4.2
    
    
    Specimen common stock certificate (2).4.3
    
    
    Specimen common stock certificate (including Rights Agreement Legend) (5).4.4
    
    
    Rights Agreement between Net Perceptions, Inc. and Wells Fargo Bank Minnesota, as
Rights Agent (6).4.5
    
    
    Amendment No. 1 to Rights Agreement dated as of December 22, 2003 (7).4.6
    
    
    Form of Certificate of Designation of Series A Junior Participating Preferred Stock
(attached as Exhibit A to the Rights Agreement filed as Exhibit 4.4 hereto) (6).4.7
    
    
    Form of Rights Certificate (attached as Exhibit B to the Rights Agreement filed as
Exhibit 4.4 hereto) (6).10.1
    *
    
    Form of Indemnification Agreement entered into between Net Perceptions, Inc. and its
directors and officers (2).10.2
    *
    
    1996 Stock Plan (2).10.3
    *
    
    1999 Equity Incentive Plan (2).10.4
    *
    
    Amended and Restated 1999 Non-Employee Director Option Plan, as amended through April
2, 2001 (8).10.5
    *
    
    Employee Stock Purchase Plan (2).10.8
    *
    
    2000 Stock Plan (9).10.9
    *
    
    Change in Control Severance Plan and Summary Plan Description (2).10.11
    *
    
    Severance Agreement, dated as of November 9, 2001, between Net Perceptions, Inc. and
Thomas M. Donnelly(10).10.12
    
    
    Full Recourse Secured Promissory Note and Security Agreement, dated December 7, 2000,
entered into by Thomas M. Donnelly in favor of Net Perceptions, Inc. (11)21.1
    
    
    List of Subsidiaries.23.1
    
    
    Consent of PricewaterhouseCoopers LLP, independent accountants.31.1
    
    
    Certification of chief executive officer and chief financial officer pursuant to
Exchange Act Rules Rule 13(a)-14(a) and 15(a)-14(a), as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 200232.1
    
    
    Certification of the chief executive officer and chief financial officer pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.
   *
    
    Represents a management contract or compensatory plan or
arrangement.(1)
    
    Incorporated by reference to Net Perceptions Current Report on
Form 8-K filed April 1, 2004.(2)
    
    Incorporated by reference to Net Perceptions Registration
Statement on Form S-1 (Registration No. 333-71919). 36




---



##### Table of Contents



(3)
    
    Incorporated by reference to Net Perceptions Annual Report on Form
10-K for the Fiscal Year Ended December 31, 2002.(4)
    
    Incorporated by reference to Net Perceptions Quarterly Report on
Form 10-Q for the Quarter Ended June 30, 2003.(5)
    
    Incorporated by reference to Net Perceptions Quarterly Report on
Form 10-Q for the Quarter Ended June 30, 2001.(6)
    
    Incorporated by reference to Net Perceptions Registration
Statement on Form 8-A filed June 6, 2001.(7)
    
    Incorporated by reference to Net Perceptions Current Report on
Form 8-K filed December 23, 2003.(8)
    
    Incorporated by reference to Net Perceptions Quarterly Report on
Form 10-Q for the Quarter Ended March 31, 2001.(9)
    
    Incorporated by reference to Net Perceptions Quarterly Report on
Form 10-Q for the Quarter Ended June 30, 2000.(10)
    
    Incorporated by reference to Net Perceptions Annual Report on Form
10-K for the Fiscal Year Ended December 31, 2001.(11)
    
    Incorporated by reference to Net Perceptions Amendment No. 1 to
its Annual Report on Form 10-K/A for the Fiscal Year Ended December 31,
2002. (b) Reports on Form 8-K The Company filed a Current Report on Form 8-K under Items 5 and 12 on
October 21, 2003 in connection with a press release announcing (a) that the
board of directors had adopted a Plan of Complete Liquidation and Dissolution
and (b) the Companys financial results for the three and nine month periods
ended September 30, 2003. The Company filed a Current Report on Form 8-K under Item 5 on December
23, 2003 in connection with a press release announcing that the Company had
entered into an amendment to its Rights Agreement. The Company filed a Current Report on Form 8-K under Item 5 on December
31, 2003 announcing that it had entered into a Patent Purchase Agreement with
Thalveg Data Flow LLC for the sale of its patent portfolio. 37




---



##### Table of Contents



ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA NET PERCEPTIONS, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS PageReport of Independent Auditors
    
    
    F-2Consolidated Balance
Sheets
    
    
    F-3Consolidated Statements of
Operations
    
    
    F-4Consolidated Statement of Stockholders Equity and Comprehensive Income
    
    
    F-5Consolidated Statements of Cash
Flows
    
    
    F-6Notes to the Consolidated Financial
Statements
    
    
    F-7
 F-1




---



##### Table of Contents



REPORT OF INDEPENDENT AUDITORS To the Board of Directors
and Stockholders of
Net Perceptions, Inc.: In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, of stockholders equity and
comprehensive income and of cash flows present fairly, in all material
respects, the financial position of Net Perceptions, Inc. and its subsidiaries
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 1 to the consolidated financial statements, the
Company has significantly curtailed operations and anticipates that its board of directors will continue to review and consider
possible actions or transactions which might be available to resolve the
Companys future in the near term. As discussed in Note 5 to the consolidated financial statements, the
Company adopted the provisions of Statement of Financial Accounting Standards
No. 142, Goodwill and Other Intangible Assets and ceased amortizing goodwill
on January 1, 2002. /s/ PricewaterhouseCoopers LLP
Minneapolis, Minnesota
April 1, 2004 F-2




---



##### Table of Contents



NET PERCEPTIONS, INC. 
 CONSOLIDATED BALANCE SHEETS (in thousands, except per share amounts)
 December 31,2003
    
    2002ASSETSCurrent assets:Cash and cash equivalents
    
    $
    11,932
    
    
    $
    39,729Short-term investments
    
    
    
    
    
    
    23,230Accounts receivable, net
    
    
    355
    
    
    
    389Prepaid expenses and other current assets
    
    
    481
    
    
    
    627Total current assets
    
    
    12,768
    
    
    
    63,975Property and equipment, net
    
    
    
    
    
    
    1,096Other assets
    
    
    35
    
    
    
    725Total assets
    
    $
    12,803
    
    
    $
    65,796LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    
    
    
    $
    52Accrued liabilities
    
    
    751
    
    
    
    1,853Deferred revenue
    
    
    380
    
    
    
    750Accrued restructuring costs
    
    
    37
    
    
    
    4,289Total current liabilities
    
    
    1,168
    
    
    
    6,944Deferred Rent
    
    
    
    
    
    
    510Total liabilities
    
    
    1,168
    
    
    
    7,454Commitments and contingencies (Notes 9 and 11)
Stockholders equity:Preferred stock  $.0001 par value; 5,000 shares
authorized; no shares issued or outstanding
    
    
    
    
    
    
    Common stock  $.0001 par value; 100,000 shares
authorized; 28,145 and 27,332 shares issued and
outstanding at December 31, 2003 and 2002,
respectively
    
    
    2
    
    
    
    2Additional paid-in capital
    
    
    233,761
    
    
    
    275,053Accumulated other comprehensive income
    
    
    
    
    
    
    122Accumulated deficit
    
    
    (222,128
    )
    
    
    (216,835
    )Total stockholders equity
    
    
    11,635
    
    
    
    58,342Total liabilities and stockholders equity
    
    $
    12,803
    
    
    $
    65,796
 See accompanying notes to the consolidated financial statements. F-3




---



##### Table of Contents



NET PERCEPTIONS, INC. 
 CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share amounts)
 Year Ended December 31,2003
    
    2002
    
    2001Revenues:Product
    
    $
    962
    
    
    $
    1,703
    
    
    $
    2,979Service and maintenance
    
    
    1,622
    
    
    
    3,541
    
    
    
    7,535Total revenues
    
    
    2,584
    
    
    
    5,244
    
    
    
    10,514Cost of revenues:Product
    
    
    12
    
    
    
    292
    
    
    
    943Service and maintenance
    
    
    755
    
    
    
    2,101
    
    
    
    5,143Total cost of revenues
    
    
    767
    
    
    
    2,393
    
    
    
    6,086Gross margin
    
    
    1,817
    
    
    
    2,851
    
    
    
    4,428Operating expenses:Sales and marketing
    
    
    1,347
    
    
    
    4,550
    
    
    
    15,215Research and development
    
    
    2,112
    
    
    
    5,933
    
    
    
    10,572General and administrative
    
    
    2,261
    
    
    
    2,819
    
    
    
    6,198Lease abandonment expense
    
    
    
    
    
    
    
    
    
    
    225Restructuring related charges and
impairments
    
    
    2,251
    
    
    
    768
    
    
    
    15,551Amortization of intangibles
    
    
    
    
    
    
    110
    
    
    
    9,650Impairment of goodwill and other intangibles
    
    
    
    
    
    
    6,546
    
    
    
    75,298Total operating expenses
    
    
    7,971
    
    
    
    20,726
    
    
    
    132,709Loss from operations
    
    
    (6,154
    )
    
    
    (17,875
    )
    
    
    (128,281
    )Other income (expense):Interest income
    
    
    610
    
    
    
    2,108
    
    
    
    4,494Interest expense
    
    
    
    
    
    
    (24
    )
    
    
    (88
    )Other income (expense)
    
    
    229
    
    
    
    (943
    )
    
    
    77Total other income, net
    
    
    861
    
    
    
    1,141
    
    
    
    4,483Net loss
    
    $
    (5,293
    )
    
    $
    (16,734
    )
    
    $
    (123,798
    )Basic and diluted net loss per share
    
    $
    (0.19
    )
    
    $
    (0.61
    )
    
    $
    (4.59
    )Shares used in computing basic and diluted net loss per
share
    
    
    27,683
    
    
    
    27,216
    
    
    
    26,951
 See accompanying notes to the consolidated financial statements. F-4




---



##### Table of Contents



NET PERCEPTIONS, INC. 
 CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY AND COMPREHENSIVE INCOME (in thousands)
 AccumulatedAdditional
    
    Other
    
    
    
    
    
    Total
    
    ComprehensiveCommon Stock
    
    Paid-in
    
    Comprehensive
    
    Accumulated
    
    Stockholders'
    
    IncomeShares
    
    Amount
    
    Capital
    
    Income (Loss)
    
    Deficit
    
    Equity
    
    (Loss)Balance, December 31, 2000
    
    
    26,870
    
    
    $
    2
    
    
    $
    274,458
    
    
    $
    361
    
    
    $
    (76,303
    )
    
    $
    198,518Exercise of stock options
    
    
    115
    
    
    
    
    
    
    
    59
    
    
    
    
    
    
    
    
    
    
    
    59
    
    
    $
    Repurchase of unvested common
stock
    
    
    (2
    )
    
    
    
    
    
    
    (6
    )
    
    
    
    
    
    
    
    
    
    
    (6
    )
    
    
    Compensation relating to stock
options .
    
    
    
    
    
    
    
    
    
    
    230
    
    
    
    
    
    
    
    
    
    
    
    230
    
    
    
    Issuance of common stock under
employee stock purchase plan
    
    
    146
    
    
    
    
    
    
    
    128
    
    
    
    
    
    
    
    
    
    
    
    128
    
    
    
    Change in unrealized gain (loss)
on available-for-sale
investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    276
    
    
    
    
    
    
    
    276
    
    
    
    276Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (123,798
    )
    
    
    (123,798
    )
    
    
    (123,798
    )Balance, December 31, 2001
    
    
    27,129
    
    
    
    2
    
    
    
    274,869
    
    
    
    637
    
    
    
    (200,101
    )
    
    
    75,407
    
    
    
    (123,522
    )Exercise of stock options
    
    
    136
    
    
    
    
    
    
    
    64
    
    
    
    
    
    
    
    
    
    
    
    64
    
    
    
    Repurchase of unvested common
stock
    
    
    (1
    )
    
    
    
    
    
    
    (1
    )
    
    
    
    
    
    
    
    
    
    
    (1
    )
    
    
    Compensation relating to stock
options
    
    
    
    
    
    
    
    
    
    
    54
    
    
    
    
    
    
    
    
    
    
    
    54
    
    
    
    Issuance of common stock under
employee stock purchase plan
    
    
    68
    
    
    
    
    
    
    
    67
    
    
    
    
    
    
    
    
    
    
    
    67
    
    
    
    Change in unrealized gain (loss)
on available-for-sale
investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (515
    )
    
    
    
    
    
    
    (515
    )
    
    
    (515
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (16,374
    )
    
    
    (16,374
    )
    
    
    (16,374
    )Balance, December 31, 2002
    
    
    27,332
    
    
    
    2
    
    
    
    275,053
    
    
    
    122
    
    
    
    (216,835
    )
    
    
    58,342
    
    
    
    (17,249
    )Exercise of stock options
    
    
    801
    
    
    
    
    
    
    
    894
    
    
    
    
    
    
    
    
    
    
    
    894
    
    
    
    Issuance of common stock under
employee stock purchase plan
    
    
    12
    
    
    
    
    
    
    
    12
    
    
    
    
    
    
    
    
    
    
    
    12
    
    
    
    Change in unrealized gain (loss)
on available-for-sale
investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (122
    )
    
    
    
    
    
    
    (122
    )
    
    
    (122
    )Cash Distribution to Stockholders
    
    
    
    
    
    
    
    
    
    
    (42,198
    )
    
    
    
    
    
    
    
    
    
    
    (42,198
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,293
    )
    
    
    (5,293
    )
    
    
    (5,293
    )Balance, December 31, 2003
    
    
    28,145
    
    
    $
    2
    
    
    $
    233,761
    
    
    $
    
    
    
    $
    (222,128
    )
    
    $
    11,635
    
    
    $
    (5,415
    )
 See accompanying notes to the consolidated financial statements. F-5




---



##### Table of Contents



NET PERCEPTIONS, INC. 
 CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
 Year Ended December 31,2003
    
    2002
    
    2001Cash flows from operating activities:Net loss
    
    $
    (5,293
    )
    
    $
    (16,734
    )
    
    $
    (123,798
    )Reconciliation of net loss to net cash used by operating
activities:Depreciation and amortization
    
    
    484
    
    
    
    2,196
    
    
    
    13,528Provision for doubtful accounts
    
    
    (54
    )
    
    
    79
    
    
    
    1,051Lease abandonment expense
    
    
    
    
    
    
    
    
    
    
    225Compensation expense related to stock options
    
    
    
    
    
    
    42
    
    
    
    230Restructuring related charges and impairments
    
    
    2,251
    
    
    
    768
    
    
    
    15,551Impairment of goodwill and other intangibles
    
    
    
    
    
    
    6,546
    
    
    
    75,298Amortization of premiums (discounts) on
investments
    
    
    183
    
    
    
    372
    
    
    
    (135
    )Loss on disposal of assets
    
    
    
    
    
    
    
    
    
    
    22Changes in assets and liabilities:Accounts receivable
    
    
    88
    
    
    
    841
    
    
    
    3,979Royalties receivable
    
    
    
    
    
    
    
    
    
    
    671Prepaid expenses and other current assets
    
    
    146
    
    
    
    1,674
    
    
    
    (462
    )Other assets
    
    
    690
    
    
    
    457
    
    
    
    613Accounts payable
    
    
    (52
    )
    
    
    (262
    )
    
    
    (1,112
    )Accrued expenses
    
    
    (6,993
    )
    
    
    (4,619
    )
    
    
    (5,957
    )Deferred revenue
    
    
    (370
    )
    
    
    (1,085
    )
    
    
    (1,908
    )Other liabilities
    
    
    (510
    )
    
    
    (67
    )
    
    
    (92
    )Net cash used in operating activities
    
    
    (9,430
    )
    
    
    (9,792
    )
    
    
    (22,296
    )Cash flows from investing activities:Purchases of short-term investments and marketable
securities
    
    
    (16,121
    )
    
    
    (47,555
    )
    
    
    (132,886
    )Sales and maturities of short-term investments and
marketable securities
    
    
    39,046
    
    
    
    82,114
    
    
    
    154,461Purchases of property and equipment
    
    
    
    
    
    
    
    
    
    
    (248
    )Net cash provided by investing
activities
    
    
    22,925
    
    
    
    34,559
    
    
    
    21,327Cash flows from financing activities:Proceeds from issuance of stock under employee stock
purchase plan
    
    
    12
    
    
    
    67
    
    
    
    128Proceeds from exercise of stock options and warrants, net
of stock repurchases
    
    
    894
    
    
    
    63
    
    
    
    53Cash distribution to stockholders
    
    
    (42,198
    )
    
    
    
    
    
    
    Principal payments under capital lease obligations and
notes payable
    
    
    
    
    
    
    (97
    )
    
    
    (679
    )Net cash (used in) provided by financing
activities
    
    
    (41,292
    )
    
    
    33
    
    
    
    (498
    )Net (decrease) increase in cash and cash equivalents
    
    
    (27,797
    )
    
    
    24,800
    
    
    
    (1,467
    )Cash and cash equivalents at beginning of year
    
    
    39,729
    
    
    
    14,929
    
    
    
    16,396Cash and cash equivalents at end of year
    
    $
    11,932
    
    
    $
    39,729
    
    
    $
    14,929Supplemental schedule of non-cash investing and financing
activities:Interest paid
    
    $
    
    
    
    $
    24
    
    
    $
    88
 See accompanying notes to the consolidated financial statements. F-6




---



##### Table of Contents



NET PERCEPTIONS, INC. 
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except per share amounts)
 1. Organization Net Perceptions, Inc. (the Company) was incorporated in Delaware on July
3, 1996. The Company developed and marketed software solutions that enabled its
customers to interact more intelligently with their customers. On October 21,
2003, the Company announced that its board of directors had unanimously
approved a plan of complete liquidation and dissolution, referred to as the
plan of liquidation. The plan of liquidation was submitted to the Companys
stockholders for approval and adoption at a special meeting of stockholders
originally scheduled for March 12, 2004, which was adjourned and reconvened on
March 23, 2004. At the reconvened special meeting, the proposal to approve and
adopt the plan of liquidation did not receive the affirmative vote of a
majority of the 28,145,338 shares of common stock outstanding as of the record
date for the special meeting required to approve the proposal. Of the
15,773,134 shares represented in person or by proxy at the reconvened special
meeting, 13,810,233 shares voted in favor of the proposal, 1,925,694 shares
voted against and 37,207 shares abstained. The Company has significantly curtailed business operations and at April
1, 2004 had two employees. The Company anticipates that its board of directors
will continue to review and consider possible actions or transactions which
might be available to resolve the Companys future in the near term in the best
interest of all stockholders. These could include, among other actions or
transactions, further sales or licenses of assets, an acquisition of or
investment in the Company or other extraordinary transaction, adopting a new
plan of complete liquidation and dissolution and seeking stockholder approval
therefor and/or changes in the composition of the Companys board of directors. The Company has historically been subject to risks and uncertainties
common to technology-based companies, including rapid technological change,
growth of electronic commerce, dependence on principal products and third-party
technology, new product development and acceptance, actions of competitors,
dependence on key personnel, lengthy sales cycle,
availability of sufficient capital and a limited operating history. 2. Summary of significant accounting policies Basis of presentation The consolidated financial statements include accounts of the Company and
its wholly owned subsidiaries. All significant inter-company accounts and
transactions have been eliminated. Revenues and identifiable assets
attributable to the Companys foreign subsidiaries were less than 10% of their
respective totals. The equity method of accounting was used to account for the
Companys equity investment in a Japanese joint venture (see Note 10). Use of estimates The preparation of financial statements in conformity with generally
accepted accounting principles in the United States of America requires
management to make estimates and assumptions that affect the reported amounts
therein. Managements estimates are based on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances. Managements estimates and assumptions are evaluated on an
on-going basis. Due to the inherent uncertainty involved in making estimates,
actual results may differ from those estimates. F-7




---



##### Table of Contents



Revenue recognition The Company recognizes revenues in accordance with the American Institute
of Certified Public Accountants (AICPA) Statement of Position (SOP) 97-2,
Software Revenue Recognition, as amended by SOP 98-4, Deferral of the
Effective Date of a Provision of SOP 97-2 and SOP 98-9, Modification of SOP
97-2, Software Revenue Recognition with Respect to Certain Transactions and in
accordance with the Securities and Exchange Commission Staff Accounting
Bulletin (SAB) No. 104, Revenue Recognition in Financial Statements. The
Company derives revenues from software licenses, software maintenance and
professional services. Maintenance includes telephone and Web-based technical
support, bug fixes and rights to unspecified upgrades on a when-and-if
available basis. Professional services include project planning and management,
implementation and testing, data analysis, data warehousing, user and partner
training, consulting, product hosting and ongoing customer support. For software arrangements that include multiple elements (e.g., software
products, and/or maintenance or services), the Company allocates the total
arrangement fee using the residual method. Under the residual method, the fair
value of the undelivered maintenance and service elements, as determined by
vendor-specific objective evidence, is deferred and the remaining (residual)
arrangement fee is recognized as software product revenue. In software
arrangements in which the Company does not have vendor-specific objective
evidence of undelivered elements, revenue is deferred until the earlier of when
vendor-specific objective evidence is determined for the undelivered elements
or when all elements have been delivered. Revenues from license fees are recognized when a non-cancelable agreement
has been executed, the product has been shipped or electronically delivered,
there are no uncertainties surrounding product acceptance, the fee is fixed or
determinable and collection of the related receivable is considered probable.
If the fee due from the customer is not fixed or determinable, revenues are
recognized as payments become due from the customer. If the Company does not
consider collection to be probable, then revenues are recognized when the fee
is collected. License revenues related to license terms less than twenty-four months are
recognized ratably over the term of the license period. When the Company offers
products and services on a hosted basis, up front set-up fees are deferred and
recognized ratably over the estimated service period. Revenues allocable to maintenance are recognized ratably over the term of
the agreement. The Company evaluates arrangements that include professional
and/or data processing services to determine whether those services are
essential to the functionality of other elements of the arrangement. If
professional services are considered essential, revenues from the arrangement
are recognized using contract accounting, generally on a
percentage-of-completion basis. When the Company does not consider the
professional services to be essential, revenues allocable to the services are
recognized as they are performed. Under general contract terms, the Company includes an indemnification
clause in its software licensing agreement that indemnifies the licensee
against liability and damages arising from any claims of patent, copyright,
trademark or trade secret infringement by the Companys software. The Company
has incurred insignificant costs as a result of this type of indemnification
clause and the Company does not maintain a product warranty liability related
to such indemnification clauses. Concentrations of credit risk and significant customers Financial instruments that potentially subject the Company to credit risk
consist primarily of accounts receivable. The Company grants credit to
customers in the ordinary course of business. To minimize credit risk, ongoing
credit evaluations are performed. Three customers accounted for 14%, 13% and
10% of total 2003 revenues and one customer accounted for 84% of accounts
receivable at December 31, 2003. One customer accounted for 22% of total 2002
revenues and three customers accounted for 33%, 27% and 20% of accounts
receivable at December 31, 2002. Three customers accounted for 12%, 11% and 10%
of total 2001 revenues. F-8




---



##### Table of Contents



Cash equivalents, short-term
investments and marketable securities Cash equivalents, short-term investments and marketable securities consist
principally of commercial paper, government agency notes and money market
funds. Cash equivalents are all highly liquid temporary cash investments
purchased with original maturities of 90 days or less. The Company determines
the appropriate classification of short-term investments and marketable
securities at the time of purchase and reevaluates such designation as of each
balance sheet date. As of December 31, 2003, all of the Companys cash was held
in money market accounts and its short-term investments and marketable
securities value was $0. Available-for-sale securities are stated at fair
market value with unrealized holding gains or losses recorded as a separate
component of stockholders equity. The Companys debt and marketable equity securities were as follows: Aggregate
    
    Unrealized
    
    UnrealizedCost
    
    Fair Value
    
    gains
    
    lossesAs of December 31, 2002:Government agencies
    
    $
    17,258
    
    
    $
    17,321
    
    
    $
    63
    
    
    $
    Corporate debt
    
    
    5,850
    
    
    
    5,909
    
    
    
    59$
    23,108
    
    
    $
    23,230
    
    
    $
    122
    
    
    $
    
 Fair value of financial instruments The carrying amounts of the Companys financial instruments, which include
cash equivalents, short-term investments, marketable securities, accounts
receivable, accounts payable, accrued expenses and capital lease obligations,
approximate their fair values at December 31, 2003 and 2002. Property and equipment Property and equipment are stated at cost. Depreciation and amortization
are computed using the straight-line method over the estimated useful lives of
the individual assets; or the shorter of the estimated useful lives or
underlying lease term (in the case of leasehold improvements and capital lease
equipment). Estimated useful lives generally range from three to ten years. At
December 31, 2003, substantially all of the Companys property and equipment
had been disposed, with the balance being fully depreciated at December 31,
2003. Long-lived assets In accordance with SFAS No. 144, Accounting for the Impairment of
Disposal of Long-Lived Assets, which was effective for the Company January 1,
2002, the Company reviews long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying amount may not be
recoverable. An impairment loss shall be recognized only if the carrying amount
of a long-lived asset (asset group) is not recoverable and exceeds its fair
value. The carrying amount of a long-lived asset (asset group) is not
recoverable if it exceeds the sum of the undiscounted cash flows expected to
result from the use and eventual disposition of the asset (asset group). That
assessment shall be based on the carrying amount of the asset (asset group) at
the date it is tested for recoverability, whether in use or under development.
An impairment loss shall be measured as the amount by which the carrying amount
of a long-lived asset (asset group) exceeds its fair value. Other assets Other assets consist primarily of operating lease deposits. Research and development Research and development expenditures, which include software development
costs, are expensed as incurred. SFAS No. 86, Accounting for the Costs of
Computer Software to Be Sold, Leased or Otherwise Marketed, requires the
capitalization of certain software development F-9




---



##### Table of Contents



costs once technological feasibility is established, which the Company defines
as the completion of a working model. To date, the period between achieving
technological feasibility and the general availability of such software has
been short and software development costs qualifying for capitalization have
been insignificant. Accordingly, the Company has not capitalized any software
development costs. Income taxes The Company calculates income taxes in accordance with the provisions of
SFAS No. 109, Accounting for Income Taxes, which requires the use of the
liability method of accounting for income taxes. Income taxes are deferred for
all temporary differences between the financial statement and income tax basis
of assets and liabilities. Deferred taxes are recorded using the enacted tax
rates scheduled by tax law to be in effect when the temporary differences are
expected to settle or be realized. Deferred tax assets are reduced by a
valuation allowance to the extent that utilization is considered uncertain. Advertising expense The Company recognizes advertising expense as incurred. Advertising
expense has been insignificant since inception. Net loss per share Net loss per share is computed under SFAS No. 128, Earnings Per Share.
Basic net loss per share is computed using the weighted-average number of
shares of common stock outstanding, excluding shares of common stock subject to
repurchase. Such shares of common stock subject to repurchase aggregated 0, 1,
and 10 shares at December 31, 2003, 2002 and 2001, respectively (see Note 9).
Diluted net loss per share does not differ from basic net loss per share since
potential shares of common stock from conversion of preferred stock, stock
options and warrants and outstanding shares of common stock subject to
repurchase are anti-dilutive for all periods presented. Options to purchase
2,029, 2,757, and 3,719 shares of the Companys common stock were outstanding
as of December 31, 2003, 2002 and 2001, respectively, and could potentially
dilute earnings per share in future periods. Foreign currency translation All assets and liabilities of the Companys foreign subsidiaries and
affiliates are translated from local currencies to United States dollars at
period end rates of exchange, while revenues and expenses are translated at the
average exchange rates during the period. The functional currency for each of
the Companys foreign subsidiaries and affiliates is the respective local
currency. Gains or losses resulting from foreign currency transactions
(transactions denominated in a currency other than the entitys local currency)
are included in the consolidated statement of operations and are not
significant. Comprehensive income (loss) Comprehensive income (loss), as defined by SFAS No. 130, Reporting
Comprehensive Income, includes net loss and items defined as other
comprehensive income. SFAS No. 130 requires that items defined as other
comprehensive income (loss), such as foreign currency translation adjustments
and unrealized gains and losses on certain investments in debt securities, be
separately classified in the financial statements. Such disclosures are
included in the consolidated statements of stockholders equity and
comprehensive loss. Stock-based compensation The Company accounts for stock-based employee compensation arrangements in
accordance with the provisions of Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees, and complies with the disclosure
provisions of Statement of Financial F-10




---



##### Table of Contents



Accounting Standards (SFAS)
No. 123, Accounting for Stock-Based Compensation and SFAS No. 148,
Accounting for Stock-Based Compensation-Transition and Disclosure-an amendment
of Financial Accounting Standards Board Statement No. 123. The Company has adopted the disclosure-only provisions of SFAS No. 123.
For purposes of the pro forma disclosures below, the estimated fair value of
the Companys stock options is amortized to expense over the options vesting
period. Had compensation cost for the Companys stock options been recognized
based on the fair value at the grant date consistent with the provisions of
SFAS No. 123, the Companys net income (loss) would have been adjusted to the
pro forma amounts indicated below: Year Ended December 312003
    
    2002
    
    2001Net loss, as reported
    
    $
    (5,293
    )
    
    $
    (16,734
    )
    
    $
    (123,798
    )Add: Stock-based employee
compensation expense included in
reported net loss
    
    
    
    
    
    
    54
    
    
    
    230Deduct: Total stock-based employee
compensation expense determined
under fair value based method for
all awards, net of related tax
effects
    
    
    (1,274
    )
    
    
    (2,358
    )
    
    
    (4,254
    )Pro forma net loss
    
    $
    (6,597
    )
    
    $
    (19,038
    )
    
    $
    (127,822
    )Basic and diluted net loss per share:As reported
    
    $
    (0.19
    )
    
    $
    (0.61
    )
    
    $
    (4.59
    )Pro forma
    
    $
    (0.24
    )
    
    $
    (0.69
    )
    
    $
    (4.74
    )
 Compensation expense for pro forma purposes is reflected over the vesting
period. The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option-pricing model with the following
weighted-average assumptions used for grants in 2003, 2002 and 2001,
respectively: dividend yield of 0% for option grants in all years; risk-free
interest rates of 3.0%, 3.9% and 4.6%; expected lives of 5 years for option
grants in all years; and volatility factors of 50%, 70% and 97%. The
weighted-average fair value of options adjustments during 2003, 2002 and 2001
using the Black-Scholes option-pricing model was $0.16, $0.77 and $1.24 per
share, respectively. Recently issued accounting pronouncements In January 2003, the FASB issued Interpretation No. (FIN) 46,
Consolidation of Variable Interest Entities, an Interpretation of Accounting
Research Bulletin No. 51. FIN No. 46 requires certain variable interest
entities, or VIEs, to be consolidated by the primary beneficiary of the entity
if the equity investors in the entity do not have the characteristics of a
controlling financial interest, or do not have sufficient equity at risk for
the entity to finance its activities without additional subordinated financial
support from other parties. In December 2003, the FASB issued FIN No. 46-R,
Consolidation of Variable Interest Entities, which represents a revision to
FIN No. 46. The provisions of FIN No. 46-R are effective for interests in VIEs
as of the first interim or annual period ending after December 15, 2003. The
Company currently has no contractual relationship or other business
relationship with a variable interest entity and therefore the adoption of FIN
No. 46 or FIN No. 46-R did not have a material effect on its consolidated
financial position, results of operations or cash flows. F-11




---



##### Table of Contents



3. Financial statement components Certain balance sheet components consist of the following: Rollforward of the allowance for doubtful accounts: Balance December 31, 2000
    
    $
    1,594Provision
    
    
    1,051Write-offs
    
    
    (2,995
    )Recoveries
    
    
    499Balance, December 31, 2001
    
    
    149Provision
    
    
    79Write-offs
    
    
    (151
    )Recoveries
    
    
    8Balance, December 31, 2002
    
    
    85Provision
    
    
    (54
    )Write-offs
    
    
    (3
    )Recoveries
    
    
    2Balance, December 31, 2003
    
    $
    30
 Property and equipment consist of the following: December 31,2003
    
    2002Computer hardware
    
    $
    128
    
    
    $
    3,719Leasehold improvements
    
    
    
    
    
    
    302Purchased computer software
    
    
    458
    
    
    
    603Furniture, fixtures and equipment
    
    
    82
    
    
    
    1,088668
    
    
    
    5,712Less: Accumulated depreciation and amortization
    
    
    (668
    )
    
    
    (4,616
    )$
    
    
    
    $
    1,096
 Depreciation and amortization expense was $484, $1,940 and $3,434 for the
years ended December 31, 2003, 2002 and 2001, respectively. Accrued liabilities consist of the following: December 31,2003
    
    2002Accrued wages and benefits
    
    $
    225
    
    
    $
    614Accrued lease abandonment costs
    
    
    
    
    
    
    383Other accrued expenses
    
    
    526
    
    
    
    856$
    751
    
    
    $
    1,853
 4. Acquisition of Knowledge Discovery One In February 2000, the Company acquired Knowledge Discovery One, Inc.
(KD1), a developer and marketer of advanced data analysis solutions for
retailers. In this transaction, the Company acquired all of the outstanding
shares of KD1 in exchange for 1,969 shares of its common stock, and KD1 became
the Companys wholly owned subsidiary. The value of the Companys common stock
issued for the KD1 F-12




---



##### Table of Contents



acquisition was determined by the average of the Companys stock price
over a period ending shortly before the announcement of the acquisition. The
Company also assumed all outstanding options to purchase KD1 common stock. The
Company reserved 266 shares of its common stock for issuance upon the exercise
of these options. The KD1 acquisition was accounted for under the purchase
method of accounting. Accordingly, the total purchase price of $117,815 was
allocated to the acquired assets and liabilities assumed at their fair market
values as of the transaction closing date, and the Companys consolidated
statements of operations do not include any revenues or expenses related to the
acquisition prior to the closing date. Such acquired assets included intangible
assets related to acquired technology (three year useful life), customer list
(three-year useful life), workforce (four-year useful life) and goodwill
(three-year useful life) of $4,000, $3,000, $1,000 and $110,755, respectively.
The Company also assumed net liabilities of approximately $940. At March 31, 2001, the Company performed an impairment assessment of the
goodwill and other intangible assets recorded in connection with the
acquisition of KD1 as provided by APB No. 17, Intangible Assets and SFAS No.
121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of. The assessment was performed primarily due to lower
than expected revenues in the first quarter of 2001 (product revenues declined
87% from the same period in 2000 and 72% from the fourth quarter of 2000) and a
downward revision in the first quarter of 2001 of the Companys internal
revenue projections based on the general economic conditions in the information
technology sector, combined with changes in valuation models for technology
companies, a continued decline in the Companys first quarter 2001 stock price
and its March 2001 plan of restructuring. As a result of its review, the
Company recorded a $75.3 million impairment charge to reduce goodwill and other
intangible assets to their estimated fair values. The charge was determined
based upon the Companys estimated discounted cash flows over the estimated
remaining useful life of the goodwill and other intangible assets, a terminal
value at the end of this estimated life and using a discount rate of 40%. The
assumptions supporting the cash flows, including the discount rate and
estimated terminal value were determined using managements best estimates
available at the time the impairment assessment was made. The estimated cash
flows were consistently based on the Companys internal operating plan. The
discount rate was based upon the historical time-weighted returns for venture
capital type investments for the ten-year period ended December 31, 2000  a
rate considered appropriate given the Companys revenue levels at that time.
The estimated terminal value was based on the Companys recent revenue multiple
based on trailing twelve months revenues as objectively observed from the
Companys then market capitalization. In conjunction with the adoption of SFAS No. 142, Goodwill and Other
Intangible Assets, the Company completed the transitional impairment test of
goodwill as of January 1, 2002 and it was determined that the carrying value of
goodwill was not impaired. At December 31, 2002, the Company performed its
annual impairment assessment of goodwill and other intangible assets. As a
result of this impairment test, the Company concluded that an impairment
existed and that the impairment occurred due to events and changes in
circumstances, which included lower than expected fourth quarter revenues and a
revised 2003 forecast. As a result of the December 2002 impairment assessment,
the Company recorded a $6.5 million impairment charge to reduce goodwill and
other intangible assets to zero value. The charge was determined based upon the
Companys estimated discounted cash flows over the estimated remaining useful
life of the goodwill and other intangible assets, a terminal value at the end
of this estimated life and using a discount rate of 35%. The assumptions
supporting the cash flows, including the discount rate and estimated terminal
value were determined using managements best estimates available at the time
the impairment assessment was made. 5. Goodwill and Other Intangible Assets  Adoption of SFAS No. 141 and No.
142 Effective January 1, 2002, in accordance with SFAS No. 141 and No. 142,
the Company ceased amortizing goodwill and certain other identified intangible
assets that had a net book value of approximately $6,500 as of January 1, 2002.
The adoption of these statements resulted in the Company not recognizing $3,100
of amortization expense for 2002 that would have been recognized had the old
standards been in effect. The Companys net loss for 2001 included $9,317 in
amortization expense relating to goodwill and certain other identified
intangible assets that are no longer being amortized. F-13




---



##### Table of Contents



The following table presents the impact of these statements on net loss
and net loss per share, as if they had been in effect for all periods
presented. Year Ended December 31,2003
    
    2002
    
    2001Reported net loss
    
    $
    (5,293
    )
    
    $
    (16,734
    )
    
    $
    (123,798
    )Addback: Goodwill amortization
    
    
    
    
    
    
    
    
    
    
    9,317Adjusted net loss
    
    $
    (5,293
    )
    
    $
    (16,734
    )
    
    $
    (114,481
    )Basic and diluted earnings
per share:Reported net loss
    
    $
    (0.19
    )
    
    $
    (0.61
    )
    
    $
    (4.59
    )Goodwill amortization
    
    
    
    
    
    
    
    
    
    
    0.34Adjusted net loss
    
    $
    (0.19
    )
    
    $
    (0.61
    )
    
    $
    (4.25
    )
 The changes in the carrying amount of goodwill and other intangible assets
for the years ended December 31, 2002 and 2001 are as follows: Goodwill
    
    Other intangibles
    
    TotalBalance at December 31, 2000
    
    $
    87,236
    
    
    $
    4,958
    
    
    $
    92,194Amortization expense
    
    
    (9,317
    )
    
    
    (777
    )
    
    
    (10,094
    )Impairment
    
    
    (71,406
    )
    
    
    (3,892
    )
    
    
    (75,298
    )Balance at December 31, 2001
    
    
    6,513
    
    
    
    289
    
    
    
    6,802Amortization expense
    
    
    
    
    
    
    (256
    )
    
    
    (256
    )Impairment
    
    
    (6,513
    )
    
    
    (33
    )
    
    
    (6,546
    )Balance at December 31, 2002
    
    $
    
    
    
    $
    
    
    
    $
    
 6. Restructuring related charges and impairments During 2003, 2002 and 2001, the Company instituted certain restructuring
plans to better align its cost structure with its business outlook and general
economic conditions. Under the restructuring plans, the Company recorded
restructuring related charges totaling $2.3 million, $768,000 and $15.6 million
during 2003, 2002 and 2001, respectively. In March 2001 the Company reduced its workforce by approximately 46%, or
124 positions throughout the organization, and recorded a charge of $13,920 to
reorganize the Company and exit certain facilities in various United States and
international locations. This $13,920 charge included $10,200 related to
facility consolidation, $1,190 of employee termination costs and $2,530 of
losses on the disposal of assets and other restructuring charges. During the
third quarter of 2001, the Company reduced its workforce by 45 employees and
recorded an additional $1,771 restructuring related charge. This $1,771 charge
included $878 for estimated losses on the disposal of fixed assets, $449 for
leasehold write-offs related to facility consolidation and $444 for employee
severance payments. During the fourth quarter of 2001, the total restructuring
charge was decreased by $140 to reflect the actual costs of exiting certain
marketing activities in connection with the restructuring. In the first quarter of 2002 the Company further reduced its workforce by
15% or 15 positions, and recorded $367 in related employee termination costs.
During the second quarter of 2002 the Company recorded restructuring related
charges of $401, of which $139 related to employee termination costs due to a
reduction in workforce by 18 positions or 21%, $291 represented the write-down
of certain fixed assets and $(29) was a reversal of previously recorded
restructuring related charges resulting from revised estimates of other costs. F-14




---



##### Table of Contents



The Company recorded restructuring related charges of $1,200 in the first
quarter of 2003 related primarily to the closure of operations in three
satellite offices, employee termination costs due to a reduction of workforce
by 22 positions and $413 for estimated losses on the disposal of fixed assets.
The Company recorded additional restructuring related charges of $1,051 in the
third quarter of 2003 related primarily to the termination of three real estate
lease agreements, and employee termination costs due to a reduction of
workforce by 12 positions. The aggregate cash payments for the lease
terminations were approximately $5.4 million. The following table presents a summary of the Companys real estate
related contractual obligations as of December 31, 2003: 2004
    
    TotalOperating leases
    
    $
    89
    
    
    $
    89Executed sublease agreements
    
    
    (59
    )
    
    
    (59
    )Net contractual cash obligation
    
    $
    30
    
    
    $
    30
 Operating lease obligations relate to one remaining vacated facility in
San Francisco, CA, the majority of which is sublet. The Company is actively
seeking to sublease the remaining vacant portion of this office space and is
also attempting to negotiate the termination of this lease. The Company
currently occupies approximately 1,500 square feet of office space pursuant to
a month-to-month lease in Edina, Minnesota. As of December 31, 2003, the
Company estimated total future sublease income of $59 pursuant to existing
sublease arrangements. The following table presents a summary of the restructuring related
activities and accrued restructuring charges as of December 31, 2003: Employee
    
    
    
    
    
    FixedLease
    
    Severance
    
    
    
    
    
    AssetCommitments
    
    and
    
    
    
    
    
    Disposalsand Related
    
    Termination
    
    
    
    
    
    and OtherItems
    
    Costs
    
    Subtotal
    
    Costs
    
    TotalRestructuring Related Charges and
Impairments Net of Reversal
    
    $
    10,649
    
    
    $
    1,634
    
    
    $
    12,283
    
    
    $
    3,268
    
    
    $
    15,551Restructuring
Payments
    
    
    (2,233
    )
    
    
    (1,523
    )
    
    
    (3,756
    )
    
    
    (195
    )
    
    
    (3,951
    )Sublease Income and proceeds from the
Sale of Fixed
Assets
    
    
    280
    
    
    
    
    
    
    
    280
    
    
    
    261
    
    
    
    541Non-Cash Asset Disposals and Deferred
Rent
Write-Off
    
    
    (1,800
    )
    
    
    
    
    
    
    (1,800
    )
    
    
    (2,908
    )
    
    
    (4,708
    )Accrued Restructuring as of December
31, 2001
    
    $
    6,896
    
    
    $
    111
    
    
    $
    7,007
    
    
    $
    426
    
    
    $
    7,433Restructuring Related Charges and
Impairments
    
    
    
    
    
    
    506
    
    
    
    506
    
    
    
    262
    
    
    
    768Restructuring
Payments
    
    
    (4,024
    )
    
    
    (547
    )
    
    
    (4,571
    )
    
    
    (66
    )
    
    
    (4,637
    )Sublease Income and Proceeds from the
Sale of Fixed
Assets
    
    
    1,299
    
    
    
    
    
    
    
    1,299
    
    
    
    68
    
    
    
    1,367Non Cash Asset
Disposals
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (642
    )
    
    
    (642
    )Reclassification of Accrued Lease
Exit Costs
    
    
    383
    
    
    
    
    
    
    
    383
    
    
    
    
    
    
    
    383Accrued Restructuring as of December
31, 2002
    
    $
    4,554
    
    
    $
    70
    
    
    $
    4,624
    
    
    $
    48
    
    
    $
    4,672Restructuring Related Charges and
Impairments
    
    
    1,249
    
    
    
    589
    
    
    
    1,838
    
    
    
    413
    
    
    
    2,251
 F-15




---



##### Table of Contents



Employee
    
    
    
    
    
    FixedLease
    
    Severance
    
    
    
    
    
    AssetCommitments
    
    and
    
    
    
    
    
    Disposalsand Related
    
    Termination
    
    
    
    
    
    and OtherItems
    
    Costs
    
    Subtotal
    
    Costs
    
    TotalRestructuring
Payments
    
    
    (8,094
    )
    
    
    (652
    )
    
    
    (8,746
    )
    
    
    (51
    )
    
    
    (8,797
    )Sublease Income and Proceeds from the
Sale of Fixed
Assets
    
    
    1,832
    
    
    
    
    
    
    
    1,832
    
    
    
    165
    
    
    
    1,997Non Cash Asset Disposals and Deferred
Rent
Write-Off
    
    
    489
    
    
    
    
    
    
    
    489
    
    
    
    (575
    )
    
    
    (86
    )Accrued Restructuring as of December
31, 2003
    
    $
    30
    
    
    $
    7
    
    
    $
    37
    
    
    $
    
    
    
    $
    37
 7. Income taxes For income tax purposes, the Company has available federal net operating
loss carry-forwards of approximately $119,000 and research and development
credit carry-forwards of $151 at December 31, 2003. The net operating loss and
research and development credit carry-forwards expire in 2011 through 2023 if
not previously utilized. The utilization of these carry-forwards may be subject
to limitations based on past and future changes in ownership of the Company
pursuant to Internal Revenue Code Section 382. Future tax benefits have not
been recognized in the financial statements, as their utilization is considered
uncertain based on the weight of available information. Deferred income taxes reflect the 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 (liabilities) are as follows: December 31,2003
    
    2002Deferred tax assets:Net operating loss carry-forwards
    
    $
    45,134
    
    
    $
    39,791Restructuring related costs
    
    
    20
    
    
    
    2,109Research and development credit carry-forwards.
    
    
    196
    
    
    
    146Accrued vacation and other current liabilities.
    
    
    843
    
    
    
    1,355Accounts receivable allowance
    
    
    12
    
    
    
    33Total deferred tax assets
    
    
    46,205
    
    
    
    43,434Valuation allowance
    
    
    (46,205
    )
    
    
    (43,434
    )Total net deferred income taxes
    
    $
    
    
    
    $
    
 8. Long-term liabilities Long-term liabilities consist of the following: December 31,2003
    
    2002Deferred rent
    
    $
    
    
    
    $
    510
    
    
    
    510Less: Current portion
    
    
    
    
    
    
    $
    
    
    
    $
    510
 F-16




---



##### Table of Contents



9. Stockholders equity The Company is authorized to issue two classes of stock designated as
common and preferred. As of December 31, 2003, the total number of shares that
the Company was authorized to issue was 105,000 shares, of which 100,000 were
common stock and 5,000 were preferred stock. On August 6, 2003 the Company
announced a cash distribution to stockholders of $1.50 per share, payable on
September 2, 2003 to stockholders of record as of August 18, 2003. On
September 2, 2003, the Company distributed $42.2 million to the common
stockholders that was reflected as a reduction to additional paid in capital. Stock option plans In April 2000, the Companys board of directors adopted the 2000 Stock
Plan (the 2000 Plan), which provides for the issuance of nonqualified stock
options to employees who are not officers. The options allow the holder to
purchase shares of the Companys common stock at fair market value on the date
of the grant. During fiscal year 2002, no options were granted under the 2000
Plan. The total number of options available for future grants under the 2000
Plan was 447 at December 31, 2003. Stock options granted under the 2000 Plan
typically vest over four years and generally expire ten years from the date of
grant. In February 1999, the Companys board of directors adopted the 1999 Equity
Incentive Plan (the 1999 Plan), which provides for the issuance of both
incentive and nonqualified stock options. The options allow the holder to
purchase shares of the Companys common stock at fair market value on the date
of the grant. For options granted to holders of more than 10% of the
outstanding common stock, the option price at the date of the grant must be at
least equal to 110% of the fair market value of the stock. During fiscal year
2003, 1,000 options were granted under the 1999 Plan. Each year, beginning
January 1, 2000 and ending January 1, 2002, the number of shares of common
stock reserved for issuance under the 1999 Plan will, in accordance with the
terms of the 1999 Plan, be increased automatically by the lesser of 5% of the
total number of common shares then outstanding or 1,500 shares. Accordingly,
the number of shares of common stock reserved for issuance under the 1999 Plan
increased by 0 and 1,356 shares in 2003 and 2002, respectively. The total
number of options available for future grants under the 1999 Plan was 2,524 at
December 31, 2002. Stock options granted under the 1999 Plan typically vest
over four years and generally expire ten years from the date of grant. In February 1999, the Companys board of directors adopted the 1999
Non-Employee Director Option Plan (the 1999 Non-Employee Plan) under which
nonqualified stock options are granted to non-employee directors of the
Company. The 1999 Non-Employee Plan was amended and restated in April 2001.
Under the 1999 Non-Employee Plan, 60, 195, and 30 options were granted in
fiscal year 2003, 2002 and 2001, respectively. As of December 31, 2003, 0
options were available for future grant under the 1999 Non-Employee Plan. Stock
options granted under the 1999 Non-Employee Plan to a director upon his or her
initial election or appointment typically become exercisable over a two-year
period after issuance and expire ten years from the date of grant. Stock
options granted under the 1999 Non-Employee Plan to a director at each annual
meeting of the Companys stockholders typically are immediately exercisable and
expire ten years from the date of grant. The Companys 1996 stock option plan (the 1996 Plan) provides for the
issuance of both incentive and nonqualified stock options to employees. The
incentive options allow the holder to purchase shares of the Companys common
stock at fair market value on the date of the grant, subject to certain
repurchase rights held by the Company. For options granted to holders of more
than 10% of the outstanding common stock, the option price at the date of the
grant must be at least equal to 110% of the fair market value of the stock.
Stock options granted under the 1996 Plan are immediately exercisable but are
subject to certain discretionary repurchase rights by the Company (all of which
rights have expired with respect to options outstanding under the 1996 Plan),
and generally expire ten years from the date of grant. Upon adoption of the
1999 Plan, the Company ceased granting options under the 1996 Plan. F-17




---



##### Table of Contents



Deferred
compensation related to stock options granted below
fair market value in 1999 and 1998 totaled $2,826. Such compensation is
considered
deferred compensation and amortized over the four-year repurchase period of the common stock underlying the related options.
Related amortization of stock compensation expense was $0, $42 and $173 in
fiscal years 2003, 2002 and 2001, respectively. Stock compensation expense related to accelerated vesting of stock options
was $12 in 2002. Stock compensation expense recorded in the functional expense categories
within operating expenses in 2003, 2002 and 2001, was allocated as follows: 2003
    
    2002
    
    2001Sales and marketing
    
    $
    
    
    
    $
    24
    
    
    $
    39Research and development
    
    
    
    
    
    
    8
    
    
    
    154General and administrative
    
    
    
    
    
    
    10
    
    
    
    37Restructuring
    
    
    
    
    
    
    12
    
    
    
    0$
    
    
    
    $
    54
    
    
    $
    230
 As a result of the September 2, 2003 cash distribution paid to
stockholders discussed above, the Board approved an adjustment to the exercise
price of all of our outstanding options to take effect on the close of business
on September 3, 2003. The adjustment was to in no event reduce the exercise
price of any options to less than $0.01 per share or increase the number of
shares subject to such options to a number exceeding the number of shares of
common stock that are registered and available for issuance. In addition, no
adjustment was made to any options with exercise prices above $2.00 per share.
As a result of the adjustment, 870 stock options with an average exercise price
of $1.51 were adjusted to 3,715 stock options with an average exercise price of
$0.32. In accordance with FIN 44, Accounting for Certain Transactions
involving Stock Compensation an interpretation of APB Opinion No. 25, there
was no accounting consequence due to the changes made to the exercise price or
the number of shares other than future potential dilution to stockholders
because the aggregate intrinsic value of each award immediately after the
change was not greater than the aggregate intrinsic value of the award
immediately before the change and the ratio of the exercise price per share to
the market value per share was not reduced. A summary of activity of the Companys stock option plans is presented
below: Years Ending December 31,2003
    
    2002
    
    2001Weighted
    
    
    
    
    
    Weighted
    
    
    
    
    
    WeightedAverage
    
    
    
    
    
    Average
    
    
    
    
    
    AverageExercise
    
    
    
    
    
    Exercise
    
    
    
    
    
    ExerciseShares
    
    Price
    
    Shares
    
    Price
    
    Shares
    
    PriceOutstanding at beginning of year
    
    
    2,757
    
    
    $
    3.26
    
    
    
    3,719
    
    
    $
    4.97
    
    
    
    3,452
    
    
    $
    14.16Granted
    
    
    61
    
    
    
    1.63
    
    
    
    275
    
    
    
    1.37
    
    
    
    2,846
    
    
    
    1.409/3/03 pre adjustment options
    
    
    (870
    )
    
    
    1.51
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9/3/03 post adjustment options
    
    
    3,715
    
    
    
    0.32
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Exercised
    
    
    (801
    )
    
    
    1.12
    
    
    
    (136
    )
    
    
    .47
    
    
    
    (115
    )
    
    
    .53Canceled
    
    
    (2,833
    )
    
    
    1.54
    
    
    
    (1,101
    )
    
    
    8.91
    
    
    
    (2,464
    )
    
    
    13.74Outstanding at end of year
    
    
    2,029
    
    
    $
    1.83
    
    
    
    2,757
    
    
    $
    3.26
    
    
    
    3,719
    
    
    $
    4.97
 The following table summarizes information about fixed-price stock options
outstanding at December 31, 2003: Options Outstanding
    
    Options ExercisableWeighted-AverageRange Of
    
    
    
    
    
    Remaining
    
    Weighted-Average
    
    
    
    
    
    Weighted-AverageExercise Prices
    
    Shares
    
    Contractual Life
    
    Exercise Price
    
    Shares
    
    Exercise Price$0.22  $0.25
    
    
    835
    
    
    
    7.65
    
    
    $
    0.23
    
    
    
    273
    
    
    $
    0.23$0.30  $0.37
    
    
    905
    
    
    
    7.76
    
    
    
    0.31
    
    
    
    315
    
    
    
    0.34$2..88  $50.00
    
    
    289
    
    
    
    6.10
    
    
    
    11.19
    
    
    
    259
    
    
    
    11.97Total
    
    
    2,029
    
    
    
    7.48
    
    
    $
    1.83
    
    
    
    847
    
    
    $
    3.86
 F-18




---



##### Table of Contents



Employee Stock Purchase Plan In February 1999, the Companys board of directors adopted the Employee
Stock Purchase Plan (the Purchase Plan). The initial number of shares of
common stock reserved for issuance under the Purchase Plan was 1,000. Each
year, beginning January 1, 2000 and ending January 1, 2004, the number of
shares of common stock reserved for issuance under the Purchase Plan was, in
accordance with the terms of the Purchase Plan, automatically increased by the
lesser of 2% of the total number of common shares then outstanding or 600
shares. The number of shares of common stock reserved for issuance under the
Purchase Plan increased by 300 in each of 2003, 2002 and 2001. The Company
terminated the Purchase Plan effective October 27, 2003. During 2003, 2002 and
2001, 12, 68, and 146 shares, respectively, were issued under the Purchase
Plan. Stockholders rights plan In June 2001, the Company entered into a Rights Agreement (the Rights
Agreement), commonly known as a poison pill. Under the Rights Agreement,
stockholders of record on June 14, 2001 were distributed Rights (the Rights)
to acquire one one-thousandth of a share of the Companys Series A Junior
Participating Preferred Stock (the Preferred Stock), at a rate of one Right
for each share of the Companys common stock (the Common Stock) held by
stockholders on such date. Each share of common stock issued after the June
14th, 2001 record date has an attached Right. The Rights trade together with
the Common Stock and generally become exercisable on the tenth day after a
person or group (i) acquires 15% of more of the outstanding Common Stock or
(ii) commences a tender offer or exchange offer that would result in such a
person or group owning 15% or more of the Common Stock. In the event that a
person or group acquires 15% or more of the Common Stock (a Stock
Acquisition), each Right not owned by the 15% or more stockholder (the
Acquiring Person) and its affiliates would become exercisable for, upon
payment of the exercise price of the Right (currently, $15), either Preferred
Stock or Common Stock in an amount equal to the then current exercise price of
the Right divided by one half the then current market price of the Common
Stock. Alternatively, in the event of certain business combinations following a
Stock Acquisition, each Right not owned by the Acquiring Person and its
affiliates would become exercisable for, upon payment of the exercise price of
the Right, common stock of the Acquiring Person in an amount equal to the then
current exercise price of the Right divided by one half the market price of the
Acquiring Persons common stock. At any time until ten days following a Stock
Acquisition, the Rights are redeemable by the Companys board of directors at a
price of $.01 per Right. The Rights have no voting privileges. The Rights will
terminate upon the earlier of the date of their redemption or ten years from
the date of issuance. On December 22, 2003, the board of directors adopted an amendment to the
Rights Agreement. The amendment provides, in effect, that the rights issued under the Rights
Agreement will not be separately distributed to the Companys stockholders and
become exercisable solely as a result of the commencement of a tender offer or
exchange offer for all outstanding shares of the Companys common stock. In
addition, the amendment provides that the rights will not flip-in and entitle
a holder to purchase shares of the Companys common stock at a discount upon
consummation of such an offer that results in the bidder beneficially owning at
least 85% of the outstanding shares of the Companys common stock, excluding
for purposes of determining the number of shares of common stock outstanding
those shares owned by directors who are also officers of the Company and shares
owned by stock plans sponsored by the Company in which Company employee
participants do not have the right to determine confidentially whether shares
of Company common stock held subject to such stock plan(s) will be tendered in
a tender offer or exchange offer. Also, pursuant to the amendment, the rights
will not be triggered by a subsequent merger of the Company with such a bidder
in which the Companys stockholders receive the same consideration as was paid
or issued in the tender offer or exchange offer. The amendment was intended to
remove the Rights Agreement as an impediment to a bidder completing its offer
and a subsequent merger, while also affording protection to stockholders who
did not tender their shares in the bidders first-step tender or exchange
offer, if the holders of a substantial majority of the Companys stock elected
to accept the bidders offer. The amendment also clarified that
stockholders who entered into voting agreements or understandings solely
regarding voting on the plan of liquidation would not be deemed, for
purposes of the Rights Agreement, to beneficially
own the shares owned by the other parties to such agreements or understandings.
This aspect of the amendment was intended to allow stockholders to freely consult with one
another, form groups, and enter into agreements, with respect to voting at the
special meeting on the plan of liquidation, without triggering the rights under
the Rights Agreement. However, since the plan of liquidation did not receive the requisite
stockholder vote required for approval, this aspect of the amendment is no
longer applicable. 10. Joint venture In July 1999, the Company entered into a joint venture agreement under
which the Company and three other companies formed Net Perceptions Japan for
the purpose of distributing the Companys and other non-competing software
products in Japan. Under the agreement, the Company contributed capital of $394
for a 45% interest in the joint venture. The Company accounted for this joint
venture investment using the equity method of accounting, recorded its share of
income or loss in the income statement and correspondingly adjusted the
carrying value of the investment. In 2000 and 1999, the Company recorded its
45% share of losses in Net Perceptions Japan, which were $197 in each year,
effectively reducing the Companys original capital investment to zero. During
2002, Net Perceptions Japan was dissolved. F-19




---



##### Table of Contents



11. Commitments and contingencies Operating leases The Company has entered into operating lease commitments for its office
space. In connection with the restructuring described in Note 6, the Company
has terminated all of its office leases with the exception of its San
Francisco, CA location. The Company is seeking to sublease this remaining
excess space. However, the Company remains obligated under this lease
agreement. Minimum future lease payments due under the agreement is $89 at
December 31, 2003. Under the terms of an existing sublease agreement, the
Company expects to receive payments of $59 in 2004. However, there is a risk
that the subtenant may breach the terms of the sublease agreement and the
Company may not receive all of the expected payments. Rent expense totaled $300, $720 and $1,709 for the years ended December
31, 2003, 2002 and 2001, respectively. Contingencies On November 2, 2001, Timothy J. Fox filed a purported class action lawsuit
against the Company, FleetBoston Robertson Stephens, Inc., the lead underwriter
of the Companys April 1999 initial public offering, several other underwriters
who participated in the initial public offering, Steven J. Snyder, the
Companys then president and chief executive officer, and Thomas M. Donnelly,
the Companys then chief financial officer and currently its president and
chief financial officer. The lawsuit was filed in the United States District
Court for the Southern District of New York and has been assigned to the judge
who is also the pretrial coordinating judge for substantially similar lawsuits
involving more than 300 other issuers. An amended class action complaint,
captioned In re Net Perceptions, Inc. Initial Public Offering Securities
Litigation,01 Civ. 9675 (SAS), was filed on April 22, 2002, expanding the
basis for the action to include allegations relating to the Companys March
2000 follow-on public offering in addition to those relating to its initial
public offering. The amended complaint generally alleges that the defendants violated
federal securities laws by not disclosing certain actions taken by the
underwriter defendants in connection with the Companys initial public offering
and follow-on public offering. The amended complaint alleges specifically that
the underwriter defendants, with the Companys direct participation and
agreement and without disclosure thereof, conspired to and did raise and
increase their underwriters compensation and the market prices of the
Companys common stock following its initial public offering and in its
follow-on public offering by requiring their customers, in exchange for
receiving allocations of shares of the Companys common stock sold in its
initial public offering, to pay excessive commissions on transactions in other
securities, to purchase additional shares of the Companys common stock in the
initial public offering aftermarket at pre-determined prices above the initial
public offering price, and to purchase shares of the Companys common stock in
its follow-on public offering. The amended complaint seeks unspecified monetary
damages and certification of a plaintiff class consisting of all persons who
acquired the Companys common stock between April 22, 1999 and December 6,
2000. The plaintiffs have since agreed to dismiss the claims against Mr. Snyder
and Mr. Donnelly without prejudice, in return for their agreement to toll any
statute of limitations applicable to those claims; and those claims have been
dismissed without prejudice. On July 15, 2002, all of the issuer defendants
filed a joint motion to dismiss the plaintiffs claims in all of the related
cases. On February 19, 2003, the court ruled against the Company on this
motion. A special committee of the Companys board of directors has authorized the
Company to negotiate a settlement of the pending claims substantially
consistent with a memorandum of understanding negotiated among class
plaintiffs, issuer defendants and their insurers. Any such settlement would be
subject to approval by the court. The Company believes that the allegations against it are without merit.
However, the Company is unable to predict the outcome or ultimate effect of
this litigation. F-20




---



##### Table of Contents



On October 29, 2003, a purported class action lawsuit was filed against
the Company, its current directors and unnamed defendants in the District
Court, Fourth Judicial District, of the State of Minnesota, County of Hennepin
captioned Don Blakstad, on Behalf of Himself and All others Similarly Situated,
vs. Net Perceptions, Inc., John F. Kennedy, Ann L. Winblad, John T. Riedl and
Does 1-25, inclusive,File No. 03-17820. The complaint alleged, among other
things, that defendants breached their fiduciary duties of loyalty, due care,
independence, good faith and fair dealing and sought to enjoin the proposed
liquidation of the Company and to recover reasonable attorneys and experts
fees. On November 24, 2003, defendants filed a motion to dismiss the lawsuit,
and by order dated March 8, 2004, the court dismissed the complaint with
prejudice. By letter dated March 9, 2004, the plaintiff requested the courts
permission to file a motion to reconsider the decision dismissing the complaint
with prejudice. On March 18, 2004, the court denied the plaintiffs request. 12. 401(k) plan The Company had a 401(k) employee retirement plan under which eligible
employees could contribute up to 20% of their annual compensation, subject to
certain limitations. Employees vested immediately in their contributions and
earnings thereon. The plan allowed for, but did not require, the Company to
match employee contributions. The Company did not make any such matching
contributions. The Company terminated this 401(k) employee retirement plan on
September 30, 2003, effective upon the distribution of all assets held by the
plan to the plan participants. 13. Segment data The Company views its operations and manages its business as one segment,
the development and marketing of computer software and related services.
Factors used to identify the Companys single operating segment include the
organizational structure of the Company and the financial information available
for evaluation by the chief operating decision maker in making decisions about
how to allocate resources and assess performance. In addition, the Company does
not allocate operating expenses to any segments, nor does it allocate specific
assets to any segments. Therefore, segment information is identical to the
consolidated balance sheet and consolidated statement of operations. Sales to customers located outside of the United States totaled 11%, 14%
and 20% of total revenues in 2003, 2002 and 2001 respectively. International
sales to customers in any one individual foreign country did not exceed 10% of
total revenues in 2003, 2002 or 2001. Assets held at international locations
did not exceed 10% of total assets at December 31, 2003 or 2002. 14. Related Party Transaction In December 2000, the Company entered into a full recourse secured
promissory note and security agreement with an officer of the Company. Under
the terms of the agreement, up to $300 could be loaned to the officer prior to
April 15, 2001 solely to pay federal income tax owed by the officer in
connection with the officers exercise in March 2000 of an option to purchase
shares of the Companys stock. Amounts outstanding under the note bear interest
at 8% per annum and are partially secured by 33,000 shares of the Companys
stock held by the officer and pledged to the Company. On April 11, 2001, $258
was loaned to the officer to pay alternative minimum tax relating to the option
exercise under the terms of the note. Principal and interest owed by the officer shall be forgiven if the
officers employment is terminated other than voluntarily or for cause, or if
there is a change in control of the Company as defined in the agreement.
Additionally, one-third of the original principal and accrued interest will be
forgiven for each year that the officer remains continuously employed by the
Company subsequent to April 2001. Otherwise, principal and accrued interest are
payable by the officer in April 2004. The principal balance of the loan is being amortized to expense ratably
over the term of the agreement commencing in April 2001. As of December 31,
2003, the balance of $21 is included in prepaid expenses and other current
assets. As of April 1, 2004, the note was
completely forgiven in accordance with its terms. F-21




---



##### Table of Contents



15. Subsequent Events On March 31, 2004, the Company entered into an amendment to the patent
purchase agreement entered into on December 30, 2003 between the Company and
Thalveg Data Flow LLC pursuant to which it received $1,800 for the sale of its
patent portfolio. The amendment removed the stockholder approval condition to
closing, through the adoption of the plan of liquidation or otherwise. The
patent purchase agreement includes a royalty-free, non-exclusive license back
to the Company. The license is transferable, subject to certain restrictions
applicable to the transferee relating to revenues that can be generated by
products covered by the license. On April 1, 2004, the Company entered into an agreement with Tornago, Inc.
(Tornago), a corporation formed by three non-officer former employees, to
fulfill existing prepaid customer support obligations in exchange for future
cash payments of approximately $60. This amount represents approximately 60%
of the remaining prepaid deferred maintenance revenue amounts under the
existing end user contracts when measured from April 1, 2004. The Company will
continue to recognize the deferred revenue as earned and the $60 will be
reflected as cost of revenue. Under the terms of the agreement, Tornago
received a non-transferable license to relevant intellectual property solely to
provide support and consulting services to end users of our products. No
intellectual property of the Company was transferred under the agreement.
Under the agreement, the Company will receive, for a period of two years, a 15%
royalty on any follow-on services sold by Tornago. In
connection with the agreement with Tornago, the Company terminated the employment of
the remaining members of its engineering staff, effective March 31, 2004, and
will pay severance to these employees in accordance with existing agreements.
As of April 1, 2004, the Company has two employees, both of whom are executive
officers. F-22




---



##### Table of Contents



SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the registrant has caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized. NET PERCEPTIONS, INC.By:
    
    /s/ Thomas M. DonnellyThomas M. DonnellyPresident and Chief Financial Officer
 Date: April 13, 2004 Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this report has been signed below by the following persons on behalf
of the registrant in the capacities indicated on April 13, 2004. Signature
    
    Title/s/ THOMAS M. DONNELLY

Thomas M. Donnelly
    
    President and Chief Financial Officer
(Principal Executive Officer and
Principal Financial and Accounting
Officer)/s/ JOHN T. RIEDL

John T. Riedl
    
    Director/s/ JOHN F. KENNEDY

John F. Kennedy
    
    Director/s/ ANN L. WINBLAD

Ann L. Winblad
    
    Director




---



##### Table of Contents



EXHIBIT INDEX ExhibitNumber
    
    Description2.1
    
    Patent Purchase Agreement, dated December 30, 2003, between Thalveg Data Flow LLC and
Net Perceptions, Inc., as amended on March 31, 2004 (1)3.1(a)
    
    Amended and Restated Certificate of Incorporation (2).3.1(b)
    
    Certificate of Amendment to the Amended and Restated Certificate of Incorporation (3).3.2
    
    Amended and Restated Bylaws as amended through August 5, 2003 (4).4.1
    
    Amended and Restated Investors Rights Agreement, dated December 18, 1997, among Net
Perceptions, Inc. and the investors and founders named therein, as amended (2).4.2
    
    Specimen common stock certificate (2).4.3
    
    Specimen common stock certificate (including Rights Agreement Legend) (5).4.4
    
    Rights Agreement between Net Perceptions, Inc. and Wells Fargo Bank Minnesota, as
Rights Agent (6).4.5
    
    Amendment No. 1 to Rights Agreement dated as of December 22, 2003 (7).4.6
    
    Form of Certificate of Designation of Series A Junior Participating Preferred Stock
(attached as Exhibit A to the Rights Agreement filed as Exhibit 4.4 hereto) (6).4.7
    
    Form of Rights Certificate (attached as Exhibit B to the Rights Agreement filed as
Exhibit 4.4 hereto) (6).10.1*
    
    Form of Indemnification Agreement entered into between Net Perceptions, Inc. and its
directors and officers (2).10.2*
    
    1996 Stock Plan (2).10.3*
    
    1999 Equity Incentive Plan (2).10.4*
    
    Amended and Restated 1999 Non-Employee Director Option Plan, as amended through April
2, 2001 (8).10.5*
    
    Employee Stock Purchase Plan (2).10.8*
    
    2000 Stock Plan (9).10.9*
    
    Change in Control Severance Plan and Summary Plan Description (2).10.11*
    
    Severance Agreement, dated as of November 9, 2001, between Net Perceptions, Inc. and
Thomas M. Donnelly(10).10.12
    
    Full Recourse Secured Promissory Note and Security Agreement, dated December 7, 2000,
entered into by Thomas M. Donnelly in favor of Net Perceptions, Inc. (11)21.1
    
    List of Subsidiaries.23.1
    
    Consent of PricewaterhouseCoopers LLP, independent accountants.31.1
    
    Certification of chief executive officer and chief financial officer pursuant to
Exchange Act Rules Rule 13(a)-14(a) and 15(a)-14(a), as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 200232.1
    
    Certification of the chief executive officer and chief financial officer pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.
  *
    
    Represents a management contract or compensatory plan or
arrangement.(1)
    
    Incorporated by reference to Net Perceptions Current Report on
Form 8-K filed April 1, 2004.(2)
    
    Incorporated by reference to Net Perceptions Registration
Statement on Form S-1 (Registration No. 333-71919).(3)
    
    Incorporated by reference to Net Perceptions Annual Report on Form
10-K for the Fiscal Year Ended December 31, 2002.(4)
    
    Incorporated by reference to Net Perceptions Quarterly Report on
Form 10-Q for the Quarter Ended June 30, 2003.(5)
    
    Incorporated by reference to Net Perceptions Quarterly Report on
Form 10-Q for the Quarter Ended June 30, 2001.(6)
    
    Incorporated by reference to Net Perceptions Registration
Statement on Form 8-A filed June 6, 2001.(7)
    
    Incorporated by reference to Net Perceptions Current Report on
Form 8-K filed December 23, 2003.




---



##### Table of Contents



(8)
    
    Incorporated by reference to Net Perceptions Quarterly Report on
Form 10-Q for the Quarter Ended March 31, 2001.(9)
    
    Incorporated by reference to Net Perceptions Quarterly Report on
Form 10-Q for the Quarter Ended June 30, 2000.(10)
    
    Incorporated by reference to Net Perceptions Annual Report on Form
10-K for Fiscal Year Ended December 31, 2001.(11)
    
    Incorporated by reference to Net Perceptions Amendment No. 1 to
its Annual Report on Form 10-K/A for the Fiscal Year Ended December 31,
2002.