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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549




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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, 2002

OR



|  |                                                                                                   
|- | --------------------------------------------------------------------------------------------------
|o | 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



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NET PERCEPTIONS, INC.

(Exact Name of Registrant as Specified in its
Charter)




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|                                                                                |  |                                                    
|------------------------------------------------------------------------------- |  | ---------------------------------------------------
|Delaware
    (State or Other Jurisdiction
    of Incorporation or Organization) |  | 41-1844584
    (I.R.S. Employer Identification No.)
|                                                                               
|7700 France Avenue South, Edina,
    Minnesota                                  |  | 55435                                              
|(Address of Principal Executive
    Offices)                                    |  | (Zip Code)                                         

(952) 842-5000

(Registrants telephone number, including
area code)




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

|                    |  |                                          
|------------------- |  | -----------------------------------------
|Title of each class |  | Name of each exchange on which registered
|                    |  |                                          
|None                |  | Not applicable                           

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

Common Stock, par value $.0001 per
share

(Title of class)


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

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

Indicate by check mark whether the registrant is
an accelerated filer (as defined in Exchange Act
Rule 12b-2).  Yes o  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 28, 2002 was $28,774,512.

As of March 20, 2003, there were outstanding
27,400,072 shares of the registrants Common Stock,
$0.0001 par value.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive Proxy Statement for
the Annual Meeting of Stockholders to be held on May 29,
2003, are incorporated by reference into Part III
(Items 10, 11, 12 and 13) of this Form 10-K.



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TABLE OF CONTENTS



|                                                  |                                                                                                         |  |  |  |  |  |  | 
|------------------------------------------------- | ------------------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
|PART I                                           
|                                                  | ITEM 1. BUSINESS                                                                                       
|                                                  | ITEM 2. PROPERTIES                                                                                     
|                                                  | ITEM 3. LEGAL PROCEEDINGS                                                                              
|                                                  | ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                            
|PART II                                          
|                                                  | ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA                                                           
|                                                  | ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS          
|                                                  | ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK                                     
|                                                  | ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                                    
|                                                  | ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE           
|PART III                                         
|                                                  | ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT                                            
|                                                  | ITEM 11. EXECUTIVE COMPENSATION                                                                        
|                                                  | ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
|                                                  | ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                                
|                                                  | ITEM 14. CONTROLS AND PROCEDURES                                                                       
|PART IV                                          
|                                                  | ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K                               
|                                                  | ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                                    
|                                                  | INDEX TO CONSOLIDATED FINANCIAL STATEMENTS                                                             
|REPORT OF INDEPENDENT ACCOUNTANTS                
|NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS   
|EX-3.1(b) Certificate of Amendment               
|EX-23.1 Consent of PricewaterhouseCoopers LLP    
|EX-99.1 Certification of Chief Executive Officer 
|EX-99.2 Certification of Chief Financial Officer 



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NET PERCEPTIONS, INC.

ANNUAL REPORT ON FORM 10-K


FOR THE YEAR ENDED DECEMBER 31, 2002


TABLE OF CONTENTS

|         |  |                                                                                                    |  |      |     | 
|-------- |  | -------------------------------------------------------------------------------------------------- |  | ---- | --- | 
|         |  |                                                                                                    |  | Page
|         |  |                                                                                                    |  |     
|PART I  
|        
|Item 1.  |  | Business                                                                                           |  |      | 4   | 
|Item 2.  |  | Properties                                                                                         |  |      | 11  | 
|Item 3.  |  | Legal Proceedings                                                                                  |  |      | 11  | 
|Item 4.  |  | Submission of Matters to a Vote of the Security
    Holders                                        |  |      | 12  | 
|PART II 
|        
|Item 5.  |  | Market for Registrants Common Equity and
    Related Stockholder Matters                          |  |      | 13  | 
|Item 6.  |  | Selected Consolidated Financial Data                                                               |  |      | 14  | 
|Item 7.  |  | Managements Discussion and Analysis of
    Financial Condition and Results of Operations          |  |      | 16  | 
|Item 7A. |  | Quantitative and Qualitative Disclosures about
    Market Risk                                     |  |      | 37  | 
|Item 8.  |  | Financial Statements and Supplementary Data                                                        |  |      | 37  | 
|Item 9.  |  | Changes in and Disagreements With Accountants on
    Accounting and Financial Disclosure           |  |      | 38  | 
|PART III
|        
|Item 10. |  | Directors and Executive Officers of the Registrant                                                 |  |      | 38  | 
|Item 11. |  | Executive Compensation                                                                             |  |      | 38  | 
|Item 12. |  | Security Ownership of Certain Beneficial Owners
    and Management and Related Stockholder Matters |  |      | 38  | 
|Item 13. |  | Certain Relationships and Related Transactions                                                     |  |      | 39  | 
|Item 14. |  | Controls and Procedures                                                                            |  |      | 39  | 
|PART IV 
|        
|Item 15. |  | Exhibits, Financial Statement Schedules and
    Reports on Form 8-K                                |  |      | 40  | 
|         |  | Signatures                                                                                         |  |      |     | 
|         |  | Index to Consolidated Financial Statements                                                         |  |      | F-1 | 

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SPECIAL NOTE REGARDING FORWARD-LOOKING
STATEMENTS


This Annual Report on Form 10-K (including
exhibits and information incorporated by reference herein)
contains both historical and forward-looking statements that
involve risks, uncertainties and assumptions. The statements
contained in this report that are not purely historical are
forward-looking statements within the meaning of
Section 21E of the Securities Exchange Act of 1934, as
amended, including statements regarding our expectations,
beliefs, intentions or strategies for the future. All
forward-looking statements included in this 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. Our actual results could differ
materially from those described in our forward-looking
statements. Factors that could cause or contribute to such
differences include, but are not limited to, those discussed
below under the heading Risks That May Affect Future
Results and those described in our previous filings with
the Securities and Exchange Commission. Readers are cautioned
not to place undue reliance on these forward-looking statements,
which speak only as of the date that they were made. We
undertake no obligation to publicly release any revisions to
these forward-looking statements to reflect events or
circumstances after the date of this 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).

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PART I







ITEM 1.     BUSINESS


Summary

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

Our software solutions extract 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 generate intelligence about
customers and products that can be inserted into operational
processes and systems to drive actions such as cross-selling and
up-selling or personalized promotions. Our software solutions
are particularly well suited to environments with large numbers
of customers, a large product assortment and large quantities of
transaction data.

We believe our software solutions are unique in
their ability to drive profitable actions at the mass market,
business entity and individual customer levels and we believe
that we offer enhanced value to our customers existing CRM
solutions. Our customers currently include 3M, Brylane, Great
Universal Stores, Half.com, J.C. Penney,
J&L Industrial Supply and Musicians Friend.

Corporate History and Recent Events

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.

In February 2000, we completed our
acquisition of KD1, a supplier of advanced data analysis
solutions for retailers. In this transaction, we acquired all of
the outstanding shares of KD1 in exchange for 1,969,630 shares
of our common stock, and KD1 became our wholly owned subsidiary.
In addition, stock options of KD1 were converted into options to
purchase approximately 265,514 shares of our common stock.

In March 2000, we completed an underwritten
public offering of 2,000,000 shares of our common stock,
resulting in net proceeds to us of approximately
$84.6 million. We have used the net proceeds of the
offering for general corporate purposes, including working
capital. As part of this public offering, certain of our
stockholders sold 625,471 shares of common stock. We did not
receive any of the proceeds from the sale of shares by the
selling stockholders.

In 2001, we instituted two separate restructuring
plans to better align our cost structure with our business
outlook and general economic conditions. In 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.
In the first quarter of 2002 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
18 positions and recorded an additional $401,000 charge. As of
December 31, 2002 we had 52 employees. In January of 2003,
we closed satellite offices in San Francisco, California, London,

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England and Austin, Texas, and reduced headcount
by 22 positions. In the first quarter of 2003, we anticipate
recording a $1.2 million charge related to this
restructuring activity.


In February 2003, in response to continued
uncertainties in the marketplace and the difficulties we are
likely to continue facing as a relatively small public company,
we engaged U.S. Bancorp Piper Jaffray, Inc. to assist us in the
exploration of near-term strategic alternatives. However, we
cannot predict whether or when a transaction will result from
this process. Based on the outcome of this process, we expect to
determine in the near term how best to proceed to maximize
stockholder value.

Industry Background

Market research has shown that acquiring new
customers is considerably more expensive than managing and
enhancing existing customer relationships. Accordingly,
companies are often looking for ways to increase the longevity
and profitability of their customer relationships. Companies may
enhance existing customer relationships by learning from all of
their customer interactions across all channels of customer
communication. Companies can use this knowledge to personalize
products, services and related interactions based on each
customers characteristics, the characteristics of customer
segments or the characteristics of the products they market.
Understanding individual customer preferences, customer
behavior, customer segments and product relationships can
facilitate more effective marketing of complementary products,
known as cross-selling, and higher-end products,
known as up-selling, as well as improve selling and
merchandising effectiveness.

The channels of communication between a company,
its partners and its customers include traditional channels,
such as direct mail, telephone, interactive voice response, or
IVR, retail stores and direct sales forces, as well as modern
channels, such as Web sites and email. The software systems that
manage these communication channels and applications capture
tremendous amounts of customer data, such as customer
demographic information and historical purchasing information.
Analysis of these data can help companies to better understand
customer purchasing patterns, thereby enabling them to market
more effectively to individual customers and customer segments.
However, the technologies historically available to analyze this
tremendous volume of information were highly complex and
required very specialized skills to deploy. As a result,
companies have experienced difficulty in managing large amounts
of customer data obtained from multiple sources and in using the
data effectively.

In addition many companies have large, and ever
changing product catalogs. The software systems that manage
products may capture large amounts of product data, such as
product descriptive information, product hierarchies, product
inventory information and product purchasing information.
Analysis of these data help companies better understand their
product catalogs. For example, what products are alternates of
one another, what products should be packaged together, and what
product sales drive other products to sell. Once again, however,
companies have experienced difficulties effectively managing
large amounts of product data.

To aggregate this customer and product data and
use it to improve customer relationships, companies may need to
implement an integrated customer relationship management, or CRM
infrastructure for automating sales, service and marketing
interactions and to facilitate merchandising decisions.

Solution

Our software solutions are designed to help
businesses to more intelligently interact with their customers
by providing actionable insight about the relationships among
products, promotions and customer interactions. Our solutions
focus on increasing revenue, improving profit, decreasing costs
and enhancing customer satisfaction.

Our software solutions are designed to enable
companies to continually improve customer interactions across
both traditional and modern customer communication channels. Our
software solutions are particularly well suited to environments
with large numbers of customers, a large product assortment and

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large quantities of transaction data, such as the
retail consumer goods, retail catalog and wholesale
manufacturing and distribution markets. We believe that the
following characteristics of our software make it attractive
when compared to our competitors:




| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Integration of analytical and operational CRM
    solutions.Our software solutions
    integrate analytical technologies, which are used to gain
    insight into customer and product data, with operational
    technologies, which make customer interactions more efficient.
    The integration of these traditionally disparate technologies
    can enable companies to increase the value of every interaction
    with a customer as the interaction is taking place. For example,
    through the integration of our analytical technologies, a
    service agent using operational software to service a customer
    over the telephone can receive real time cross-sell and
    up-sell recommendations for that customer.
|
| |  | Designed to span many channels of customer
    interaction.Our software solutions
    are designed to improve customer relationships across many
    channels of customer interaction. For example, companies can use
    our software to enhance customer interactions on Web sites,
    during telephone interactions, in printed media, in email and
    other direct marketing campaigns and in face-to-face selling
    situations.                                                                                                                                                                                                                                                                                               
|
| |  | Web-based design to promote ease of use and
    wide-scale deployment.Our software
    solutions offer easy to use interfaces that are similar to those
    used on most Web sites. Our customers access the interface
    through a corporate network or the Internet using a Web browser.
    Our software is installed in a central location, generally on
    our customers own computer servers. This Web-based design
    does not require our software to be installed on each
    users computer, which reduces the costs of deploying and
    maintaining software.                                                                                                                                                         
|
| |  | Packaged software suite for faster and less
    expensive implementation.Our software
    solutions are designed to facilitate the integration of the many
    technologies required to collect and analyze customer data,
    create and deploy campaigns and enhance customer interactions.
    As a result, our software can generally be implemented in four
    to ten weeks.                                                                                                                                                                                                                                                                                                                                                     

Our software solutions are designed to provide
measurable economic benefits to our customers. Specifically, we
deliver return on investment to our customers through the
analytical impact of our software, which is usually delivered in
real time into the workflow of our customers, or through
management facilitation, which is usually delivered as an online
or printed report. The principle analytical impact benefits and
management facilitation benefits of our software are summarized
below:

|                                                                                                                                                                                                                                                                                                                                         |  |                                                                                                                                                                                                                                          
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Analytical Impact                                                                                                                                                                                                                                                                                                                        |  | Management Facilitation                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                                         |  |                                                                                                                                                                                                                                          
| Up-sell and cross-sell
     Replacement product recommendation
     Find customers for specific products
     Coordinate recommendation
     Personalize catalog mailings
     Personalize email campaigns
     Increase customer purchase categories
     Recommend products for reorder
     Facilitate customer acquisition |  |  Sales and sales effectiveness
    reporting
     Promotional campaign management and scheduling
     Business rule management
     Trend analysis and reporting
     Overstock management and reporting
     Tactical intelligence

Products

We offer 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.

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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 recommendation
and promotion strategy, and deploy new recommendation and
promotions.

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:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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.                                                                                                                                                                                                                  

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                            
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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, Net Perceptions
Recommendation Engine, Advertising Advisorand the Retail
Analyst. NetP 7(or its predecessor products) has
accounted for all historical company revenue since inception.

Professional Services

We believe professional services are an important
component of our product offerings. We deploy services personnel
to help ensure that our customers business requirements
are met. Our professional services include:



| |   |                                
| | - | -------------------------------
| |  | Project planning and management
|
| |  | Implementation and testing     
|
| |  | Data analysis                  
|
| |  | Data warehousing               
|
| |  | User training                  
|
| |  | Consulting                     
|
| |  | Product hosting                
|
| |  | Ongoing customer support       

We believe that providing quality customer
service and technical support is critical to customer
satisfaction. As of March 20, 2003, we had 5 employees
dedicated to providing professional services and support. We
generally charge customers for our professional services on a
time and materials basis. Customers benefit from our
consultants and engineers expertise in applied
retail data analysis, data warehousing, software implementation
and integration. We believe our professional services personnel
can assist businesses in developing innovative ways to implement
our solutions, leading to increased product adoption.

Sales and Marketing

We market our software and professional services
through our direct sales organization. As of March 20,
2003, our direct sales force was comprised of 5 employees. Of
the 5 employees, 3 were quota-carrying sales representatives.
Initial sales activities typically include a demonstration of
our product capabilities followed by one or more detailed
technical reviews and a simulation of our product using a sample
of the prospective customers data. Sales activities
sometimes result in a customer pilot to measure and quantify the
value our solutions provide.

As of March 20, 2003, our marketing
organization consisted of 1 employee primarily engaged in
marketing research, producing marketing materials, managing
press coverage and other public relations, identifying potential
customers, attending and exhibiting at trade shows, seminars and
conferences, creating presentations and sales tools,
establishing and maintaining relationships with industry
analysts and maintaining our Web site. In addition, we rely on
various outside consultants to supplement our marketing
organization for various public relations and market research
requirements.

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Research and Development

Our research and development organization
contributes to product strategy, and is responsible for product
architecture, core technology, quality assurance and product
documentation. In addition, this organization supports some
pre-sales and customer support activities. The organization
operates primarily out of our Minneapolis, Minnesota location.

As of March 20, 2003, our research and
development staff consisted of 12 employees. Our total expenses
for research and development were $5.9 million in 2002,
$10.6 million in 2001 and $19.4 million in 2000. To
date, our development efforts have not resulted in any
capitalized software development costs.

Competition

The market for our products is intensely
competitive, evolving and subject to rapid technological change.
We expect the intensity of competition to increase in the
future. Competitors vary in size and in the scope and breadth of
the products and services they offer. Principal competitive
factors include: quality, breadth and depth of application
offerings, product scalability, core technology and
architecture, ease of deployment and maintenance, customer
service and support, vendor viability and price. Although we
believe our products currently compare favorably with respect to
certain factors, our market is relatively new and is rapidly
evolving, and, as market conditions have continued to be
adverse, our competitive position has eroded especially as
against those with significantly greater financial, marketing,
sales, service, support, technical and other resources.

We have three primary sources of competition for
our product offerings:



| |   |                                                                                                                                                                                                               
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | CRM vendors, such as E.piphany, Kana and Siebel;                                                                                                                                                              
|
| |  | enterprise resource planning
    (ERP) companies, such as Retek, JDA, Ecometry and Blue
    Martini; and                                                                                                      
|
| |  | in-house application development efforts by
    potential customers using traditional statistical analysis and
    decision support tools and services marketed by vendors such as
    SPSS, SAS and digiMine.

In addition, we face competition from vendors of
other enterprise applications as they expand the functionality
of their product offerings. These vendors include ATG, i2, IBM,
Microsoft, NCR, Oracle, PeopleSoft and SAP.

Of these competitors, E.piphany, ATG, digiMine
and the in-house development efforts referred to above directly
compete against NetP 7.

Most of our competitors have longer operating
histories, significantly greater financial, technical, marketing
and other resources, significantly greater name recognition and
a larger installed base of customers than we have. In addition,
many of our competitors have well-established relationships with
current and potential customers of ours, have extensive
knowledge of our industry and are capable of offering a
single-vendor solution. As a result, our competitors may be able
to respond more quickly to new or emerging technologies and
changes in customer requirements, or to devote greater resources
to the development, promotion and sale of their products, than
we can. In addition, current and potential competitors have
established or may establish cooperative relationships among
themselves or with third parties to increase the ability of
their products to address customer needs. Accordingly, it is
possible that new competitors or alliances among competitors may
emerge and rapidly acquire significant market share. We also
expect that competition will increase as a result of software
industry consolidations. Increased competition is likely to
result in price reductions, reduced gross margins and loss of
market share. As noted above, as market conditions have
deteriorated, our competitive position has eroded as against
certain current competitors. Also, we may not be able to compete
successfully against other current or future competitors.

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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 license our software and require our customers to
enter into license agreements, which impose restrictions on our
customers ability to utilize the software. In addition, we
seek to avoid disclosure of our trade secrets, including but not
limited to requiring those persons with access to our
proprietary information to execute confidentiality agreements
with us and restricting access to the source code for our
software.

As of March 20, 2003, we had
seven pending United States patent applications and
four issued United States patents. We also have exclusive
license rights to three issued United States patents from
the University of Minnesota. These patents have expiration dates
from 2016 through 2019. Of the seven pending United States
patent applications, we intend only to pursue
four prosecutions due to the large costs of the prosecution
process. We do not believe that the decision not to pursue these
patents will have a material impact on our business. However, it
is possible that no patents will be issued from the currently
pending patent applications that we intend to pursue. It is also
possible that our current patents or potential future patents
may be found invalid or unenforceable, or otherwise be
successfully challenged. It is also possible that any patent
issued to us may not provide us with any competitive advantages.
Moreover, we may not develop future proprietary products or
technologies that are patentable, and the patents of others may
seriously limit our ability to conduct our business. In this
regard, we have not performed any comprehensive analysis of the
patents of others that may limit our ability to conduct our
business.

We own a number of trademarks that we consider to
be of substantial importance to our ability to market NetP 7 and
future products and to our business generally. These include
Net Perceptions and NetP. The Net
Perceptions mark is federally registered for a term of
ten years and the NetP mark is expected to be
federally registered within six months to a year.

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

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

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Certain Legal and Regulatory Matters

Our products and services are often used in
conjunction with user preference and profile information
collected by our customers. Privacy concerns may cause users to
resist providing the personal data necessary to support this
profiling capacity. Our customers generally have implemented
security measures to protect their customers data from
unauthorized disclosure or interception by third parties.
However, the security measures may not be effective against all
potential security threats. If a breach of customer data
security were to be publicized, our products may be perceived as
less desirable, and our future sales may be negatively impacted.
More importantly, even the perception of privacy and security
concerns, whether or not valid, may indirectly inhibit our
customers collection of user preference and customer
profile data. In addition, legislative or regulatory
requirements may heighten such concerns if users must be
notified that the data captured after these interactions may be
used by marketing entities for direct product promotion and
advertising. During the last few years, many pieces of
legislation have been proposed at the federal and state level
that address some aspect of the Internet, including a number of
bills that specifically address Internet privacy matters. Such
proposed legislation indicates that some federal and state
legislators believe that certain aspects of the Internet and
e-commerce, including data privacy, are appropriate matters for
regulation and review. Various other countries and political
entities, such as the European Union, have adopted legislation
or regulatory requirements addressing issues, such as data
privacy, that may directly impact some of our customers. If user
privacy concerns are not adequately addressed or if restrictive
legislation is adopted in the United States, our business could
be seriously harmed and we could experience increased operating
losses.

Employees

As of December 31, 2002, we had a total of
52 employees, including 13 in sales and marketing, 23 in
research and development, 8 in customer support and 8 in
administration. 50 of these employees were located in North
America and 2 employees were located in Europe. As of
March 20, 2003, we had a total of 29 employees,
including 6 in sales and marketing, 12 in research and
development, 5 in customer support and 6 in
administration. All of these employees are located in North
America. None of our employees are represented by a collective
bargaining agreement, nor have we experienced any work stoppage.
We consider our relations with our employees to be good.






ITEM 2.     PROPERTIES


Net Perceptions principal administrative,
research and development and sales and marketing activities are
conducted in 125,800 square feet of leased space in
Minneapolis, Minnesota under a lease that expires in July 2010.
The majority of the unused space of this facility has been
subleased and the Company remains obligated under the lease
agreement. The Company believes that its current facilities are
suitable and adequate for its present and anticipated near-term
needs.

As of December 31, 2002, Net Perceptions was
also a party to lease agreements for an aggregate of
55,608 square feet of space in Minneapolis, Texas,
New Jersey, California and the United Kingdom that expire
prior to November 2005. The Company does not currently occupy
any of these facilities and they are either subleased or
available to sublet to third parties. There is a risk that we
may not be able to sublease the remaining space in these
facilities under favorable terms, if at all, which could
negatively impact our cash flow and future operating results.






ITEM 3.     LEGAL
PROCEEDINGS


On or about November 2, 2001,
Timothy J. Fox filed a purported class action lawsuit
against us, FleetBoston Robertson Stephens, Inc., the lead
underwriter of our April 1999 initial public offering, several
other underwriters who participated in our initial public
offering, Steven J. Snyder, our then president and chief
executive officer, and Thomas M. Donnelly, our chief
operating officer and chief financial officer. The lawsuit,
Fox v. Net Perceptions, Inc., et al., Civil Action
No. 01-CV-9675, was filed in the United States District
Court for the Southern District of New York and has been
assigned to the

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judge who is also the pretrial coordinating judge
for substantially similar lawsuits involving more than 300 other
issuers. An amended class action complaint was filed on
April 22, 2002, expanding the basis for the action to
include allegations relating to our March 2000 follow-on public
offering in addition to those relating to our initial public
offering.


The amended complaint generally alleges that the
defendants violated federal securities laws by not disclosing
certain actions taken by the underwriter defendants in
connection with our initial public offering and our follow-on
public offering. The amended complaint alleges specifically that
the underwriter defendants, with our direct participation and
agreement and without disclosure thereof, conspired to and did
raise and increase their underwriters compensation and the
market prices of our common stock following our initial public
offering and in our follow-on public offering by requiring their
customers, in exchange for receiving allocations of shares of
our common stock sold in our initial public offering, to pay
excessive commissions on transactions in other securities, to
purchase additional shares of our common stock in the initial
public offering aftermarket at pre-determined prices above the
initial public offering price, and to purchase shares of our
common stock in our follow-on public offering. The amended
complaint seeks unspecified monetary damages and certification
of a plaintiff class consisting of all persons who acquired our
common stock between April 22, 1999 through
December 6, 2000. 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 and the case may proceed to discovery.

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






ITEM 4.     SUBMISSION OF
MATTERS TO A VOTE OF SECURITY HOLDERS


None.

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PART II




|        |                                                                            
|------- | ---------------------------------------------------------------------------
|ITEM 5. | MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED 
     STOCKHOLDER MATTERS

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 of
|               |  | Common Stock  
|               |  |               
|               |  | High           |      | Low
|               |  |                |      |    
|2001           |  |                |      |     |  |   |      | 
|First Quarter  |  | $              | 3.75 |     |  | $ | .88  | 
|Second Quarter |  |                | 2.25 |     |  |   | .88  | 
|Third Quarter  |  |                | 1.90 |     |  |   | .85  | 
|Fourth Quarter |  |                | 1.97 |     |  |   | 1.03 | 
|2002           |  |                |      |     |  |   |      | 
|First Quarter  |  |                | 2.28 |     |  |   | 1.32 | 
|Second Quarter |  |                | 1.63 |     |  |   | 1.02 | 
|Third Quarter  |  |                | 1.19 |     |  |   | .76  | 
|Fourth Quarter |  |                | 1.47 |     |  |   | .78  | 

On March 20, 2003, the last reported sale
price of our common stock on the NASDAQ National Market was
$1.42 per share. As of March 20, 2003, there were 219
stockholders of record registered with our transfer agent, Wells
Fargo Bank Minnesota, N.A.

We have not declared or paid any cash dividends
on our capital stock since our inception and do not intend to
pay any cash dividends in the foreseeable future. We currently
intend to retain future earnings, if any, to fund our ongoing
business. 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. Therefore, you
will not receive any funds without selling your shares.

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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, 2002, 2001 and 2000, and the
balance sheet data at December 31, 2002 and 2001, 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, 1999 and 1998 and the balance sheet data at
December 31, 2000, 1999 and 1998 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,                 
|                                                                  |                                                 |                                         
|                                                                  |                                                 | 2002                                     |         | 2001  |        | 2000 |          | 1999   |         | 1998
|                                                                  |                                                 |                                          |         |       |        |      |          |        |         |     
|                                                                  |                                                 |                                         
|                                                                  |                                                 | (in thousands, except per share amounts)
|Statement of Operations Data                                      |                                                 |                                          |         |       |        |      |          |        |         |      |         |        |        |   |         |        |        |   |        |      
|Revenues:                                                         |                                                 |                                          |         |       |        |      |          |        |         |      |         |        |        |   |         |        |        |   |        |      
|                                                                  | Product                                         |                                          | $       | 1,703 |        |      | $        | 2,979  |         |      | $       | 25,087 |        |   | $       | 11,408 |        |   | $      | 3,955 |      
|                                                                  | Service and maintenance                         |                                          |         | 3,541 |        |      |          | 7,535  |         |      |         | 12,342 |        |   |         | 3,922  |        |   |        | 542   |      
|                                                                  |                                                 |                                          |         |       |        |      |          |        |         |      |         |        |        |   |         |        |        |   |        |      
|                                                                  |                                                 | Total revenues                           |         |       | 5,244  |      |          |        | 10,514  |      |         |        | 37,429 |   |         |        | 15,330 |   |        |       | 4,497 | 
|                                                                  |                                                 |                                          |         |       |        |      |          |        |         |      |         |        |        |   |         |        |        |   |        |      
|Cost of revenues:                                                 |                                                 |                                          |         |       |        |      |          |        |         |      |         |        |        |   |         |        |        |   |        |      
|                                                                  | Product                                         |                                          |         | 292   |        |      |          | 943    |         |      |         | 1,807  |        |   |         | 286    |        |   |        | 52    |      
|                                                                  | Service and maintenance                         |                                          |         | 2,101 |        |      |          | 5,143  |         |      |         | 11,532 |        |   |         | 2,936  |        |   |        | 393   |      
|                                                                  |                                                 |                                          |         |       |        |      |          |        |         |      |         |        |        |   |         |        |        |   |        |      
|                                                                  |                                                 | Total cost of revenues                   |         |       | 2,393  |      |          |        | 6,086   |      |         |        | 13,339 |   |         |        | 3,222  |   |        |       | 445   | 
|                                                                  |                                                 |                                          |         |       |        |      |          |        |         |      |         |        |        |   |         |        |        |   |        |      
|Gross margin                                                      |                                                 |                                          | 2,851   |       |        |      | 4,428    |        |         |      | 24,090  |        |        |   | 12,108  |        |        |   | 4,052  |      
|                                                                  |                                                 |                                          |         |       |        |      |          |        |         |      |         |        |        |   |         |        |        |   |        |      
|Operating expenses:                                               |                                                 |                                          |         |       |        |      |          |        |         |      |         |        |        |   |         |        |        |   |        |      
|                                                                  | Sales and marketing                             |                                          |         | 4,550 |        |      |          | 15,215 |         |      |         | 25,589 |        |   |         | 12,883 |        |   |        | 5,238 |      
|                                                                  | Research and development                        |                                          |         | 5,933 |        |      |          | 10,572 |         |      |         | 19,354 |        |   |         | 8,625  |        |   |        | 2,372 |      
|                                                                  | General and administrative                      |                                          |         | 2,819 |        |      |          | 6,198  |         |      |         | 11,146 |        |   |         | 4,005  |        |   |        | 1,474 |      
|                                                                  | Lease abandonment expense                       |                                          |         |      |        |      |          | 225    |         |      |         | 1,250  |        |   |         |       |        |   |        |      |      
|                                                                  | Restructuring related charges(2)                |                                          |         | 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                 |         |       | 20,726 |      |          |        | 132,709 |      |         |        | 82,733 |   |         |        | 25,513 |   |        |       | 9,084 | 
|                                                                  |                                                 |                                          |         |       |        |      |          |        |         |      |         |        |        |   |         |        |        |   |        |      
|Loss from operations                                              |                                                 |                                          | (17,875 | )     |        |      | (128,281 | )      |         |      | (58,643 | )      |        |   | (13,405 | )      |        |   | (5,032 | )    
|Other income, net                                                 |                                                 |                                          | 1,141   |       |        |      | 4,483    |        |         |      | 5,096   |        |        |   | 1,366   |        |        |   | 64     |      
|                                                                  |                                                 |                                          |         |       |        |      |          |        |         |      |         |        |        |   |         |        |        |   |        |      
|Net loss                                                          |                                                 | $                                        | (16,734 | )     |        | $    | (123,798 | )      |         | $    | (53,547 | )      |        | $ | (12,039 | )      |        | $ | (4,968 | )    
|                                                                  |                                                 |                                          |         |       |        |      |          |        |         |      |         |        |        |   |         |        |        |   |        |      
|Basic and diluted net loss per share                              |                                                 | $                                        | (0.61   | )     |        | $    | (4.59    | )      |         | $    | (2.12   | )      |        | $ | (0.78   | )      |        | $ | (1.40  | )    
|                                                                  |                                                 |                                          |         |       |        |      |          |        |         |      |         |        |        |   |         |        |        |   |        |      
|Shares used in computing basic and diluted net
    loss per share |                                                 |                                          | 27,216  |       |        |      | 26,951   |        |         |      | 25,209  |        |        |   | 15,402  |        |        |   | 3,546  |      
|                                                                  |                                                 |                                          |         |       |        |      |          |        |         |      |         |        |        |   |         |        |        |   |        |      
|Balance Sheet Data                                                |                                                 |                                          |         |       |        |      |          |        |         |      |         |        |        |   |         |        |        |   |        |      
|Cash, cash equivalents and short-term investments                 |                                                 | $                                        | 62,959  |       |        | $    | 73,605   |        |         | $    | 68,880  |        |        | $ | 36,854  |        |        | $ | 972    |      
|Working capital                                                   |                                                 |                                          | 57,031  |       |        |      | 64,321   |        |         |      | 66,364  |        |        |   | 37,372  |        |        |   | 468    |      
|Total assets                                                      |                                                 |                                          | 65,796  |       |        |      | 88,878   |        |         |      | 211,834 |        |        |   | 58,748  |        |        |   | 5,637  |      
|Long-term liabilities, net of current portion                     |                                                 |                                          | 510     |       |        |      | 577      |        |         |      | 1,951   |        |        |   | 707     |        |        |   | 538    |      
|Redeemable preferred stock                                        |                                                 |                                          |        |       |        |      |         |        |         |      |        |        |        |   |        |        |        |   | 650    |      
|Total stockholders equity                                        |                                                 |                                          | 58,342  |       |        |      | 75,407   |        |         |      | 198,518 |        |        |   | 48,388  |        |        |   | 421    |      

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|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | The selected consolidated financial data for the
    years ended December 31, 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. 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.

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

We sell our solutions worldwide primarily through
a direct sales force. We license our products under various
pricing plans, such as per user, per CPU, per site and per
enterprise. We generally grant licenses on a perpetual basis.
License fees for our products range from $50,000 to in excess of
$1.0 million. We provide product maintenance pursuant to
service agreements, the pricing of which is typically based on a
percentage of the related product license fee and is generally
paid in advance. Professional service fees for business
consulting, implementation support, data processing and
educational services are generally priced on a time and
materials basis.

We were incorporated in Delaware in
July 1996, and our initial product was shipped in
January 1997. From inception through late 2000, we expanded
our organization by hiring personnel in key areas, particularly
marketing, sales and research and development. Our total number
of employees was 315 on December 31, 2000. During 2002 and
2001, we instituted certain restructuring plans to align our
cost structure with our business outlook and general economic
conditions. In connection with our restructuring activities, our
total number of employees was reduced to 98 as of
December 31, 2001 and 52 as of December 31, 2002.

We have sustained losses on a quarterly and
annual basis since inception. As of December 31, 2002, we
had an accumulated deficit of $217 million. Our net loss
was $16.7 million in 2002 (including $768,000 in
restructuring charges, $299,000 of amortization of intangibles
and non-cash stock compensation expense and a $6.5 million
charge for the impairment of goodwill and other intangibles)
compared to a net loss of $123.8 million in the prior year
(including $15.6 million in restructuring 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). These losses resulted from significant costs
incurred in the development and sale of our products and
services, as well as a decline in our product revenues since the
third quarter of 2000 which, based upon current marked
conditions and other factors, is likely to continue in 2003. We
anticipate that our operating expenses will also continue to
decline in 2003 and will continue to constitute a material use
of our cash resources. We also expect to incur additional losses
and continued negative cash flow from operations for the
foreseeable future. We do not expect to achieve profitability in
2003.

Our relatively limited operating history makes
the prediction of future operating results very difficult. We
believe that period-to-period comparisons of our operating
results should not be relied upon as predictive of future
performance. Our prospects must be considered in light of the
risks, expenses and difficulties encountered by companies in
relatively new and rapidly evolving markets. We may not be
successful in addressing these risks and difficulties.

As described above in Business 
Corporate History and Recent Events, in
February 2003, in response to continued uncertainties in
the marketplace and the difficulties we are likely to continue
facing as a relatively small public company, we engaged U.S.
Bancorp Piper Jaffray, Inc. to assist us in the exploration of
near-term strategic alternatives. However, we cannot predict
whether or when a

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transaction will result from this process. Based
on the outcome of this process, we expect to determine in the
near term how best to proceed to maximize stockholder value.


The KD1 Acquisition

In February 2000, we acquired KD1, a
developer and marketer of advanced data analysis solutions for
retailers. In this transaction, we acquired all of the
outstanding shares of KD1 in exchange for 1,969,630 shares of
our common stock, and KD1 became our wholly owned subsidiary. In
addition, stock options of KD1 were converted into options to
purchase approximately 265,514 shares of our common stock.

For a discussion of the impairment of goodwill
and other intangible assets relating to the KD1 acquisition, see
Note 4 to the Consolidated Financial Statements and
Valuation of long-lived and intangible assets and
goodwill below.

Critical Accounting Policies and Estimates

Our discussion and analysis of financial
condition and results of operations are based upon our
consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements
requires us to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses,
and related disclosure of contingent assets and liabilities. On
an on-going basis, we evaluate our estimates, including those
related to bad debts, investments, intangible assets,
restructuring liabilities, contingencies and litigation. We base
our estimates on historical experience and on various other
assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results
may differ from these estimates under different assumptions or
conditions.

We believe the following critical accounting
policies affect significant judgments and estimates used in the
preparation of our consolidated financial statements:

Revenue Recognition.Our revenues are recognized in
accordance with the American Institute of Certified Public
Accountants Statement of Position (SOP) 97-2,
Software Revenue Recognition, as amended by
SOP 98-4 and SOP 98-9, 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. 101, Revenue Recognition in
Financial Statements. We derive revenues from software
licenses, software maintenance and professional services.
Maintenance includes telephone and Web-based technical support,
bug fixes and rights to unspecified upgrades on a when-and-if
available basis. Professional services include project planning
and management, implementation and testing, data analysis, user
and partner training, consulting, product hosting and ongoing
customer support.

For software arrangements that include multiple
software products, maintenance or services, we allocate the
total arrangement fee using the residual method. Under the
residual method, the fair value of the undelivered maintenance
and services elements, as determined by vendor-specific
objective evidence, is deferred and the remaining (residual)
arrangement fee is recognized as software product revenue. For
software arrangements in which we do not have vendor-specific
objective evidence of undelivered elements, revenue is deferred
until the earlier of when vendor-specific objective evidence is
determined for the undelivered elements or when all elements for
which we do not have vendor-specific objective evidence have
been delivered.

Revenues from license fees are recognized when a
non-cancelable agreement has been executed, the product has been
shipped or electronically delivered, there are no uncertainties
surrounding product acceptance, the fee is fixed or determinable
and collection of the related receivable is considered probable.
If the fee due from the customer is not fixed or determinable,
revenues are recognized as

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payments become due from the customer. If we do
not consider collection to be probable, then revenues are
recognized when the fee is collected.


License revenues related to license terms of less
than twenty-four months are recognized ratably over the term of
the license period. When we offer products and services on a
hosted basis, up front set-up fees are deferred and recognized
ratably over the estimated service period.

We recognize revenues allocable to maintenance
ratably over the term of the agreement. We evaluate arrangements
that include professional and/or data processing services to
determine whether those services are essential to the
functionality of other elements of the arrangement. If services
are considered essential, revenues from the arrangement are
recognized using contract accounting, generally on a
percentage-of-completion basis. When we do not consider the
professional services to be essential, we recognize the revenues
allocable to the services as they are performed.

Revenue recognition rules for software companies
are very complex. We follow specific and detailed guidelines in
determining the proper amount of revenue to be recorded;
however, certain judgments affect the application of our revenue
recognition policy. Revenue results are difficult to predict,
and any shortfall in revenue or delay in recognizing revenue
could cause our operating results to vary significantly from
quarter to quarter.

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
which 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.

Sublease income.In
conjunction with the restructuring related charges recorded in
2002 and 2001, we made certain estimates regarding future
sublease income that have a significant impact on our
anticipated cash obligations. Although we believe that our lease
commitment estimates are appropriate in the current
circumstances, future changes in real estate markets could
impact the ultimate amount of cash paid to resolve these
obligations. As of December 31, 2002, we estimated total
future sublease income of $16.8 million of which
$13.9 million is covered by known sublease arrangements.

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 class action
lawsuit in which we are named. For a discussion of this matter,
see the section of this report entitled Legal
Proceedings. Due to the uncertainties related to both the
likelihood and the amount of any potential loss, we are unable
to make a reasonable estimate of the liability that could result
from an unfavorable outcome. As additional information becomes
available, we will assess the potential liability and revise our
estimates accordingly. Revisions in our estimates of the
potential liability could materially impact our results of
operations and financial position.

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

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guidance of SFAS 142. All of our goodwill was
assigned to a single reporting unit, which is our sole operating
segment.


For a discussion of the impairment of goodwill
and other intangible assets relating to the KD1 acquisition, see
Note 4 to the Consolidated Financial Statements.

Results of Operations for the Years Ended December 31,
2002, 2001 and 2000

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, 
|                     |                                              |                         
|                     |                                              | 2002                     |      | 2001 |     | 2000
|                     |                                              |                          |      |      |     |     
|Revenues:            |                                              |                          |      |      |     |      |        |     |       |  |      |   
|                     | Product                                      |                          |      | 32   | %   |      |        | 28  | %     |  |      | 67 | %  
|                     | Service and maintenance                      |                          |      | 68   |     |      |        | 72  |       |  |      | 33 |    
|                     |                                              |                          |      |      |     |      |        |     |       |  |      |   
|                     |                                              | Total revenues           |      |      | 100 |      |        |     | 100   |  |      |    | 100 | 
|Cost of revenues:    |                                              |                          |      |      |     |      |        |     |       |  |      |   
|                     | Product                                      |                          |      | 6    |     |      |        | 9   |       |  |      | 5  |    
|                     | Service and maintenance                      |                          |      | 40   |     |      |        | 49  |       |  |      | 31 |    
|                     |                                              |                          |      |      |     |      |        |     |       |  |      |   
|                     |                                              | Total cost of revenues   |      |      | 46  |      |        |     | 58    |  |      |    | 36  | 
|Gross margin         |                                              |                          | 54   |      |     |      | 42     |     |       |  | 64   |   
|Operating expenses:  |                                              |                          |      |      |     |      |        |     |       |  |      |   
|                     | Sales and marketing                          |                          |      | 87   |     |      |        | 145 |       |  |      | 68 |    
|                     | Research and development                     |                          |      | 113  |     |      |        | 101 |       |  |      | 52 |    
|                     | General and administrative                   |                          |      | 54   |     |      |        | 58  |       |  |      | 30 |    
|                     | Lease abandonment expense                    |                          |      |     |     |      |        | 2   |       |  |      | 3  |    
|                     | Restructuring related charges                |                          |      | 14   |     |      |        | 148 |       |  |      |   |    
|                     | Amortization of intangibles                  |                          |      | 2    |     |      |        | 92  |       |  |      | 68 |    
|                     | Impairment of goodwill and other intangibles |                          |      | 125  |     |      |        | 716 |       |  |      |   |    
|                     |                                              |                          |      |      |     |      |        |     |       |  |      |   
|                     |                                              | Total operating expenses |      |      | 395 |      |        |     | 1,262 |  |      |    | 221 | 
|                     |                                              |                          |      |      |     |      |        |     |       |  |      |   
|Loss from operations |                                              |                          | (341 | )    |     |      | (1,220 | )   |       |  | (157 | ) 
|                     |                                              |                          |      |      |     |      |        |     |       |  |      |   
|Other income, net    |                                              |                          | 22   |      |     |      | 43     |     |       |  | 14   |   
|                     |                                              |                          |      |      |     |      |        |     |       |  |      |   
|Net loss             |                                              |                          | (319 | )%   |     |      | (1,177 | )%  |       |  | (143 | )%
|                     |                                              |                          |      |      |     |      |        |     |       |  |      |   

Revenues

We have not publicly provided any specific
revenue guidance for 2003. The current market and geopolitical
environment make the prediction of sales very difficult and we
are uncertain when market conditions will improve. There can be
no assurance that we will meet any internal or external revenue
expectations.

Total revenues.Total revenues declined 50% to
$5.2 million in 2002, from $10.5 million in 2001.
Revenues declined 72% in 2001 from $37.4 million in 2000.
Revenues from sales in the United States were $4.5 million
in 2002 compared to $8.5 million in 2001 and
$29.1 million in 2000, representing 86%, 80% and 78% of
total revenues, respectively. Revenues from international sales
in 2002 were $719,000, or 14% of total revenues, compared to
$2.0 million, or 20% of total revenues in 2001 and
$8.3 million, or 22% of total revenues, in 2000. The
majority of international sales were made in Europe and Asia by
our direct sales organizations based in the United States and
the United Kingdom. In connection with the restructuring plan
described elsewhere in Managements Discussion and Analysis
of Financial Condition and Results of Operations and the Notes
to the Consolidated Financial Statements, we do not expect to
maintain a direct sales force in the United Kingdom during 2003.
International sales are generally

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denominated in United States dollars. Revenues
from one customer represented 22% of our total revenues in 2002.
Revenues from three customers represented 12%, 11% and 10% of
our total revenues in 2001. Revenues from one customer
represented 11% of our total revenues in 2000.


During 2002, as part of our strategy to focus our
marketing and development efforts on our primary product
NetP 7, we continued to wind-down our non-strategic product
and service offerings, including Advertising Advisor, which in
2001 accounted for a significant portion of our total revenues.
NetP 7 incorporates certain key components from our
non-strategic product offerings, including components from
Personalization Manager and Distribution Analyst.

Product revenues.Product revenues declined 43% to
$1.7 million in 2002 from $3.0 million in 2001.
Product revenues declined 88% in 2001 from $25.1 million in
2000. Product revenues comprised 32%, 28%, and 67% of total
revenues for 2002, 2001 and 2000. The decrease in product
revenues in 2002 from 2001 was attributable to a continuation of
the same factors that caused product revenues to decline in 2001
from 2000, including the further deterioration of Internet
retailers, a longer sales cycle due to our pursuit of larger
transactions with larger organizations, greater competition, and
increased deferral of purchase decisions by our current and
potential customers due to worsening economic and political
uncertainty. Prior percentage growth rates of our product
revenues have not been sustainable and we do not currently
expect to achieve such prior percentage growth rates in the
future. Based on current market conditions and other factors,
the decline in our product revenues is likely to continue in
2003.

Service and maintenance revenues.Service and maintenance revenues
consist primarily of professional and maintenance services and,
secondarily, product hosting services. Our professional service
revenues include business consulting, implementation support,
data warehousing and processing and educational services and are
generally offered on a time and materials basis. Maintenance
revenues are generally derived from annual service agreements
and are recognized ratably over the term of the agreement.
Service and maintenance revenues decreased 53% to
$3.5 million in 2002 from $7.5 million in 2001.
Service and maintenance revenues decreased 39% in 2001 from
$12.3 million in 2000. Service and maintenance revenues
comprised 68%, 72% and 33% of total revenues for 2002, 2001 and
2000, respectively. The decrease in service and maintenance
revenues in absolute dollars in 2002 from 2001 reflected the
further deterioration of the factors that caused the decline in
service revenues in 2001 from 2000, including lower levels of
consulting and maintenance services due to the combined effect
of fewer new customer acquisitions and a decline in our customer
base, particularly Internet retailers. Prior percentage growth
rates of our service and maintenance revenues have not been
sustainable and we do not currently expect to achieve such prior
percentage growth rates in the future. Based on current market
conditions and other factors, the decline in our service and
maintenance revenues is likely to continue in 2003.

In accordance with Emerging Issue Task Force
Issue No. 01-14, Income Statement Characterization of
Reimbursements Received for Out-of-Pocket Expenses
Incurred, we began to account for such items as revenue
and cost of revenue effective January 1, 2002. Service
revenues include $129,000 of such amounts for 2002.
Additionally, service revenues of $351,000 and $841,000 for 2001
and 2000 respectively, have been reclassified to conform to
current period presentation.

Cost of Revenues

Cost of product revenues.Cost of product revenues consists
primarily of the cost of royalties paid to third-party vendors,
amortization of acquired technology costs, product media and
duplication, manuals, packaging materials and shipping expenses.
Cost of product revenues decreased 69% to $292,000 in 2002 from
$943,000 in 2001. Cost of product revenues decreased 48% in 2001
from $1.8 million in 2000. Cost of product revenues
represented 17%, 32% and 7% of related product revenues in 2002,
2001, and 2000, respectively. The decrease in cost of product
revenues in absolute dollars in 2002 compared to 2001 is due
primarily to reduced product revenues and royalties payable to
third parties. The decrease in cost of product revenues in 2001
from 2000 is primarily attributable to a decrease in
amortization of acquired technology cost in connection with our
acquisition of KD1 in February 2000

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and also to reduced product revenues and
royalties payable to third parties. Since all internal
development costs incurred in the research and development of
new software products and enhancements to existing software
products have been expensed as incurred, cost of product
revenues includes no amortization of capitalized software
development costs. We believe that the cost of product revenues
will decline as a percentage of product revenues in 2003 as our
reliance on licensed third-party technology continues to decline.


Cost of service and maintenance revenues.Cost of service and maintenance
revenues consists primarily of personnel-related and
infrastructure costs incurred in providing telephone and
Web-based support of our software products, as well as
professional, consulting, educational and hosted product related
services to customers. Cost of service and maintenance revenues
decreased 59% to $2.1 million in 2002 from
$5.1 million in 2001. Cost of service and maintenance
revenues decreased 55% in 2001 from $11.5 million in 2000.
Cost of service and maintenance revenues in 2002, 2001 and 2000
represented 59%, 68% and 93% of the related services and
maintenance revenues, respectively. The decrease in cost of
services and maintenance revenues in absolute dollars and as a
percentage of revenues in 2002 compared to prior years is
primarily due to continued headcount reductions in our service
organization as a result of our 2001 and 2002 restructuring and
decreased use of third-party consultants to staff consulting
engagements. Cost of service and maintenance revenues may vary
significantly from quarter to quarter depending upon the mix of
services that we provide and the utilization rate of our service
personnel.

As stated above, and in Note 2 to the
Consolidated Financial Statements, in accordance with Emerging
Issue Task Force Issue No. 01-14, Income Statement
Characterization of Reimbursements Received for
Out-of-Pocket Expenses Incurred, we began to
account for such items as cost of revenue effective
January 1, 2002. Cost of service revenues includes $129,000
of such amounts for 2002. Additionally, cost of service revenues
of $351,000 and $841,000 for 2001 and 2000 respectively, have
been reclassified to conform to current period presentation.

Operating Expenses

In the first quarter of 2003, we further reduced
our operating expenses through the closure of three remote
offices and a reduction in workforce affecting 22 employees. We
anticipate continuing to vigorously manage expense levels and,
accordingly, that our operating expenses will continue to
decline in 2003.

Sales and marketing.Sales and marketing expenses consist
primarily of salaries, other employee-related costs, commissions
and other incentive compensation, travel and entertainment and
expenditures for marketing programs, such as collateral
materials, trade shows, public relations and creative services.
Sales and marketing expenses decreased 70% to $4.6 million
in 2002 compared to $15.2 million in 2001. Sales and
marketing expenses decreased 41% in 2001 compared to
$25.6 million in 2000. As a percent of total revenues,
sales and marketing expenses were 87%, 145% and 68% in 2002,
2001 and 2000, respectively. The decrease in sales and marketing
expenses in absolute dollars in 2001 and 2002 was primarily due
to headcount reductions as a result of our restructuring efforts
and decreased spending on marketing programs.

Research and development.Research and development expenses
consist primarily of salaries, other employee-related costs and
consulting fees relating to the development of our products.
Research and development expenses decreased 44% to
$5.9 million in 2002 from $10.6 million in 2001.
Research and development expenses decreased 45% in 2001 from
$19.4 million in 2000. As a percent of total revenues,
research and development expenses were 113%, 101% and 52% in
2002, 2001 and 2000, respectively. The decrease in research and
development expenses in absolute dollars in 2001 and 2002 is
primarily due to headcount reductions as a result of our
restructuring efforts. We believe 2003 research and development
spending will be less than our spending in 2002.

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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 55% to
$2.8 million in 2002 from $6.2 million in 2001.
General and administrative expenses decreased 44% in 2001 from
$11.1 million in 2000. As a percent of total revenues,
general and administrative expenses were 54%, 58% and 30% in
2002, 2001 and 2000, respectively. General and administrative
expenses decreased in absolute dollars in 2001 and 2002 due
primarily to lower headcount as a result of our restructuring
efforts.

Lease abandonment expense.We recorded lease abandonment expense
of $225,000 and $1.3 million in 2001 and 2000,
respectively. As a percent of total revenues, lease abandonment
expenses were 2% and 3% in 2001 and 2000 respectively. The
$225,000 of lease abandonment expense was recorded in 2001 in
response to declining conditions in the Minneapolis area real
estate market. The $1.3 million charge recorded in 2000
reflected estimated lease abandonment expenses related to the
Companys August 2000 move to our current corporate
headquarters. In October 2001, we entered into an agreement
to sublease the majority of our previous headquarters facility
to a third party.

Restructuring related charges.In 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 $768,000 and $15.6 million for the years
ended December 31, 2002 and 2001, respectively.

A total of approximately $3.9 million was
charged against the restructuring reserve during 2002, lowering
the accrued restructuring liability to approximately
$4.3 million. Charges against the reserve during 2002
included $642,000 of non-cash fixed asset write-offs, $547,000
in employee severance payments, $2.9 million in rent
payments, $1.2 million in costs relating to subletting
facilities and $66,000 in costs relating to facility closures.
These charges were partially offset by $1.3 million of
sublease income and $68,000 in proceeds from the sale of fixed
assets. In conjunction with the restructuring related charges
recorded, we made certain estimates regarding future sublease
income that have a significant impact on our anticipated cash
obligations and related restructuring reserves. Although we
believe that the lease commitment estimates are appropriate in
the current circumstances, future changes in real estate markets
could impact the ultimate amount of cash paid to discharge these
obligations. As of December 31, 2002, we estimated total
future sublease income of $16.8 million of which
$13.9 million is covered by known sublease arrangements.

The following table presents a summary of the
restructuring related activities and accrued restructuring
charges as of December 31, 2002 (in thousands):

|                                         |  |               |        |               |  |          |        |           |  |               |     |               |  |               |        |          |  |           |       |               |  |   |     |  |  |   |        |   |  |   |       |  |  |   |      |   |  |   |       | 
|---------------------------------------- |  | ------------- | ------ | ------------- |  | -------- | ------ | --------- |  | ------------- | --- | ------------- |  | ------------- | ------ | -------- |  | --------- | ----- | ------------- |  | - | --- |  |  | - | ------ | - |  | - | ----- |  |  | - | ---- | - |  | - | ----- | 
|                                         |  |               |        |               |  | Sublease |        |           |  |               |     |               |  |               |        | Sublease |  |           |       |              
|                                         |  |               |        |               |  | Income   |        | Non-Cash  |  |               |     |               |  |               |        | Income   |  |           |       |              
|                                         |  |               |        |               |  | and      |        | Asset     |  |               |     |               |  |               |        | and      |  |           |       |              
|                                         |  |               |        |               |  | Proceeds |        | Disposals |  |               |     |               |  |               |        | Proceeds |  |           |       |              
|                                         |  | 2001          |        |               |  | from the |        | and       |  | Accrued       |     |               |  |               |        | from the |  |           |       | Accrued      
|                                         |  | Restructuring |        |               |  | Sale of  |        | Deferred  |  | Restructuring |     |               |  |               |        | Sale of  |  | Non Cash  |       | Restructuring
|                                         |  | Charges Net   |        | Restructuring |  | Fixed    |        | Rent      |  | as of Dec 31, |     | Restructuring |  | Restructuring |        | Fixed    |  | Asset     |       | as of Dec 31,
|Description                              |  | of Reversal   |        | Payments      |  | Assets   |        | Write-Off |  | 2001          |     | Charges       |  | Payments      |        | Assets   |  | Disposals |       | 2002         
|                                         |  |               |        |               |  |          |        |           |  |               |     |               |  |               |        |          |  |           |       |              
|Lease commitments and related items      |  | $             | 10,649 |               |  | $        | (2,233 | )         |  | $             | 280 |               |  | $             | (1,800 | )        |  | $         | 6,896 |               |  | $ |    |  |  | $ | (4,024 | ) |  | $ | 1,299 |  |  | $ |     |   |  | $ | 4,171 | 
|Employee Severance and termination costs |  |               | 1,634  |               |  |          | (1,523 | )         |  |               |    |               |  |               |       |          |  |           | 111   |               |  |   | 506 |  |  |   | (547   | ) |  |   |      |  |  |   |     |   |  |   | 70    | 
|                                         |  |               |        |               |  |          |        |           |  |               |     |               |  |               |        |          |  |           |       |               |  |   |     |  |  |   |        |   |  |   |       |  |  |   |      |   |  |   |       | 
|Subtotal                                 |  |               | 12,283 |               |  |          | (3,756 | )         |  |               | 280 |               |  |               | (1,800 | )        |  |           | 7,007 |               |  |   | 506 |  |  |   | (4,571 | ) |  |   | 1,299 |  |  |   |     |   |  |   | 4,241 | 
|Fixed Asset Disposals and Other Costs    |  |               | 3,268  |               |  |          | (195   | )         |  |               | 261 |               |  |               | (2,908 | )        |  |           | 426   |               |  |   | 262 |  |  |   | (66    | ) |  |   | 68    |  |  |   | (642 | ) |  |   | 48    | 
|                                         |  |               |        |               |  |          |        |           |  |               |     |               |  |               |        |          |  |           |       |               |  |   |     |  |  |   |        |   |  |   |       |  |  |   |      |   |  |   |       | 
|                                         |  | $             | 15,551 |               |  | $        | (3,951 | )         |  | $             | 541 |               |  | $             | (4,708 | )        |  | $         | 7,433 |               |  | $ | 768 |  |  | $ | (4,637 | ) |  | $ | 1,367 |  |  | $ | (642 | ) |  | $ | 4,289 | 
|                                         |  |               |        |               |  |          |        |           |  |               |     |               |  |               |        |          |  |           |       |               |  |   |     |  |  |   |        |   |  |   |       |  |  |   |      |   |  |   |       | 

See also Liquidity and Financial
Resources, below, and Note 6 to the Consolidated
Financial Statements.

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Amortization of intangibles.Amortization expense related to
intangibles acquired in the February 2000 acquisition of
KD1 was $257,000 (including $147,000 amortization of intangibles
included in cost of product revenues) during 2002. This is
compared to $10.1 million and $26.6 million (including
$443,000 and $1.2 million of amortization of goodwill and
other intangibles included in the cost of product revenues) in
2001 and 2000, respectively. These amounts represented 5%, 96%
and 71% of 2002, 2001 and 2000 total revenues, respectively.
Total amortization of goodwill and other intangibles is expected
to be $0 for 2003 due to the $6.5 million impairment of
goodwill and other intangibles charge recorded in the fourth
quarter of 2002 discussed below. See Note 4 to the Consolidated
Financial Statements.

Impairment of goodwill and other
intangibles.At March 31, 2001,
and December 31, 2002, among other dates, we performed
impairment assessments of the goodwill and other intangible
assets recorded in connection with the acquisition of KD1. As a
result of our March 2001 review, we recorded a $75.3
million impairment charge to reduce goodwill and other
intangible assets to their estimated fair values. As a result of
our December 2002 review, we recorded a $6.5 million
impairment charge to reduce goodwill and other intangible assets
to zero value.

For a discussion of the impairment of goodwill
and other intangible assets relating to the KD1 acquisition, see
Note 4 to the Consolidated Financial Statements.

Stock compensation expense.Compensation charges related to stock
options were $42,000 in 2002, $230,000 in 2001 and
$1.1 million in 2000 comprising .8%, 2% and 3% of total
revenues in each of the respective periods. Stock compensation
expense represents the amortization of deferred compensation
related to stock options granted in 1999 and 1998. Such
compensation is amortized over the four-year repurchase or
vesting period of the common stock underlying the related
options. See Note 9 to the Consolidated Financial Statements.

Other income, net.Other income, net, consists of
interest income, interest expense, the Companys share in
gains or losses of a joint venture, foreign currency transaction
gains or losses and other expense. Net other income decreased
75% to $1.1 million from $4.5 million in 2001. Net
other income decreased 12% in 2001 from $5.1 million in
2000. The decrease in net other income for both 2002 compared to
2001 and 2001 compared to 2000 was attributable to a decrease in
interest income earned on the proceeds from our follow-on public
offering completed in March 2000. Net other income for 2002
compared to 2001 also decreased as a result of 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
in the third quarter 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, 2002. As of
December 31, 2002, we had federal net operating loss
carry-forwards of approximately $107.4 million available to
reduce future taxable income expiring at various dates beginning
in 2011. In addition, as of December 31, 2002, we had
$146,000 of tax credit carry-forwards, expiring at various dates
beginning in 2011. Under the provisions of the Internal Revenue
Code of 1986, as amended, if certain substantial changes in our
ownership were to occur, we could be limited in the future in
the amount of net operating loss and tax credit carry-forwards
that could be utilized annually to offset future taxable income.

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

Selected Consolidated Quarterly Operating Results

The following table sets forth quarterly
unaudited financial data for 2002 and 2001, 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

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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 31
|                                     |                                              | 2002                                             |        | 2002     |       | 2002    |        | 2002     |       | 2001    |        | 2001     |       | 2001    |        | 2001    
|                                     |                                              |                                                  |        |          |       |         |        |          |       |         |        |          |       |         |        |         
|                                     |                                              |                                                 
|                                     |                                              | (Amounts in thousands, except per share amounts)
|                                     |                                              | (Unaudited)                                     
|Results of Operations:               |                                              |                                                  |        |          |       |         |        |          |       |         |        |          |       |         |        |          |       |   |        |       |       |   |        |       |       |   |        |       |       |   |          |       
|Revenues:                            |                                              |                                                  |        |          |       |         |        |          |       |         |        |          |       |         |        |          |       |   |        |       |       |   |        |       |       |   |        |       |       |   |          |       
|                                     | Product                                      |                                                  | $      | 145      |       |         | $      | 613      |       |         | $      | 902      |       |         | $      | 43       |       |   | $      | 911   |       |   | $      | 674   |       |   | $      | 386   |       |   | $        | 1,008  |        
|                                     | Service and maintenance                      |                                                  |        | 748      |       |         |        | 999      |       |         |        | 697      |       |         |        | 1,097    |       |   |        | 1,587 |       |   |        | 1,525 |       |   |        | 2,096 |       |   |          | 2,327  |        
|                                     |                                              |                                                  |        |          |       |         |        |          |       |         |        |          |       |         |        |          |       |   |        |       |       |   |        |       |       |   |        |       |       |   |          |       
|                                     |                                              | Total Revenues                                   |        |          | 893   |         |        |          | 1,612 |         |        |          | 1,599 |         |        |          | 1,140 |   |        |       | 2,498 |   |        |       | 2,199 |   |        |       | 2,482 |   |          |        | 3,335   | 
|                                     |                                              |                                                  |        |          |       |         |        |          |       |         |        |          |       |         |        |          |       |   |        |       |       |   |        |       |       |   |        |       |       |   |          |       
|Cost of Revenues                     |                                              |                                                  |        |          |       |         |        |          |       |         |        |          |       |         |        |          |       |   |        |       |       |   |        |       |       |   |        |       |       |   |          |       
|                                     | Product                                      |                                                  |        | 38       |       |         |        | 68       |       |         |        | 63       |       |         |        | 123      |       |   |        | 264   |       |   |        | 158   |       |   |        | 80    |       |   |          | 441    |        
|                                     | Service and maintenance                      |                                                  |        | 319      |       |         |        | 473      |       |         |        | 539      |       |         |        | 770      |       |   |        | 795   |       |   |        | 755   |       |   |        | 1,301 |       |   |          | 2,292  |        
|                                     |                                              |                                                  |        |          |       |         |        |          |       |         |        |          |       |         |        |          |       |   |        |       |       |   |        |       |       |   |        |       |       |   |          |       
|                                     |                                              | Total Cost of Revenues                           |        |          | 357   |         |        |          | 541   |         |        |          | 602   |         |        |          | 893   |   |        |       | 1,059 |   |        |       | 913   |   |        |       | 1,381 |   |          |        | 2,733   | 
|                                     |                                              |                                                  |        |          |       |         |        |          |       |         |        |          |       |         |        |          |       |   |        |       |       |   |        |       |       |   |        |       |       |   |          |       
|Gross margin                         |                                              |                                                  | 536    |          |       |         | 1,071  |          |       |         | 997    |          |       |         | 247    |          |       |   | 1,439  |       |       |   | 1,286  |       |       |   | 1,101  |       |       |   | 602      |       
|                                     |                                              |                                                  |        |          |       |         |        |          |       |         |        |          |       |         |        |          |       |   |        |       |       |   |        |       |       |   |        |       |       |   |          |       
|Operating expenses:                  |                                              |                                                  |        |          |       |         |        |          |       |         |        |          |       |         |        |          |       |   |        |       |       |   |        |       |       |   |        |       |       |   |          |       
|                                     | Sales and marketing                          |                                                  |        | 940      |       |         |        | 753      |       |         |        | 1,376    |       |         |        | 1,481    |       |   |        | 1,750 |       |   |        | 2,454 |       |   |        | 3,041 |       |   |          | 7,970  |        
|                                     | Research and development                     |                                                  |        | 1,136    |       |         |        | 1,213    |       |         |        | 1,624    |       |         |        | 1,960    |       |   |        | 2,156 |       |   |        | 2,121 |       |   |        | 2,262 |       |   |          | 4,033  |        
|                                     | General and administrative                   |                                                  |        | 628      |       |         |        | 514      |       |         |        | 935      |       |         |        | 742      |       |   |        | 768   |       |   |        | 1,014 |       |   |        | 2,129 |       |   |          | 2,287  |        
|                                     | Lease abandonment expense                    |                                                  |        |         |       |         |        |         |       |         |        |         |       |         |        |         |       |   |        |      |       |   |        |      |       |   |        |      |       |   |          | 225    |        
|                                     | Restructuring related charges                |                                                  |        |         |       |         |        |         |       |         |        | 401      |       |         |        | 367      |       |   |        | (140  | )     |   |        | 1,771 |       |   |        |      |       |   |          | 13,920 |        
|                                     | Amortization of intangibles                  |                                                  |        | 27       |       |         |        | 28       |       |         |        | 27       |       |         |        | 28       |       |   |        | 798   |       |   |        | 798   |       |   |        | 798   |       |   |          | 7,256  |        
|                                     | Impairment of goodwill and other intangibles |                                                  |        | 6,546    |       |         |        |         |       |         |        |         |       |         |        |         |       |   |        |      |       |   |        |      |       |   |        |      |       |   |          | 75,298 |        
|                                     |                                              |                                                  |        |          |       |         |        |          |       |         |        |          |       |         |        |          |       |   |        |       |       |   |        |       |       |   |        |       |       |   |          |       
|                                     |                                              | Total operating expenses                         |        |          | 9,277 |         |        |          | 2,508 |         |        |          | 4,363 |         |        |          | 4,578 |   |        |       | 5,332 |   |        |       | 8,158 |   |        |       | 8,230 |   |          |        | 110,989 | 
|                                     |                                              |                                                  |        |          |       |         |        |          |       |         |        |          |       |         |        |          |       |   |        |       |       |   |        |       |       |   |        |       |       |   |          |       
|Loss from operations                 |                                              |                                                  | (8,741 | )        |       |         | (1,437 | )        |       |         | (3,366 | )        |       |         | (4,331 | )        |       |   | (3,893 | )     |       |   | (6,872 | )     |       |   | (7,129 | )     |       |   | (110,387 | )     
|Other income (expense), net          |                                              |                                                  | 443    |          |       |         | 811    |          |       |         | (972   | )        |       |         | 859    |          |       |   | 881    |       |       |   | 714    |       |       |   | 1,295  |       |       |   | 1,593    |       
|                                     |                                              |                                                  |        |          |       |         |        |          |       |         |        |          |       |         |        |          |       |   |        |       |       |   |        |       |       |   |        |       |       |   |          |       
|Net loss                             |                                              | $                                                | (8,298 | )        |       | $       | (626   | )        |       | $       | (4,338 | )        |       | $       | (3,472 | )        |       | $ | (3,012 | )     |       | $ | (6,158 | )     |       | $ | (5,834 | )     |       | $ | (108,794 | )     
|                                     |                                              |                                                  |        |          |       |         |        |          |       |         |        |          |       |         |        |          |       |   |        |       |       |   |        |       |       |   |        |       |       |   |          |       
|Basic and diluted net loss per share |                                              | $                                                | (0.30  | )        |       | $       | (0.02  | )        |       | $       | (0.16  | )        |       | $       | (0.13  | )        |       | $ | (0.11  | )     |       | $ | (0.23  | )     |       | $ | (0.22  | )     |       | $ | (4.05    | )     
|                                     |                                              |                                                  |        |          |       |         |        |          |       |         |        |          |       |         |        |          |       |   |        |       |       |   |        |       |       |   |        |       |       |   |          |       

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|                              |                                              |                          |      |          |       |         |     |          |     |         |      |          |     |         |      |          |     |  |      |    |     |  |      |     |     |  |      |     |     |  |        |       |       | 
|----------------------------- | -------------------------------------------- | ------------------------ | ---- | -------- | ----- | ------- | --- | -------- | --- | ------- | ---- | -------- | --- | ------- | ---- | -------- | --- |  | ---- | -- | --- |  | ---- | --- | --- |  | ---- | --- | --- |  | ------ | ----- | ----- | 
|                              |                                              | Dec. 31                  |      | Sept. 30 |       | June 30 |     | March 31 |     | Dec. 31 |      | Sept. 30 |     | June 30 |      | March 31
|                              |                                              | 2002                     |      | 2002     |       | 2002    |     | 2002     |     | 2001    |      | 2001     |     | 2001    |      | 2001    
|                              |                                              |                          |      |          |       |         |     |          |     |         |      |          |     |         |      |         
|                              |                                              |                         
|                              |                                              | (Unaudited)             
|Percentage of Total Revenues: |                                              |                          |      |          |       |         |     |          |     |         |      |          |     |         |      |          |     |  |      |    |     |  |      |     |     |  |      |     |     |  |        |      
|Revenues:                     |                                              |                          |      |          |       |         |     |          |     |         |      |          |     |         |      |          |     |  |      |    |     |  |      |     |     |  |      |     |     |  |        |      
|                              | Product                                      |                          |      | 16       | %     |         |     | 38       | %   |         |      | 56       | %   |         |      | 4        | %   |  |      | 36 | %   |  |      | 31  | %   |  |      | 16  | %   |  |        | 30    | %    
|                              | Service and maintenance                      |                          |      | 84       |       |         |     | 62       |     |         |      | 44       |     |         |      | 96       |     |  |      | 64 |     |  |      | 69  |     |  |      | 84  |     |  |        | 70    |      
|                              |                                              |                          |      |          |       |         |     |          |     |         |      |          |     |         |      |          |     |  |      |    |     |  |      |     |     |  |      |     |     |  |        |      
|                              |                                              | Total Revenues           |      |          | 100   |         |     |          | 100 |         |      |          | 100 |         |      |          | 100 |  |      |    | 100 |  |      |     | 100 |  |      |     | 100 |  |        |       | 100   | 
|                              |                                              |                          |      |          |       |         |     |          |     |         |      |          |     |         |      |          |     |  |      |    |     |  |      |     |     |  |      |     |     |  |        |      
|Cost of Revenues              |                                              |                          |      |          |       |         |     |          |     |         |      |          |     |         |      |          |     |  |      |    |     |  |      |     |     |  |      |     |     |  |        |      
|                              | Product                                      |                          |      | 4        |       |         |     | 4        |     |         |      | 4        |     |         |      | 11       |     |  |      | 11 |     |  |      | 7   |     |  |      | 3   |     |  |        | 13    |      
|                              | Service and maintenance                      |                          |      | 36       |       |         |     | 30       |     |         |      | 34       |     |         |      | 67       |     |  |      | 31 |     |  |      | 34  |     |  |      | 52  |     |  |        | 69    |      
|                              |                                              |                          |      |          |       |         |     |          |     |         |      |          |     |         |      |          |     |  |      |    |     |  |      |     |     |  |      |     |     |  |        |      
|                              |                                              | Total Cost of Revenues   |      |          | 40    |         |     |          | 34  |         |      |          | 38  |         |      |          | 78  |  |      |    | 42  |  |      |     | 41  |  |      |     | 55  |  |        |       | 82    | 
|                              |                                              |                          |      |          |       |         |     |          |     |         |      |          |     |         |      |          |     |  |      |    |     |  |      |     |     |  |      |     |     |  |        |      
|Gross margin                  |                                              |                          | 60   |          |       |         | 66  |          |     |         | 62   |          |     |         | 22   |          |     |  | 58   |    |     |  | 59   |     |     |  | 45   |     |     |  | 18     |      
|                              |                                              |                          |      |          |       |         |     |          |     |         |      |          |     |         |      |          |     |  |      |    |     |  |      |     |     |  |      |     |     |  |        |      
|Operating expenses:           |                                              |                          |      |          |       |         |     |          |     |         |      |          |     |         |      |          |     |  |      |    |     |  |      |     |     |  |      |     |     |  |        |      
|                              | Sales and marketing                          |                          |      | 105      |       |         |     | 47       |     |         |      | 86       |     |         |      | 130      |     |  |      | 70 |     |  |      | 112 |     |  |      | 123 |     |  |        | 239   |      
|                              | Research and development                     |                          |      | 127      |       |         |     | 75       |     |         |      | 101      |     |         |      | 172      |     |  |      | 86 |     |  |      | 97  |     |  |      | 91  |     |  |        | 121   |      
|                              | General and administrative                   |                          |      | 71       |       |         |     | 31       |     |         |      | 58       |     |         |      | 65       |     |  |      | 32 |     |  |      | 46  |     |  |      | 86  |     |  |        | 68    |      
|                              | Lease abandonment expense                    |                          |      |         |       |         |     |         |     |         |      |         |     |         |      |         |     |  |      |   |     |  |      |    |     |  |      |    |     |  |        | 7     |      
|                              | Restructuring related charges                |                          |      |         |       |         |     |         |     |         |      | 25       |     |         |      | 32       |     |  |      | (6 | )   |  |      | 81  |     |  |      |    |     |  |        | 417   |      
|                              | Amortization of intangibles                  |                          |      | 3        |       |         |     | 2        |     |         |      | 2        |     |         |      | 3        |     |  |      | 32 |     |  |      | 36  |     |  |      | 32  |     |  |        | 218   |      
|                              | Impairment of goodwill and other intangibles |                          |      | 733      |       |         |     |         |     |         |      |         |     |         |      |         |     |  |      |   |     |  |      |    |     |  |      |    |     |  |        | 2,258 |      
|                              |                                              |                          |      |          |       |         |     |          |     |         |      |          |     |         |      |          |     |  |      |    |     |  |      |     |     |  |      |     |     |  |        |      
|                              |                                              | Total operating expenses |      |          | 1,039 |         |     |          | 155 |         |      |          | 272 |         |      |          | 402 |  |      |    | 214 |  |      |     | 372 |  |      |     | 332 |  |        |       | 3,328 | 
|                              |                                              |                          |      |          |       |         |     |          |     |         |      |          |     |         |      |          |     |  |      |    |     |  |      |     |     |  |      |     |     |  |        |      
|Loss from operations          |                                              |                          | (979 | )        |       |         | (89 | )        |     |         | (210 | )        |     |         | (380 | )        |     |  | (156 | )  |     |  | (313 | )   |     |  | (287 | )   |     |  | (3,310 | )    
|                              | Other income (expense), net                  |                          |      | 50       |       |         |     | 50       |     |         |      | (61      | )   |         |      | 75       |     |  |      | 35 |     |  |      | 33  |     |  |      | 52  |     |  |        | 48    |      
|                              |                                              |                          |      |          |       |         |     |          |     |         |      |          |     |         |      |          |     |  |      |    |     |  |      |     |     |  |      |     |     |  |        |      
|Net loss                      |                                              |                          | (929 | )%       |       |         | (39 | )%       |     |         | (271 | )%       |     |         | (305 | )%       |     |  | (121 | )% |     |  | (280 | )%  |     |  | (235 | )%  |     |  | (3,262 | )%   
|                              |                                              |                          |      |          |       |         |     |          |     |         |      |          |     |         |      |          |     |  |      |    |     |  |      |     |     |  |      |     |     |  |        |      

Liquidity and Capital Resources

Since inception, we have financed our operations
primarily through the sale of equity securities. As of
December 31, 2002, we had $63.0 million of cash, cash
equivalents and short-term investments, compared to
$73.6 million on December 31, 2001 and
$68.9 million on December 31, 2000.

Cash used in operations was $9.8 million for
the year ended December 31, 2002, compared to
$22.3 million for 2001 and $22.2 million for 2000.
Cash used in operations in all periods resulted primarily from
net losses, as adjusted for non-cash expenses. In
April 2000, we signed a ten-year lease for a new corporate
facility in Minneapolis, Minnesota, with annual total rent
payments beginning at $1.4 million per year, excluding
operating expenses.

A total of $34.6 million in net cash was
provided from investing activities for the year ended
December 31, 2002, compared to $21.3 million of cash
provided in the same period for 2001 and a cash use of
$63.7 million, representing the investment of the proceeds
of our follow-on public offering, in the same period for 2000.
Our investing activities consisted primarily of net sales of
short-term investments and marketable securities. Our investment
portfolio as of December 31, 2002, was invested, as a
percentage of total cash and investments as follows: 63% in
money market accounts, 9% in corporate bonds and 28% in federal
agency securities. We are presently investing cash in excess of
current requirements in investment grade, interest-bearing
securities and plan to continue this policy.

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Capital expenditures were $0, $248,000, and
$9.4 million for the years ended December 31, 2002,
2001 and 2000, respectively. Capital expenditures in years prior
to 2001 were significantly higher and reflected our rapidly
growing employee base and expanded operations.

Net cash provided from financing activities was
$33,000 for the year ended December 31, 2002, compared to
net cash used for financing activities of $498,000 for the same
period in 2001 and net cash provided from financing activities
of $84.8 million, representing the proceeds of our
follow-on public offering, for the same period in 2000.

During 2002 and 2001, we instituted certain
restructuring plans to better align our cost structure with our
business outlook and general economic conditions. Under the
restructuring plans, we recorded restructuring related charges
totaling $768,000 and $15.6 million for the year ended
December 31, 2002 and 2001, respectively. A total of
approximately $3.9 million was charged against the
restructuring reserve during 2002, lowering the accrued
restructuring liability to approximately $4.3 million. See
the table below summarizing our contractual obligations as of
December 31, 2002 and the related discussion regarding our
operating lease obligations and related sublease agreements.

Of the $4.3 million restructuring reserve
remaining as of December 31, 2002, management estimates
that approximately $4.2 million will be a use of cash in
future periods through July 2010, for remaining rent
commitments and other carrying costs, less estimated sublease
income, related to facilities we have vacated. The remaining
$100,000 relates to other miscellaneous restructuring related
costs.

During the first quarter of 2003, we anticipate
recording an additional $1.2 million restructuring charge,
of which we anticipate approximately $600,000 will be related to
lease commitments. Although we believe that our lease commitment
estimates are appropriate in the current circumstances, future
changes in real estate markets could impact the ultimate amount
of cash paid to resolve these obligations.

As of December 31, 2002, we had no material
long-term commitments for capital expenditures.

Since 1999, we have purchased property and
equipment with cash. From inception through 1998, we generally
funded the purchase of property and equipment with capital
leases. As of December 31, 2002, we had $510,000 in
long-term liabilities, all comprised of deferred rent credits.

The following summarizes our real estate related
contractual obligations as of December 31, 2002, and the
effect such obligations are expected to have on our liquidity
and cash flow in future periods (in thousands). See the
discussion below regarding our operating lease obligations and
related sublease agreements.

|                                |  |      |       |      |  |      |       |      |  |      |       |       |  |       |       |  |  |   |       |  |  |   |       |  |  |   |        | 
|------------------------------- |  | ---- | ----- | ---- |  | ---- | ----- | ---- |  | ---- | ----- | ----- |  | ----- | ----- |  |  | - | ----- |  |  | - | ----- |  |  | - | ------ | 
|                                |  |      |       |      |  |      |       |      |  |      |       | 2008- |  |      
|                                |  | 2003 |       | 2004 |  | 2005 |       | 2006 |  | 2007 |       | 2010  |  | Total
|                                |  |      |       |      |  |      |       |      |  |      |       |       |  |      
|Operating leases                |  | $    | 4,187 |      |  | $    | 3,374 |      |  | $    | 3,168 |       |  | $     | 2,930 |  |  | $ | 2,973 |  |  | $ | 7,876 |  |  | $ | 24,508 | 
|Executed sublease agreements    |  |      | 2,482 |      |  |      | 1,956 |      |  |      | 1,671 |       |  |       | 1,671 |  |  |   | 1,693 |  |  |   | 4,445 |  |  |   | 13,918 | 
|                                |  |      |       |      |  |      |       |      |  |      |       |       |  |       |       |  |  |   |       |  |  |   |       |  |  |   |        | 
|Net contractual cash obligation |  | $    | 1,705 |      |  | $    | 1,418 |      |  | $    | 1,497 |       |  | $     | 1,259 |  |  | $ | 1,280 |  |  | $ | 3,431 |  |  | $ | 10,590 | 
|                                |  |      |       |      |  |      |       |      |  |      |       |       |  |       |       |  |  |   |       |  |  |   |       |  |  |   |        | 

Operating lease obligations relate to our
existing facilities. As of March 20, 2003, we have signed
agreements to sublease approximately 108,000 square feet of our
existing facilities. We are actively seeking to sublease our
remaining excess facilities. Specifically, we are currently
seeking to sublease an additional portion of our Minneapolis,
Minnesota and San Francisco, California office space, and our
entire Roseland, New Jersey and Austin, Texas facilities.
However, there is a risk that we may not be able to sublease
these facilities under favorable terms, if at all, which would
negatively impact our cash flow and future operating results. In
addition, if our existing sub-tenants fail to make sublease
payments required under their respective sublease agreements, we
may experience greater than anticipated

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operating expenses in the future. As of
December 31, 2002, we estimated total future sublease
income of $16.8 million of which $13.9 million is
covered by known sublease arrangements.


We believe that existing cash and investments
will be sufficient to meet our working capital and capital
expenditure needs for at least the next 12 months.

Recently issued accounting pronouncements

In June 2002, the Financial Accounting
Standards Board (FASB) issued SFAS No. 146,
Accounting for Exit or Disposal Activities. The new
statement addresses the accounting for costs associated with
exit or disposal activities. The provisions of the statement
will be effective for disposal activities initiated after
December 31, 2002. The adoption of this statement is not
expected to have a material impact on the Companys
consolidated financial position, results of operations or cash
flows.

In November 2002, the FASB issued
Interpretation No. 45, Guarantors Accounting
and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others. This interpretation
elaborates on the disclosures to be made by a guarantor in its
interim and annual financial statements about its obligations
under certain guarantees that it has issued. It also clarifies
(for guarantees issued after January 1, 2003) that a
guarantor is required to recognize, at the inception of a
guarantee, a liability for the fair value of the obligations
undertaken in issuing the guarantee. This interpretation is not
expected to have a material impact on the Companys
consolidated financial statements.

In January 2003, the FASB issued
Interpretation No. 46, Consolidation of Variable
Interest Entities. This interpretation addresses the
requirements for business enterprises to consolidate related
entities in which they are determined to be the primary
beneficiary as a result of their variable economic interest. The
interpretation is intended to provide guidance in judging
multiple economic interests in an entity and in determining the
primary beneficiary. The interpretation outlines disclosure
requirements for Variable Interest Entities in existence prior
to January 31, 2003, and outlines consolidation
requirements for Variable Interest Entities created after
January 31, 2003. This interpretation is not expected to have a
material impact on the Companys consolidated financial
statements.

In accordance with Emerging Issue Task Force
Issue No. 01-14, Income Statement Characterization of
Reimbursements Received for Out-of-Pocket Expenses
Incurred, the Company began to account for such items as
revenue and cost of revenue effective January 1, 2002.
Service revenues and cost of service revenues include $129,000
for 2002. Additionally, service revenues and cost of service
revenues of $351,000 and $841,000 for 2001 and 2000
respectively, have been reclassified to conform to current
period presentation.

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Risks That May Affect Future Results

The risks and uncertainties described below
are not the only ones we face. Additional risks and
uncertainties not presently known to us or which are currently
deemed immaterial may also impair our business, financial
condition and results of operations. If any of these risks
actually occur, our business, financial condition and results of
operations could be materially adversely affected.

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

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

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

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

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



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

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

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

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

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

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

We had net losses of $4.7 million in 1997,
$5.0 million in 1998, $12.0 million in 1999,
$53.5 million in 2000 (including $27.6 million of
amortization of goodwill and other intangibles related to the
acquisition of KD1 and non-cash stock compensation expense) and
$123.8 million 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 intangibles). As of December 31, 2002, we had an
accumulated deficit of $216.8 million. We have not had a
profitable quarter and do not expect to have a profitable
quarter in 2003. We expect to continue to incur significant
sales and marketing, research and development and general and
administrative expenses. We will need to generate significant
additional revenues to achieve profitability. We may never
achieve profitability.

A decline in the price of, demand for, or market acceptance
of NetP 7 would seriously harm our business.

Recently, we have derived a substantial portion
of our revenues from one product  NetP 7. As
part of our strategy to focus our marketing and development
efforts on NetP 7, we have continued to wind-down certain
product and service offerings, including Advertising Advisor,
which in 2001 accounted for a significant portion of our
revenues.

We anticipate that NetP 7 will account for a
substantial majority of any revenues for the foreseeable future.
Consequently, a decline in the price of or demand for
NetP 7, or the continued failure to achieve broad market
acceptance for NetP 7, would materially adversely affect
our business and results of operations.

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

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



| |   |                                                                                                                                             
| | - | --------------------------------------------------------------------------------------------------------------------------------------------
| |  | actual or anticipated variations in our quarterly
    operating results;                                                                    
|
| |  | announcements of new technological innovations,
    increased cost of operations or new products or services offered
    by our competitors;
|
| |  | conditions or trends in the industries into which
    we sell our products and services;                                                    
|
| |  | changes in the economic performance and/or market
    valuations of other comparable companies;                                             

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| |   |                                                                                                                                                                         
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | volatility in the stock markets, particularly
    with respect to technology stocks, and decreases in the
    availability of capital for technology-related businesses;
|
| |  | announcements by us or our competitors of
    significant acquisitions, strategic partnerships, joint ventures
    or capital commitments;                              
|
| |  | additions or departures of key personnel;                                                                                                                               
|
| |  | sales of additional shares of common stock; and                                                                                                                         
|
| |  | potential litigation.                                                                                                                                                   

From April 23, 1999 (the first day of public
trading of our common stock), through December 31, 2002,
the high and low sales prices for our common stock fluctuated
between $66.50 and $0.76. On March 20, 2003, the last
reported sale price of our common stock on the NASDAQ National
Market was $1.42. In the past, securities class action
litigation has often been brought against a company following
periods of volatility in the market price of its securities.

Securities litigation could result in substantial expense and
distraction.

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

Our common stock may be delisted from NASDAQ.

During 2002, the closing price of our common
stock was below $1.00 for as many as 14 consecutive business
days. We may fail to maintain the minimum closing bid price of
$1.00 for 30 consecutive business days as required by the NASDAQ
National Market. If we are unable to demonstrate compliance with
this or any other NASDAQ requirement, NASDAQ may take further
action with respect to a potential delisting of our common
stock. We may appeal any such decision by NASDAQ to the NASDAQ
Listing Qualifications Panel. If our common stock were delisted
from NASDAQ this could result, among other things, in a number
of negative implications, including reduced liquidity in our
common stock as a result of the loss of market efficiencies
associated with NASDAQ, as well as the potential loss of
confidence by suppliers, customers and employees, the loss of
analyst coverage and institutional investor interest, fewer
business development opportunities and greater difficulty in
obtaining financing.

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

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

We believe principal competitive factors for our
product include: quality, breadth and depth of application
offerings, product scalability, core technology and
architecture, ease of deployment and maintenance, customer
service and support, vendor viability and price. Although we
believe our products currently compete favorably with respect to
certain factors, our market is relatively new and is rapidly
evolving. We may not be able to maintain our competitive
position against current and potential competitors, especially
those with significantly greater financial, marketing, sales,
service, support, technical and other resources.

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

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

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

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

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

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



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

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

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

In June 2002, we announced the commercial
launch of NetP 7.0. In October, 2002, we announced the launch of
NetP 7.1, offering enhancements to NetP 7.0, and we expect to
continue to introduce new and enhanced product features in the
future.

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

NetP 7.0 and NetP 7.1, enhancements thereof, and
any new products will be subject to significant technical risks.
We may fail to introduce or deploy new products or new releases
on a timely basis, or at all. In the past, we have experienced
some delays in the commencement of commercial shipments of our
new releases and new products. These delays caused customer
frustrations and delay or loss of product revenues. Some of our
competitors currently offer products with features and
functionality similar to those of NetP 7.0 and NetP 7.1. In the
past, we have also experienced delays in purchases of our
products by customers anticipating our launch of new releases or
new products. We could experience increased expenses or lost
revenues if customers defer material orders in anticipation of
new releases or new product introductions.

The software products we offer are complex and
may contain undetected errors or failures when first introduced,
or as new versions are released. We have in the past discovered
software errors in our new releases and new products after their
introduction. We experienced delays in release during the period
required to correct these errors. We may discover errors in new
releases or new products after the commencement of commercial
shipments, despite testing by our personnel and our current and
potential customers. This may result in loss of or delay in
market acceptance of our products, which could seriously impair
our ability to achieve profitability.

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

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

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

During 2002, we were unable to materially expand
our customer base and we may not be able to do so in the near
future. We currently depend on a limited number of key,
high-profile customers, and a substantial portion of our revenue
is attributable to a single customer. Our ability to attract new
customers will depend on a variety of factors, including the
accuracy, scalability, reliability and cost-effectiveness of our
products and services and our ability to effectively market such
products and services. In the past, we have lost potential
customers to competitors for various reasons, including lower
prices and other incentives not matched by us. Many of our
customers demand an evaluation of our products prior to
purchase. If such evaluation is successful, the customer may
purchase a license to use our products. If we fail to generate
business from our current and future customers, we may be unable
to build a critical mass of customers necessary to achieve
increased sales and market share.

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

Our products and services require a sophisticated
sales effort targeted at the senior management of our
prospective customers. As of December 31, 2002, our direct
sales organization consisted of 11 employees, which was
decreased to 5 employees by March 20, 2003. We may need to
hire additional direct sales personnel in the future to sustain
or expand our business. However, we do not expect to increase
the size of our sales organization in the near future.
Furthermore, we might not be able to retain the kind and number
of sales personnel we need. If we are unable to retain needed
skilled sales personnel, we may not be able to sustain our
business.

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

Customers that license our software typically
engage our professional services organization to assist with
support, training, consulting and implementation. We believe
that growth in our product sales depends on our ability to
provide our customers with these services and to educate
resellers on how to use our products. From time to time, we
receive customer complaints about the timeliness and accuracy of
our customer support. As of December 31, 2002, our
professional services and customer support organization
consisted of 8 employees, which was decreased to 5 employees by
March 20, 2003. We may not be able to retain a sufficient
number of the highly qualified service personnel that our
business needs.

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

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

If our intellectual property is not protected adequately, we
may be unable to compete in the market.

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

We have seven pending United States patent
applications and four issued United States patents. We also have
exclusive license rights to three issued United States patents
from the University of Minnesota. We plan to continue the
prosecution process for only four of our seven pending
applications. It is possible that no patents will issue from the
currently pending patent applications that we intend to pursue.
It is also possible that our current patents and potential
future patents may be invalid or unenforceable. It is also
possible that any patent issued to us may not provide us with
any competitive advantages. Moreover, we may not develop future
proprietary products or technologies that are patentable, and
the patents of

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others may seriously limit our ability to conduct
our business. In this regard, we have not performed any
comprehensive analysis of patents of others that may limit our
ability to conduct our business.


We own a number of trademarks that we consider to
be of substantial importance to our ability to market NetP 7 and
future products and to our business generally. These include
Net Perceptions and NetP. The Net
Perceptions mark is federally registered for a term of ten
years and the NetP mark is expected to be federally
registered within six months to a year.

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

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

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

In addition, in all of our paid software license
agreements, we generally indemnify our customers against losses
attributable to intellectual property infringement by our
software. Should a third party bring a suit against a customer
alleging that the customers use of our software infringes
its intellectual property rights, we could incur substantial
costs in defending and resolving the suit.

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

Our business depends on the continued service of
our key personnel. The loss of the services of one or more of
our key employees could seriously harm our ability to sustain
our customer base and to sell our products. As of
December 31, 2002, we had 52 employees, which decreased to
29 as of March 20, 2003. We do not carry any key person
life insurance policies.

Our business also depends on our continuing
ability to retain an adequate number of highly skilled
managerial, technical, sales, marketing and customer support
personnel. If we fail to retain our key employees, we may be
unable to service our current customers or attract new customers.

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

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

Because our customers use our products for
important applications, errors or defects in, or other
performance problems with, our products could result in
financial or other damages to our customers. Our customers could
seek damages for losses from us. Although our license agreements
typically contain provisions designed to limit our exposure to
product liability claims, existing or future laws or unfavorable
judicial decisions could negate these limitation of liability
provisions. Any product liability claim brought against us, even
if unsuccessful, would likely be time-consuming and costly, and
potential liabilities could exceed our available insurance
coverage.

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

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

Provisions of our corporate organizational documents and
rights agreement could delay or prevent a change of control,
even if it would be beneficial to our stockholders.

Various provisions of our certificate of
incorporation and bylaws could have the effect of delaying or
preventing a change in control and make it more difficult for a
third party to acquire us, even if doing so would be beneficial
to our stockholders. In addition, the rights issued under our
rights agreement may be a substantial deterrent to a person
acquiring 15% or more of our common stock without the approval
of our Board of Directors. These provisions in our certificate
of incorporation, 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.

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

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

35



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the United States, our business could be
seriously harmed and we could experience increased operating
losses.


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

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

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



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

In addition, we may:



| |   |                                                                                                                                                                                    
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | fail to develop and market new products and
    enhancements to existing products that respond to technological
    changes or evolving industry standards;                        
|
| |  | experience difficulties that could delay or
    prevent the successful development, introduction and marketing
    of these new products and enhancements to existing products; and
|
| |  | fail to develop new products and enhancements to
    existing products that adequately meet the requirements of the
    marketplace or achieve market acceptance.                  

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

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

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

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

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



| |   |                                                                                                                                      
| | - | -------------------------------------------------------------------------------------------------------------------------------------
| |  | use of the Internet, the Web and other on-line
    services does not continue to increase or increases more slowly
    than expected;

36



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

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

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






ITEM 7A.     QUANTITATIVE AND
QUALITATIVE DISCLOSURE ABOUT MARKET RISK


Through December 31, 2002, the majority of
our recognized revenues were denominated in United States
dollars and were primarily from customers in the United States,
and our exposure to foreign currency exchange rate changes has
been immaterial. However, future product license and service
revenues could increasingly be derived from international
markets and denominated in the currency of the applicable
market. As a result, our operating results could become subject
to significant fluctuations based upon changes in the exchange
rates of certain currencies in relation to the United States
dollar. Furthermore, to the extent that we engage in
international sales denominated in United States dollars, an
increase in the value of the United States dollar relative to
foreign currencies could make our products less competitive in
international markets. Although we will continue to monitor our
exposure to currency fluctuations, and, when appropriate, may
use financial hedging techniques in the future to minimize the
effect of these fluctuations, exchange rate fluctuations may
adversely affect our financial results in the future.

Our exposure to market risk is otherwise limited
to interest income sensitivity, which is affected by changes in
the general level of United States interest rates, particularly
because the majority of our investments are in debt securities
issued by corporations and the United States government. A
hypothetical 100 basis point increase in interest rates would
result in an approximate $141,000 decrease in the fair value of
our investments as of December 31, 2002. The same
hypothetical increase in interest rates as of December 31,
2001, would have resulted in a decrease in the fair value of our
investments of approximately $496,000. Our objective in managing
our exposure to interest rate risk is to preserve principal
while at the same time maximizing the income we receive from our
investments. To minimize this risk, we maintain our portfolio of
cash equivalents and short-term investments in a variety of
securities in addition to debt and have adopted practices and
policies to ensure that our portfolio remains adequately
diversified. Due to the conservative nature of our investments
and relatively short duration, interest risk is mitigated.
Furthermore, we place our investments with high-quality issuers
and limit the amount of credit exposure to any one issuer. We do
not have any derivative financial instruments and do not hold
any instruments for trading purposes.






ITEM 8.     FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA


The financial statements required by this item
are included on pages F-1 through F-23 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.

37



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##### Table of Contents








|        |                                                                                           
|------- | ------------------------------------------------------------------------------------------
|ITEM 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON 
     ACCOUNTING AND FINANCIAL DISCLOSURE



None.






PART III







ITEM 10.     DIRECTORS AND EXECUTIVE
OFFICERS OF THE REGISTRANT


Information required by this Item with respect to
directors, executive officers and compliance with
Section 16(a) of the Securities Act of 1934, as amended,
may be found in the sections captioned Nominees for
Election to the Board of Directors, Executive
Officers Who Are Not Directors and
Section 16(a) Beneficial Ownership Reporting
Compliance appearing in our definitive Proxy Statement to
be delivered to stockholders in connection with the Annual
Meeting of Stockholders expected to be held on May 29, 2003
and filed with the Securities and Exchange Commission not later
than 120 days after the close of the fiscal year ended
December 31, 2002 (the Proxy Statement). Such
information is incorporated herein by reference.






ITEM 11.     EXECUTIVE
COMPENSATION


Information required by this Item may be found in
the sections captioned Director Compensation,
Summary Compensation Table, Executive
Compensation and Other Information, Compensation
Committee Report on Executive Compensation,
Stockholder Return Performance Presentation and
Compensation Committee Interlocks and Insider
Participation appearing in the Proxy Statement. Such
information is incorporated herein by reference.






|         |                                                                                                   
|-------- | --------------------------------------------------------------------------------------------------
|ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
    MANAGEMENT AND RELATED STOCKHOLDER MATTERS

Information required by this Item may be found in
the section captioned Stock Ownership of Certain
Beneficial Owners and Management appearing in the Proxy
Statement. Such information is incorporated herein by reference.

Equity Compensation Plan Information

The following table sets forth information
regarding our equity compensation plans as of December 31,
2002:

|                                                                   |  |                      |           |                      |  |                                |      |  |  |  |           |       
|------------------------------------------------------------------ |  | -------------------- | --------- | -------------------- |  | ------------------------------ | ---- |  |  |  | --------- | ------
|                                                                   |  | Number of securities |           |                      |  | Number of securities remaining
|                                                                   |  | to be issued upon    |           | Weighted-average     |  | available for future issuance 
|                                                                   |  | exercise of          |           | exercise price of    |  | under equity compensation     
|                                                                   |  | outstanding options, |           | outstanding options, |  | plans (excluding securities   
|Plan Category                                                      |  | warrants and rights  |           | warrants and rights  |  | reflected in column (a))      
|                                                                   |  |                      |           |                      |  |                               
|                                                                   |  | (a)                  |           | (b)                  |  | (c)                           
|Equity compensation plans approved by security
    holders         |  |                      | 2,649,878 | (1)                  |  | $                              | 3.20 |  |  |  | 5,547,077 | (2)(3)
|Equity compensation plans not approved by
    security holders (4) |  |                      | 103,146   |                      |  | $                              | 4.65 |  |  |  | 395,754   |       
|                                                                   |  |                      |           |                      |  |                                |      |  |  |  |           |       
|Total                                                              |  |                      | 2,753,024 | (5)                  |  | $                              | 3.26 |  |  |  | 5,942,831 |       




|    |                                                                                                                                                                                                                                                                                                            
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Excludes purchase rights accruing under the
    Employee Stock Purchase Plan, pursuant to which 1,568,428 shares
    were available for issuance at December 31, 2002. Each
    year, beginning January 1, 2000 and ending January 1,
    2004, the number of shares of common stock available for issuance

38



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|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    | under the Employee Stock Purchase Plan will, in
    accordance with the terms of the Plan, be increased
    automatically by the lesser of 2% of the total number of shares
    of common stock then outstanding or 600,000 shares. See
    Note 9 to the Consolidated Financial Statements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   
|(2) | Includes 1,568,428 shares available for issuance
    at December 31, 2002 under the Employee Stock Purchase Plan.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|   
|(3) | Includes 2,424,427 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   
|(4) | 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. 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, 2002, options covering 103,146 shares of
    common stock were outstanding under the 2000 Stock Plan, 395,754
    shares remained available for future option grants, and options
    covering 1,100 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.
|   
|(5) | The table does not include a total of 3,689
    shares of common stock issuable upon the exercise of outstanding
    options under the KD1 1996 Stock Option/ Stock Issuance Plan.
    These options were assumed by the Company through its
    acquisition of KD1, and no additional options may be granted
    under this plan. The weighted-average exercise price of these
    options is $8.89 per share.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       






ITEM 13.     CERTAIN RELATIONSHIPS
AND RELATED TRANSACTIONS


Information required by this Item may be found in
the section captioned Certain Relationships and Related
Transactions appearing in the Proxy Statement. Such
information is incorporated herein by reference.






ITEM 14.     CONTROLS AND
PROCEDURES


Evaluation of Disclosure Controls and
Procedures.Our chief executive
officer and chief financial officer have evaluated the
effectiveness of our disclosure controls and procedures (as such
term is defined in Rules 13a-14(c) and 15d-14(c) under the
Exchange Act) as of an evaluation date within 90 days prior
to the filing date of this Annual Report on Form 10-K.
Based on this evaluation, they have concluded that, as of the
evaluation date, our disclosure controls and procedures are
effective in alerting them on a timely basis to material
information relating to the Company (including our consolidated
subsidiaries) required to be included in our reports filed or
submitted under the Exchange Act.

Changes in Internal
Controls.Since the evaluation date
referred to above, there have not been any significant changes
in our internal controls or in other factors that could
significantly affect such controls.

39



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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

|        |        |             |  |                                                                                                                                                                                
|------- | ------ | ----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |        |            
|Number  |        | Description
|        |        |            
|        | 3.1(a) |             |  | Amended and Restated Certificate of
    Incorporation(1).                                                                                                                      
|        | 3.1(b) |             |  | Certificate of Amendment to the Amended and
    Restated Certificate of Incorporation(2).                                                                                      
|        | 3.2    |             |  | Amended and Restated Bylaws as amended through
    April 18, 2001(4).                                                                                                          
|        | 4.1    |             |  | Amended and Restated Investor Rights Agreement,
    dated December 18, 1997, among Net Perceptions, Inc. and
    the investors and founders named therein, as amended(1).      
|        | 4.2    |             |  | Specimen common stock certificate(1).                                                                                                                                          
|        | 4.3    |             |  | Specimen common stock certificate (including
    Rights Agreement Legend)(5).                                                                                                  
|        | 4.4    |             |  | Rights Agreement between Net Perceptions, Inc.
    and Wells Fargo Bank Minnesota, as Rights Agent(6).                                                                         
|        | 4.5    |             |  | Form of Certificate of Designation of
    Series A Junior Participating Preferred Stock (attached as
    Exhibit A to the Rights Agreement filed as Exhibit 4.4
    hereto)(6).
|        | 4.6    |             |  | 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(1).                                                            
|        | 10.2*  |             |  | 1996 Stock Plan(1).                                                                                                                                                            
|        | 10.3*  |             |  | 1999 Equity Incentive Plan(1).                                                                                                                                                 
|        | 10.4*  |             |  | Amended and Restated 1999 Non-Employee Director
    Option Plan, as amended through April 2, 2001(4).                                                                          
|        | 10.5*  |             |  | Employee Stock Purchase Plan(1).                                                                                                                                               
|        | 10.6*  |             |  | Knowledge Discovery One, Inc. 1996 Stock
    Option/Stock Issuance Plan(7).                                                                                                    
|        | 10.7   |             |  | Office Lease Agreement between DRF Holding LLC
    and Net Perceptions, Inc. dated April 5, 2000(8).                                                                           
|        | 10.8*  |             |  | 2000 Stock Plan(3).                                                                                                                                                            
|        | 10.9*  |             |  | Change in Control Severance Plan and Summary Plan
    Description(1).                                                                                                          
|        | 10.10* |             |  | Employment Agreement, dated as of May 24,
    2001, between Net Perceptions, Inc. and Donald C.
    Peterson(5).                                                               
|        | 10.11* |             |  | Severance Agreement, dated as of November 9,
    2001, between Net Perceptions, Inc. and Thomas M.
    Donnelly(9).                                                            

40



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|        |      |             |  |                                                                                                                                                               
|------- | ---- | ----------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |      |            
|Number  |      | Description
|        |      |            
|        | 21.1 |             |  | List of Subsidiaries(9).                                                                                                                                      
|        | 23.1 |             |  | Consent of PricewaterhouseCoopers LLP,
    independent accountants.                                                                                           
|        | 99.1 |             |  | Certification of the Chief Executive Officer
    pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
    Section 906 of the Sarbanes-Oxley Act of 2002.
|        | 99.2 |             |  | Certification of the Chief Financial Officer
    pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
    Section 906 of the Sarbanes-Oxley Act of 2002.






| |                                                                             
| | ----------------------------------------------------------------------------
| | *  Represents a management contract or
    compensatory plan or arrangement.



|    |                                                                                                                                                                                                                          
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Incorporated by reference to Net
    Perceptions Registration Statement on Form S-1
    (Registration No. 333-71919).                                                                                                   
|   
|(2) | Filed solely to correct a typographical error in
    the same exhibit, previously filed as an exhibit to Net
    Perceptions Quarterly Report on Form 10-Q for the
    Quarter Ended June 30, 2000 (File No. 000-25781).
|   
|(3) | Incorporated by reference to Net
    Perceptions Quarterly Report on Form 10-Q for the
    Quarter Ended June 30, 2000 (File No. 000-25781).                                                                            
|   
|(4) | Incorporated by reference to Net
    Perceptions Quarterly Report on Form 10-Q for the
    Quarter Ended March 31, 2001 (File No. 000-25781).                                                                           
|   
|(5) | Incorporated by reference to Net
    Perceptions Quarterly Report on Form 10-Q for the
    Quarter Ended June 30, 2001 (File No. 000-25781).                                                                            
|   
|(6) | Incorporated by reference to Net
    Perceptions Registration Statement on Form 8-A filed
    June 6, 2001 (File No. 000-25781).                                                                                        
|   
|(7) | Incorporated by reference to Net
    Perceptions Registration Statement on Form S-1
    (Registration No. 333-31230).                                                                                                   
|   
|(8) | Incorporated by reference to Net
    Perceptions Quarterly Report on Form 10-Q for the
    Quarter Ended March 31, 2000 (File No. 000-25781).                                                                           
|   
|(9) | Incorporated by reference to Net
    Perceptions Annual Report on Form 10-K for the Fiscal Year
    Ended December 31, 2001 (File No. 000-25781).                                                                       

(b) Reports on Form 8-K

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

41



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##### Table of Contents








ITEM 8.     FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA


NET PERCEPTIONS, INC.






INDEX TO CONSOLIDATED FINANCIAL
STATEMENTS


|                                                                            |  |      |     | 
|--------------------------------------------------------------------------- |  | ---- | --- | 
|                                                                            |  | Page
|                                                                            |  |     
|Report of Independent Accountants                                           |  |      | F-2 | 
|Consolidated Balance Sheets                                                 |  |      | F-3 | 
|Consolidated Statements of Operations                                       |  |      | F-4 | 
|Consolidated Statement of Stockholders
    Equity and Comprehensive Income |  |      | F-5 | 
|Consolidated Statements of Cash Flows                                       |  |      | F-6 | 
|Notes to the Consolidated Financial Statements                              |  |      | F-7 | 

F-1



---



##### Table of Contents








REPORT OF INDEPENDENT ACCOUNTANTS


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, 2002 and 2001, and the
results of their operations and their cash flows for each of the
three years in the period ended December 31, 2002 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 5 to the consolidated
financial statements, the Company adopted Statement of Financial
Accounting Standards No. 142, Goodwill and Other
Intangible Assets on January 1, 2002.

PricewaterhouseCoopers LLP

Minneapolis, Minnesota


January 24, 2003


F-2



---



##### Table of Contents



NET PERCEPTIONS, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except per share
amounts)


ASSETS

|                                               |                                                                                                                                                                 |                                            |       |          |        |  |       |          |        | 
|---------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ----- | -------- | ------ |  | ----- | -------- | ------ | 
|                                               |                                                                                                                                                                 |                                           
|                                               |                                                                                                                                                                 | December 31,                              
|                                               |                                                                                                                                                                 |                                           
|                                               |                                                                                                                                                                 | 2002                                       |       | 2001    
|                                               |                                                                                                                                                                 |                                            |       |         
|Current assets:                                |                                                                                                                                                                 |                                            |       |          |        |  |       |         
|                                               | Cash and cash equivalents                                                                                                                                       |                                            | $     | 39,729   |        |  | $     | 14,929   |       
|                                               | Short-term investments                                                                                                                                          |                                            |       | 23,230   |        |  |       | 58,676   |       
|                                               | Accounts receivable, net                                                                                                                                        |                                            |       | 389      |        |  |       | 1,309    |       
|                                               | Prepaid expenses and other current assets                                                                                                                       |                                            |       | 627      |        |  |       | 2,301    |       
|                                               |                                                                                                                                                                 |                                            |       |          |        |  |       |         
|                                               |                                                                                                                                                                 | Total current assets                       |       |          | 63,975 |  |       |          | 77,215 | 
|Property and equipment, net                    |                                                                                                                                                                 |                                            | 1,096 |          |        |  | 3,679 |         
|Goodwill and other intangible assets, net      |                                                                                                                                                                 |                                            |      |          |        |  | 6,802 |         
|Other assets                                   |                                                                                                                                                                 |                                            | 725   |          |        |  | 1,182 |         
|                                               |                                                                                                                                                                 |                                            |       |          |        |  |       |         
|                                               |                                                                                                                                                                 | Total assets                               |       | $        | 65,796 |  |       | $        | 88,878 | 
|                                               |                                                                                                                                                                 |                                            |       |          |        |  |       |         
|LIABILITIES AND STOCKHOLDERS
    EQUITY      
|Current liabilities:                           |                                                                                                                                                                 |                                            |       |          |        |  |       |         
|                                               | Accounts payable                                                                                                                                                |                                            | $     | 52       |        |  | $     | 314      |       
|                                               | Accrued liabilities                                                                                                                                             |                                            |       | 1,853    |        |  |       | 3,215    |       
|                                               | Deferred revenue                                                                                                                                                |                                            |       | 750      |        |  |       | 1,835    |       
|                                               | Accrued restructuring costs                                                                                                                                     |                                            |       | 4,289    |        |  |       | 7,433    |       
|                                               | Current portion of long-term liabilities                                                                                                                        |                                            |       |         |        |  |       | 97       |       
|                                               |                                                                                                                                                                 |                                            |       |          |        |  |       |         
|                                               |                                                                                                                                                                 | Total current liabilities                  |       |          | 6,944  |  |       |          | 12,894 | 
|Deferred Rent                                  |                                                                                                                                                                 |                                            | 510   |          |        |  | 577   |         
|                                               |                                                                                                                                                                 |                                            |       |          |        |  |       |         
|                                               |                                                                                                                                                                 | Total liabilities                          |       |          | 7,454  |  |       |          | 13,471 | 
|                                               |                                                                                                                                                                 |                                            |       |          |        |  |       |         
|Commitments 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; 27,332 and 27,129 shares issued and
    outstanding at December 31, 2002 and 2001, respectively |                                            |       | 2        |        |  |       | 2        |       
|                                               | Additional paid-in capital                                                                                                                                      |                                            |       | 275,053  |        |  |       | 274,869  |       
|                                               | Accumulated other comprehensive income                                                                                                                          |                                            |       | 122      |        |  |       | 637      |       
|                                               | Accumulated deficit                                                                                                                                             |                                            |       | (216,835 | )      |  |       | (200,101 | )     
|                                               |                                                                                                                                                                 |                                            |       |          |        |  |       |         
|                                               |                                                                                                                                                                 | Total stockholders equity                 |       |          | 58,342 |  |       |          | 75,407 | 
|                                               |                                                                                                                                                                 |                                            |       |          |        |  |       |         
|                                               |                                                                                                                                                                 | Total liabilities and stockholders equity |       | $        | 65,796 |  |       | $        | 88,878 | 
|                                               |                                                                                                                                                                 |                                            |       |          |        |  |       |         

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, 
|                                                                  |                                              |                         
|                                                                  |                                              | 2002                     |         | 2001  |        | 2000
|                                                                  |                                              |                          |         |       |        |     
|Revenues:                                                         |                                              |                          |         |       |        |      |          |        |         |   |         |       
|                                                                  | Product                                      |                          | $       | 1,703 |        |      | $        | 2,979  |         |   | $       | 25,087 |       
|                                                                  | Service and maintenance                      |                          |         | 3,541 |        |      |          | 7,535  |         |   |         | 12,342 |       
|                                                                  |                                              |                          |         |       |        |      |          |        |         |   |         |       
|                                                                  |                                              | Total revenues           |         |       | 5,244  |      |          |        | 10,514  |   |         |        | 37,429 | 
|                                                                  |                                              |                          |         |       |        |      |          |        |         |   |         |       
|Cost of revenues:                                                 |                                              |                          |         |       |        |      |          |        |         |   |         |       
|                                                                  | Product                                      |                          |         | 292   |        |      |          | 943    |         |   |         | 1,807  |       
|                                                                  | Service and maintenance                      |                          |         | 2,101 |        |      |          | 5,143  |         |   |         | 11,532 |       
|                                                                  |                                              |                          |         |       |        |      |          |        |         |   |         |       
|                                                                  |                                              | Total cost of revenues   |         |       | 2,393  |      |          |        | 6,086   |   |         |        | 13,339 | 
|                                                                  |                                              |                          |         |       |        |      |          |        |         |   |         |       
|Gross margin                                                      |                                              |                          | 2,851   |       |        |      | 4,428    |        |         |   | 24,090  |       
|                                                                  |                                              |                          |         |       |        |      |          |        |         |   |         |       
|Operating expenses:                                               |                                              |                          |         |       |        |      |          |        |         |   |         |       
|                                                                  | Sales and marketing                          |                          |         | 4,550 |        |      |          | 15,215 |         |   |         | 25,589 |       
|                                                                  | Research and development                     |                          |         | 5,933 |        |      |          | 10,572 |         |   |         | 19,354 |       
|                                                                  | General and administrative                   |                          |         | 2,819 |        |      |          | 6,198  |         |   |         | 11,146 |       
|                                                                  | Lease abandonment expense                    |                          |         |      |        |      |          | 225    |         |   |         | 1,250  |       
|                                                                  | Restructuring related charges                |                          |         | 768   |        |      |          | 15,551 |         |   |         |       |       
|                                                                  | Amortization of intangibles                  |                          |         | 110   |        |      |          | 9,650  |         |   |         | 25,394 |       
|                                                                  | Impairment of goodwill and other intangibles |                          |         | 6,546 |        |      |          | 75,298 |         |   |         |       |       
|                                                                  |                                              |                          |         |       |        |      |          |        |         |   |         |       
|                                                                  |                                              | Total operating expenses |         |       | 20,726 |      |          |        | 132,709 |   |         |        | 82,733 | 
|                                                                  |                                              |                          |         |       |        |      |          |        |         |   |         |       
|Loss from operations                                              |                                              |                          | (17,875 | )     |        |      | (128,281 | )      |         |   | (58,643 | )     
|                                                                  |                                              |                          |         |       |        |      |          |        |         |   |         |       
|Other income (expense):                                           |                                              |                          |         |       |        |      |          |        |         |   |         |       
|                                                                  | Interest income                              |                          |         | 2,108 |        |      |          | 4,494  |         |   |         | 5,851  |       
|                                                                  | Interest expense                             |                          |         | (24   | )      |      |          | (88    | )       |   |         | (160   | )     
|                                                                  | Other income (expense)                       |                          |         | (943  | )      |      |          | 77     |         |   |         | (595   | )     
|                                                                  |                                              |                          |         |       |        |      |          |        |         |   |         |       
|                                                                  |                                              | Total other income, net  |         |       | 1,141  |      |          |        | 4,483   |   |         |        | 5,096  | 
|                                                                  |                                              |                          |         |       |        |      |          |        |         |   |         |       
|Net loss                                                          |                                              | $                        | (16,734 | )     |        | $    | (123,798 | )      |         | $ | (53,547 | )     
|                                                                  |                                              |                          |         |       |        |      |          |        |         |   |         |       
|Basic and diluted net loss per share                              |                                              | $                        | (0.61   | )     |        | $    | (4.59    | )      |         | $ | (2.12   | )     
|                                                                  |                                              |                          |         |       |        |      |          |        |         |   |         |       
|Shares used in computing basic and diluted net
    loss per share |                                              |                          | 27,216  |       |        |      | 26,951   |        |         |   | 25,209  |       
|                                                                  |                                              |                          |         |       |        |      |          |        |         |   |         |       

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)


|                                                                                                              |  |              |        |            |  |         |   |  |  |   |         |  
|------------------------------------------------------------------------------------------------------------- |  | ------------ | ------ | ---------- |  | ------- | - |  |  | - | ------- | -
|                                                                                                              |  |              |        |           
|                                                                                                              |  | Common Stock |        | Additional
|                                                                                                              |  |              |        | Paid-in   
|                                                                                                              |  | Shares       |        | Amount     |  | Capital
|                                                                                                              |  |              |        |            |  |        
|Balance, December 31, 1999                                                                                    |  |              | 22,026 |            |  | $       | 2 |  |  | $ | 71,231  |  
|Issuance of common stock for acquisition of
    Knowledge Discovery One, Inc. net of $2,175 acquisition costs |  |              | 1,969  |            |  |         |  |  |  |   | 115,640 |  
|Proceeds from follow-on public offering net of
    $5,853 offering costs                                      |  |              | 2,000  |            |  |         |  |  |  |   | 84,647  |  
|Issuance of common stock under employee stock
    purchase plan                                               |  |              | 216    |            |  |         |  |  |  |   | 1,174   |  
|Exercise of stock options                                                                                     |  |              | 764    |            |  |         |  |  |  |   | 779     |  
|Repurchase of unvested common stock                                                                           |  |              | (105   | )          |  |         |  |  |  |   | (65     | )
|Compensation relating to stock options                                                                        |  |              |       |            |  |         |  |  |  |   | 1,052   |  
|Change in unrealized gain (loss) on
    available-for-sale investments                                        |  |              |       |            |  |         |  |  |  |   |        |  
|Net loss                                                                                                      |  |              |       |            |  |         |  |  |  |   |        |  
|                                                                                                              |  |              |        |            |  |         |   |  |  |   |         |  
|Balance, December 31, 2000.                                                                                   |  |              | 26,870 |            |  |         | 2 |  |  |   | 274,458 |  
|Exercise of stock options                                                                                     |  |              | 115    |            |  |         |  |  |  |   | 59      |  
|Repurchase of unvested common stock                                                                           |  |              | (2     | )          |  |         |  |  |  |   | (6      | )
|Compensation relating to stock options                                                                        |  |              |       |            |  |         |  |  |  |   | 230     |  
|Issuance of common stock under employee stock
    purchase plan                                               |  |              | 146    |            |  |         |  |  |  |   | 128     |  
|Change in unrealized gain (loss) on
    available-for-sale investments                                        |  |              |       |            |  |         |  |  |  |   |        |  
|Net loss                                                                                                      |  |              |       |            |  |         |  |  |  |   |        |  
|                                                                                                              |  |              |        |            |  |         |   |  |  |   |         |  
|Balance, December 31, 2001.                                                                                   |  |              | 27,129 |            |  |         | 2 |  |  |   | 274,869 |  
|Exercise of stock options                                                                                     |  |              | 136    |            |  |         |  |  |  |   | 64      |  
|Repurchase of unvested common stock                                                                           |  |              | (1     | )          |  |         |  |  |  |   | (1      | )
|Compensation relating to stock options                                                                        |  |              |       |            |  |         |  |  |  |   | 54      |  
|Issuance of common stock under employee stock
    purchase plan                                               |  |              | 68     |            |  |         |  |  |  |   | 67      |  
|Change in unrealized gain (loss) on
    available-for-sale investments                                        |  |              |       |            |  |         |  |  |  |   |        |  
|Net loss                                                                                                      |  |              |       |            |  |         |  |  |  |   |        |  
|                                                                                                              |  |              |        |            |  |         |   |  |  |   |         |  
|Balance, December 31, 2002.                                                                                   |  |              | 27,332 |            |  | $       | 2 |  |  | $ | 275,053 |  
|                                                                                                              |  |              |        |            |  |         |   |  |  |   |         |  

[Additional columns below]

[Continued from above table, first column(s) repeated]

|                                                                                                              |  |               |      |  
|------------------------------------------------------------------------------------------------------------- |  | ------------- | ---- | -
|                                                                                                              |  | Accumulated  
|                                                                                                              |  | Other        
|                                                                                                              |  | Comprehensive
|                                                                                                              |  | Income(Loss) 
|                                                                                                              |  |              
|Balance, December 31, 1999                                                                                    |  | $             | (89  | )
|Issuance of common stock for acquisition of
    Knowledge Discovery One, Inc. net of $2,175 acquisition costs |  |               |     |  
|Proceeds from follow-on public offering net of
    $5,853 offering costs                                      |  |               |     |  
|Issuance of common stock under employee stock
    purchase plan                                               |  |               |     |  
|Exercise of stock options                                                                                     |  |               |     |  
|Repurchase of unvested common stock                                                                           |  |               |     |  
|Compensation relating to stock options                                                                        |  |               |     |  
|Change in unrealized gain (loss) on
    available-for-sale investments                                        |  |               | 450  |  
|Net loss                                                                                                      |  |               |     |  
|                                                                                                              |  |               |      |  
|Balance, December 31, 2000.                                                                                   |  |               | 361  |  
|Exercise of stock options                                                                                     |  |               |     |  
|Repurchase of unvested common stock                                                                           |  |               |     |  
|Compensation relating to stock options                                                                        |  |               |     |  
|Issuance of common stock under employee stock
    purchase plan                                               |  |               |     |  
|Change in unrealized gain (loss) on
    available-for-sale investments                                        |  |               | 276  |  
|Net loss                                                                                                      |  |               |     |  
|                                                                                                              |  |               |      |  
|Balance, December 31, 2001.                                                                                   |  |               | 637  |  
|Exercise of stock options                                                                                     |  |               |     |  
|Repurchase of unvested common stock                                                                           |  |               |     |  
|Compensation relating to stock options                                                                        |  |               |     |  
|Issuance of common stock under employee stock
    purchase plan                                               |  |               |     |  
|Change in unrealized gain (loss) on
    available-for-sale investments                                        |  |               | (515 | )
|Net loss                                                                                                      |  |               |     |  
|                                                                                                              |  |               |      |  
|Balance, December 31, 2002.                                                                                   |  | $             | 122  |  
|                                                                                                              |  |               |      |  

[Additional columns below]

[Continued from above table, first column(s) repeated]

|                                                                                                              |  |             |          |  
|------------------------------------------------------------------------------------------------------------- |  | ----------- | -------- | -
|                                                                                                              |  | Accumulated
|                                                                                                              |  | Deficit    
|                                                                                                              |  |            
|Balance, December 31, 1999                                                                                    |  | $           | (22,756  | )
|Issuance of common stock for acquisition of
    Knowledge Discovery One, Inc. net of $2,175 acquisition costs |  |             |         |  
|Proceeds from follow-on public offering net of
    $5,853 offering costs                                      |  |             |         |  
|Issuance of common stock under employee stock
    purchase plan                                               |  |             |         |  
|Exercise of stock options                                                                                     |  |             |         |  
|Repurchase of unvested common stock                                                                           |  |             |         |  
|Compensation relating to stock options                                                                        |  |             |         |  
|Change in unrealized gain (loss) on
    available-for-sale investments                                        |  |             |         |  
|Net loss                                                                                                      |  |             | (53,547  | )
|                                                                                                              |  |             |          |  
|Balance, December 31, 2000.                                                                                   |  |             | (76,303  | )
|Exercise of stock options                                                                                     |  |             |         |  
|Repurchase of unvested common stock                                                                           |  |             |         |  
|Compensation relating to stock options                                                                        |  |             |         |  
|Issuance of common stock under employee stock
    purchase plan                                               |  |             |         |  
|Change in unrealized gain (loss) on
    available-for-sale investments                                        |  |             |         |  
|Net loss                                                                                                      |  |             | (123,798 | )
|                                                                                                              |  |             |          |  
|Balance, December 31, 2001.                                                                                   |  |             | (200,101 | )
|Exercise of stock options                                                                                     |  |             |         |  
|Repurchase of unvested common stock                                                                           |  |             |         |  
|Compensation relating to stock options                                                                        |  |             |         |  
|Issuance of common stock under employee stock
    purchase plan                                               |  |             |         |  
|Change in unrealized gain (loss) on
    available-for-sale investments                                        |  |             |         |  
|Net loss                                                                                                      |  |             | (16,734  | )
|                                                                                                              |  |             |          |  
|Balance, December 31, 2002.                                                                                   |  | $           | (216,835 | )
|                                                                                                              |  |             |          |  

[Additional columns below]

[Continued from above table, first column(s) repeated]

|                                                                                                              |  |               |          |               |  |   |          |  
|------------------------------------------------------------------------------------------------------------- |  | ------------- | -------- | ------------- |  | - | -------- | -
|                                                                                                              |  | Total         |          | Comprehensive
|                                                                                                              |  | Stockholders |          | Income       
|                                                                                                              |  | Equity        |          | (Loss)       
|                                                                                                              |  |               |          |              
|Balance, December 31, 1999                                                                                    |  | $             | 48,388   |               |  |   |         |  
|Issuance of common stock for acquisition of
    Knowledge Discovery One, Inc. net of $2,175 acquisition costs |  |               | 115,640  |               |  |   |         |  
|Proceeds from follow-on public offering net of
    $5,853 offering costs                                      |  |               | 84,647   |               |  |   |         |  
|Issuance of common stock under employee stock
    purchase plan                                               |  |               | 1,174    |               |  |   |         |  
|Exercise of stock options                                                                                     |  |               | 779      |               |  |   |         |  
|Repurchase of unvested common stock                                                                           |  |               | (65      | )             |  |   |         |  
|Compensation relating to stock options                                                                        |  |               | 1,052    |               |  |   |         |  
|Change in unrealized gain (loss) on
    available-for-sale investments                                        |  |               | 450      |               |  | $ | 450      |  
|Net loss                                                                                                      |  |               | (53,547  | )             |  |   | (53,547  | )
|                                                                                                              |  |               |          |               |  |   |          |  
|Balance, December 31, 2000.                                                                                   |  |               | 198,518  |               |  |   | (53,097  | )
|Exercise of stock options                                                                                     |  |               | 59       |               |  |   |         |  
|Repurchase of unvested common stock                                                                           |  |               | (6       | )             |  |   |         |  
|Compensation relating to stock options                                                                        |  |               | 230      |               |  |   |         |  
|Issuance of common stock under employee stock
    purchase plan                                               |  |               | 128      |               |  |   |         |  
|Change in unrealized gain (loss) on
    available-for-sale investments                                        |  |               | 276      |               |  |   | 276      |  
|Net loss                                                                                                      |  |               | (123,798 | )             |  |   | (123,798 | )
|                                                                                                              |  |               |          |               |  |   |          |  
|Balance, December 31, 2001.                                                                                   |  |               | 75,407   |               |  |   | (123,522 | )
|Exercise of stock options                                                                                     |  |               | 64       |               |  |   |         |  
|Repurchase of unvested common stock                                                                           |  |               | (1       | )             |  |   |         |  
|Compensation relating to stock options                                                                        |  |               | 54       |               |  |   |         |  
|Issuance of common stock under employee stock
    purchase plan                                               |  |               | 67       |               |  |   |         |  
|Change in unrealized gain (loss) on
    available-for-sale investments                                        |  |               | (515     | )             |  |   | (515     | )
|Net loss                                                                                                      |  |               | (16,734  | )             |  |   | (16,734  | )
|                                                                                                              |  |               |          |               |  |   |          |  
|Balance, December 31, 2002.                                                                                   |  | $             | 58,342   |               |  | $ | (17,249  | )
|                                                                                                              |  |               |          |               |  |   |          |  

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,                                                        
|                                                                          |                                                                                                                         |                                                                                
|                                                                          |                                                                                                                         | 2002                                                                            |                                           | 2001                                                    |       | 2000  
|                                                                          |                                                                                                                         |                                                                                 |                                           |                                                         |       |       
|Cash flows from operating activities:                                     |                                                                                                                         |                                                                                 |                                           |                                                         |       |        |        |          |        |        |         |         
|                                                                          | Net loss                                                                                                                |                                                                                 | $                                         | (16,734                                                 | )     |        | $      | (123,798 | )      |        | $       | (53,547  | )     
|                                                                          | Reconciliation of net loss to net cash used by
    operating activities:                                                |                                                                                 |                                           |                                                         |       |        |        |          |        |        |         |          |       
|                                                                          |                                                                                                                         | Depreciation and amortization                                                   |                                           |                                                         | 2,196 |        |        |          | 13,528 |        |         |          | 29,975 |       
|                                                                          |                                                                                                                         | Provision for doubtful accounts                                                 |                                           |                                                         | 79    |        |        |          | 1,051  |        |         |          | 2,073  |       
|                                                                          |                                                                                                                         | Lease abandonment expense                                                       |                                           |                                                         |      |        |        |          | 225    |        |         |          | 1,250  |       
|                                                                          |                                                                                                                         | Compensation expense related to stock options                                   |                                           |                                                         | 42    |        |        |          | 230    |        |         |          | 1,052  |       
|                                                                          |                                                                                                                         | Restructuring related charges                                                   |                                           |                                                         | 768   |        |        |          | 15,551 |        |         |          |       |       
|                                                                          |                                                                                                                         | Impairment of goodwill and other intangibles                                    |                                           |                                                         | 6,546 |        |        |          | 75,298 |        |         |          |       |       
|                                                                          |                                                                                                                         | Amortization of premiums (discounts) on
    investments                         |                                           |                                                         | 372   |        |        |          | (135   | )      |         |          | (540   | )     
|                                                                          |                                                                                                                         | Loss on disposal of assets                                                      |                                           |                                                         |      |        |        |          | 22     |        |         |          | 23     |       
|                                                                          |                                                                                                                         | Equity in losses of joint venture                                               |                                           |                                                         |      |        |        |          |       |        |         |          | 197    |       
|                                                                          |                                                                                                                         | Changes in assets and liabilities excluding
    effect of business combination: |                                           |                                                         |       |        |        |          |        |        |         |          |        |       
|                                                                          |                                                                                                                         |                                                                                 | Accounts receivable                       |                                                         |       | 841    |        |          |        | 3,979  |         |          |        | 278    |        
|                                                                          |                                                                                                                         |                                                                                 | Royalties receivable                      |                                                         |       |       |        |          |        | 671    |         |          |        | 464    |        
|                                                                          |                                                                                                                         |                                                                                 | Prepaid expenses and other current assets |                                                         |       | 1,674  |        |          |        | (462   | )       |          |        | (177   | )      
|                                                                          |                                                                                                                         |                                                                                 | Other assets                              |                                                         |       | 457    |        |          |        | 613    |         |          |        | (1,314 | )      
|                                                                          |                                                                                                                         |                                                                                 | Accounts payable                          |                                                         |       | (262   | )      |          |        | (1,112 | )       |          |        | (2,167 | )      
|                                                                          |                                                                                                                         |                                                                                 | Accrued expenses                          |                                                         |       | (4,619 | )      |          |        | (5,957 | )       |          |        | 663    |        
|                                                                          |                                                                                                                         |                                                                                 | Deferred revenue                          |                                                         |       | (1,085 | )      |          |        | (1,908 | )       |          |        | (110   | )      
|                                                                          |                                                                                                                         |                                                                                 | Other liabilities                         |                                                         |       | (67    | )      |          |        | (92    | )       |          |        | (340   | )      
|                                                                          |                                                                                                                         |                                                                                 |                                           |                                                         |       |        |        |          |        |        |         |         
|                                                                          |                                                                                                                         |                                                                                 |                                           | Net cash used in operating activities                   |       |        | (9,792 | )        |        |        | (22,296 | )        |        |        | (22,220 | )
|                                                                          |                                                                                                                         |                                                                                 |                                           |                                                         |       |        |        |          |        |        |         |         
|Cash flows from investing activities:                                     |                                                                                                                         |                                                                                 |                                           |                                                         |       |        |        |          |        |        |         |         
|                                                                          | Purchases of short-term investments and
    marketable securities                                                       |                                                                                 |                                           | (47,555                                                 | )     |        |        | (132,886 | )      |        |         | (136,853 | )     
|                                                                          | Sales and maturities of short-term investments
    and marketable securities                                            |                                                                                 |                                           | 82,114                                                  |       |        |        | 154,461  |        |        |         | 83,717   |       
|                                                                          | Purchases of property and equipment                                                                                     |                                                                                 |                                           |                                                        |       |        |        | (248     | )      |        |         | (9,390   | )     
|                                                                          | Net cash paid in acquisition, net of cash acquired                                                                      |                                                                                 |                                           |                                                        |       |        |        |         |        |        |         | (1,156   | )     
|                                                                          |                                                                                                                         |                                                                                 |                                           |                                                         |       |        |        |          |        |        |         |         
|                                                                          |                                                                                                                         |                                                                                 |                                           | Net cash (used in) provided by investing
    activities |       |        | 34,559 |          |        |        | 21,327  |          |        |        | (63,682 | )
|                                                                          |                                                                                                                         |                                                                                 |                                           |                                                         |       |        |        |          |        |        |         |         
|Cash flows from financing activities:                                     |                                                                                                                         |                                                                                 |                                           |                                                         |       |        |        |          |        |        |         |         
|                                                                          | Proceeds from public stock offerings, net of
    offering costs of $5,853 and $5,543 in 2000 and 1999,
    respectively |                                                                                 |                                           |                                                        |       |        |        |         |        |        |         | 84,647   |       
|                                                                          | Proceeds from issuance of stock under employee
    stock purchase plan                                                  |                                                                                 |                                           | 67                                                      |       |        |        | 128      |        |        |         | 1,174    |       
|                                                                          | Proceeds from exercise of stock options and
    warrants, net of stock repurchases                                      |                                                                                 |                                           | 63                                                      |       |        |        | 53       |        |        |         | 714      |       
|                                                                          | Repayment of acquired entity bank loan                                                                                  |                                                                                 |                                           |                                                        |       |        |        |         |        |        |         | (1,000   | )     
|                                                                          | Principal payments under capital lease
    obligations and notes payable                                                |                                                                                 |                                           | (97                                                     | )     |        |        | (679     | )      |        |         | (694     | )     
|                                                                          |                                                                                                                         |                                                                                 |                                           |                                                         |       |        |        |          |        |        |         |         
|                                                                          |                                                                                                                         |                                                                                 |                                           | Net cash (used in) provided by financing
    activities |       |        | 33     |          |        |        | (498    | )        |        |        | 84,841  |  
|                                                                          |                                                                                                                         |                                                                                 |                                           |                                                         |       |        |        |          |        |        |         |         
|Net (decrease) increase in cash and cash
    equivalents                  |                                                                                                                         |                                                                                 | 24,800                                    |                                                         |       |        | (1,467 | )        |        |        | (1,061  | )       
|Cash and cash equivalents at beginning of year                            |                                                                                                                         |                                                                                 | 14,929                                    |                                                         |       |        | 16,396 |          |        |        | 17,457  |         
|                                                                          |                                                                                                                         |                                                                                 |                                           |                                                         |       |        |        |          |        |        |         |         
|Cash and cash equivalents at end of year                                  |                                                                                                                         | $                                                                               | 39,729                                    |                                                         |       | $      | 14,929 |          |        | $      | 16,396  |         
|                                                                          |                                                                                                                         |                                                                                 |                                           |                                                         |       |        |        |          |        |        |         |         
|Supplemental schedule of non-cash investing and
    financing activities: |                                                                                                                         |                                                                                 |                                           |                                                         |       |        |        |          |        |        |         |         
|                                                                          | Issuance of common stock for acquisition of
    Knowledge Discovery One, Inc.                                           |                                                                                 | $                                         |                                                        |       |        | $      |         |        |        | $       | 117,815  |       
|                                                                          | Interest paid                                                                                                           |                                                                                 |                                           | 24                                                      |       |        |        | 88       |        |        |         | 160      |       

See accompanying notes to the consolidated
financial statements.

F-6



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##### 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
develops and markets software solutions that enable its
customers to interact more intelligently with their customers.
The Companys solutions integrate and analyze information
about customers, products and transaction activity to generate
specific actions its customers can take to improve their
marketing, selling, merchandising and advertising effectiveness,
leading to increased revenue, improved profit, decreased costs
and enhanced customer satisfaction. The Company combines its
software products with industry expertise and professional
services to create highly-focused, industry-specific solutions
that are designed to integrate with and add significant value to
existing custom or purchased customer relationship management,
or CRM, systems and processes.

The Company is 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, international expansion, 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 is 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.

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. 101, 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.

F-7



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##### Table of Contents



NET PERCEPTIONS, INC.


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Continued)

(in thousands, except per share
amounts)


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. 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 and four customers accounted for 31%, 24%, 14% and 11%
of accounts receivable at December 31, 2001. One customer
accounted for 11% of total 2000 revenues.

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, 2002, all

F-8



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##### Table of Contents



NET PERCEPTIONS, INC.


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Continued)

(in thousands, except per share
amounts)


of the Companys short-term investments and
marketable securities were classified as available-for-sale.
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 |        | Unrealized
|                                    |  | Cost |        | Fair Value |  | gains      |        | losses    
|                                    |  |      |        |            |  |            |        |           
|As of December 31, 2002:            |  |      |        |            |  |            |        |            |  |   |     |  |  |   |   | 
|Government agencies                 |  | $    | 17,258 |            |  | $          | 17,321 |            |  | $ | 63  |  |  | $ |  | 
|Corporate debt                      |  |      | 5,850  |            |  |            | 5,909  |            |  |   | 59  |  |  |   |  | 
|                                    |  |      |        |            |  |            |        |            |  |   |     |  |  |   |   | 
|                                    |  | $    | 23,108 |            |  | $          | 23,230 |            |  | $ | 122 |  |  | $ |  | 
|                                    |  |      |        |            |  |            |        |            |  |   |     |  |  |   |   | 
|As of December 31, 2001:            |  |      |        |            |  |            |        |            |  |   |     |  |  |   |   | 
|Government agencies                 |  | $    | 11,146 |            |  | $          | 11,165 |            |  | $ | 19  |  |  | $ |  | 
|State and local municipalities debt |  |      | 8,400  |            |  |            | 8,400  |            |  |   |    |  |  |   |  | 
|Corporate debt                      |  |      | 38,493 |            |  |            | 39,111 |            |  |   | 618 |  |  |   |  | 
|                                    |  |      |        |            |  |            |        |            |  |   |     |  |  |   |   | 
|                                    |  | $    | 58,039 |            |  | $          | 58,676 |            |  | $ | 637 |  |  | $ |  | 
|                                    |  |      |        |            |  |            |        |            |  |   |     |  |  |   |   | 

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,
2002 and 2001.

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.

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.

F-9



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##### Table of Contents



NET PERCEPTIONS, INC.


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Continued)

(in thousands, except per share
amounts)


Other assets

Other assets consist primarily of capital and
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
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 1, 10, and 87 shares at December 31,
2002, 2001 and 2000, 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 2,757, 3,719, and 3,452
shares of the Companys common stock were outstanding as of
December 31, 2002, 2001 and 2000, 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.

F-10



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##### Table of Contents



NET PERCEPTIONS, INC.


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Continued)

(in thousands, except per share
amounts)


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

In December 2002, the FASB issued
SFAS 148, Accounting for Stock-Based
compensationTransition and Disclosure, An amendment to
FASB Statement No. 123. The Company is choosing to
continue with its current practice of applying the recognition
and measurement principles of APB No. 25, Accounting
for Stock Issued to Employees. The Company has adopted the
disclosure requirements of SFAS No. 148 in its discussion
of stock based employee compensation but the alternative
transition options made available by the standard are not being
implemented.

The intrinsic value method is used to account for
stock-based compensation plans. If compensation expense had been
determined based on the fair value method, net loss and loss per
share would have been adjusted to the pro forma amounts
indicated below:

|                                                                                                                    |             |                         |         |       |   |      |          |       |   |   |         |       |  
|------------------------------------------------------------------------------------------------------------------- | ----------- | ----------------------- | ------- | ----- | - | ---- | -------- | ----- | - | - | ------- | ----- | -
|                                                                                                                    |             |                        
|                                                                                                                    |             | Year Ended December 31,
|                                                                                                                    |             |                        
|                                                                                                                    |             | 2002                    |         | 2001  |   | 2000
|                                                                                                                    |             |                         |         |       |   |     
|Net loss, as reported                                                                                               |             | $                       | (16,734 | )     |   | $    | (123,798 | )     |   | $ | (53,547 | )    
|Add: Stock-based employee compensation expense
    included in reported net loss                                    |             |                         | 54      |       |   |      | 230      |       |   |   | 1,052   |      
|Deduct: Total stock-based employee compensation
    expense determined under fair value based method for all awards |             |                         | (2,358  | )     |   |      | (4,254   | )     |   |   | (8,653  | )    
|                                                                                                                    |             |                         |         |       |   |      |          |       |   |   |         |      
|Pro forma net loss                                                                                                  |             | $                       | (19,038 | )     |   | $    | (127,822 | )     |   | $ | (61,148 | )    
|                                                                                                                    |             |                         |         |       |   |      |          |       |   |   |         |      
|Basic and diluted net loss per share:                                                                               |             |                         |         |       |   |      |          |       |   |   |         |      
|                                                                                                                    | As reported |                         | $       | (0.61 | ) |      | $        | (4.59 | ) |   | $       | (2.12 | )
|                                                                                                                    |             |                         |         |       |   |      |          |       |   |   |         |      
|                                                                                                                    | Pro forma   |                         | $       | (0.69 | ) |      | $        | (4.74 | ) |   | $       | (2.43 | )
|                                                                                                                    |             |                         |         |       |   |      |          |       |   |   |         |      

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 2002, 2001 and 2000,
respectively: dividend yield of 0% for option grants in all
years; risk-free interest rates of 3.9%, 4.6% and 6.1%; expected
lives of 5 years for option grants in all years; and
volatility factors of 70%, 97% and 90% (in the case of 2000, for
grants after the IPO). Volatility factors were not used for
periods prior to the IPO as this factor is not applicable to
non-public companies for these fair value calculations. The
weighted-average fair value of options granted during 2002, 2001
and 2000 using the Black-Scholes option-pricing model was $0.77,
$1.24 and $14.60 per share, respectively.

Recently issued accounting pronouncements

In June 2002, the Financial Accounting
Standards Board (FASB) issued SFAS No. 146,
Accounting for Exit or Disposal Activities. The new
statement addresses the accounting for costs

F-11



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##### Table of Contents



NET PERCEPTIONS, INC.


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Continued)

(in thousands, except per share
amounts)


associated with exit or disposal activities. The
provisions of the statement will be effective for disposal
activities initiated after December 31, 2002. The adoption
of this statement is not expected to have a material impact on
the Companys consolidated financial position, results of
operations or cash flows.

In November 2002, the FASB issued
Interpretation No. 45, Guarantors Accounting
and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others. This interpretation
elaborates on the disclosures to be made by a guarantor in its
interim and annual financial statements about its obligations
under certain guarantees that it has issued. It also clarifies
(for guarantees issued after January 1, 2003) that a
guarantor is required to recognize, at the inception of a
guarantee, a liability for the fair value of the obligations
undertaken in issuing the guarantee. This interpretation does
not have a material impact on the Companys consolidated
financial statements.

In January 2003, the FASB issued
Interpretation No. 46, Consolidation of Variable
Interest Entities. This interpretation addresses the
requirements for business enterprises to consolidate related
entities in which they are determined to be the primary
beneficiary as a result of their variable economic interest. The
interpretation is intended to provide guidance in judging
multiple economic interests in an entity and in determining the
primary beneficiary. The interpretation outlines disclosure
requirements for Variable Interest Entities in existence prior
to January 31, 2003, and outlines consolidation
requirements for Variable Interest Entities created after
January 31, 2003. This interpretation does not have a material
impact on the Companys consolidated financial statements.

In accordance with Emerging Issue Task Force
Issue No. 01-14, Income Statement Characterization of
Reimbursements Received for Out-of-Pocket Expenses
Incurred, the Company began to account for such items as
revenue and cost of revenue effective January 1, 2002.
Service revenues and cost of service revenues include $129 for
2002. Additionally, service revenues and cost of service
revenues of $351 and $841 for 2001 and 2000 respectively, have
been reclassified to conform to current period presentation.

3. Financial statement components

Certain balance sheet components consist of the
following:

Rollforward of the allowance for doubtful
accounts:

|                           |            |   |       |        |  
|-------------------------- | ---------- | - | ----- | ------ | -
|Balance December 31, 1999  |            | $ | 672   |       
|                           | Provision  |   |       | 2,073  |  
|                           | Write-offs |   |       | (1,289 | )
|                           | Recoveries |   |       | 138    |  
|                           |            |   |       |       
|Balance, December 31, 2000 |            |   | 1,594 |       
|                           | Provision  |   |       | 1,051  |  
|                           | Write-offs |   |       | (2,995 | )
|                           | Recoveries |   |       | 499    |  
|                           |            |   |       |       
|Balance, December 31, 2001 |            |   | 149   |       
|                           | Provision  |   |       | 79     |  
|                           | Write-offs |   |       | (151   | )
|                           | Recoveries |   |       | 8      |  
|                           |            |   |       |       
|Balance, December 31, 2002 |            | $ | 85    |       

F-12



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##### Table of Contents



NET PERCEPTIONS, INC.


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Continued)

(in thousands, except per share
amounts)


Property and equipment consist of the following:

|                                                |  |              |        |      |  |   |        |  
|----------------------------------------------- |  | ------------ | ------ | ---- |  | - | ------ | -
|                                                |  |             
|                                                |  | December 31,
|                                                |  |             
|                                                |  | 2002         |        | 2001
|                                                |  |              |        |     
|Computer hardware                               |  | $            | 3,719  |      |  | $ | 5,663  |  
|Leasehold improvements                          |  |              | 302    |      |  |   | 380    |  
|Purchased computer software                     |  |              | 603    |      |  |   | 1,369  |  
|Furniture, fixtures and equipment               |  |              | 1,088  |      |  |   | 1,216  |  
|                                                |  |              |        |      |  |   |        |  
|                                                |  |              | 5,712  |      |  |   | 8,628  |  
|Less: Accumulated depreciation and amortization |  |              | (4,616 | )    |  |   | (4,949 | )
|                                                |  |              |        |      |  |   |        |  
|                                                |  | $            | 1,096  |      |  | $ | 3,679  |  
|                                                |  |              |        |      |  |   |        |  

Depreciation and amortization expense was $1,940,
$3,434 and $3,415 for the years ended December 31, 2002,
2001 and 2000, respectively.

Accrued liabilities consist of the following:

|                                |  |              |       |      |  |   |       | 
|------------------------------- |  | ------------ | ----- | ---- |  | - | ----- | 
|                                |  |             
|                                |  | December 31,
|                                |  |             
|                                |  | 2002         |       | 2001
|                                |  |              |       |     
|Accrued wages and benefits      |  | $            | 614   |      |  | $ | 1,424 | 
|Accrued lease abandonment costs |  |              | 383   |      |  |   | 448   | 
|Other accrued expenses          |  |              | 856   |      |  |   | 1,343 | 
|                                |  |              |       |      |  |   |       | 
|                                |  | $            | 1,853 |      |  | $ | 3,215 | 
|                                |  |              |       |      |  |   |       | 

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
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, customer list, workforce and goodwill 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 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

F-13



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##### Table of Contents



NET PERCEPTIONS, INC.


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Continued)

(in thousands, except per share
amounts)


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 then recent revenue levels. 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 accordance with SFAS No. 142,
Goodwill and Other Intangible Assets, the Company
completed the transitional impairment test of goodwill as of
January 1, 2002 and 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 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 impairment occurred due to events and changes in
circumstances, which included lower than expected fourth quarter
revenues and a revised 2003 forecast. 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.

The following table presents the consolidated
results of operations for the year ended December 31, 2000
on an unaudited pro forma basis as if the acquisition of KD1 had
taken place at the beginning of the period presented:

|                   |  |                   |         |  
|------------------ |  | ----------------- | ------- | -
|                   |  | Year Ended       
|                   |  | December 31, 2000
|                   |  |                  
|                   |  | (unaudited)      
|Total revenues     |  | $                 | 37,052  |  
|Net loss           |  | $                 | (58,906 | )
|Net loss per share |  | $                 | (2.31   | )

The unaudited pro forma results of operations are
for comparative purposes only and do not necessarily reflect the
results that would have occurred had the acquisition occurred at
the beginning of the periods presented or the results which may
occur in the future.

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-14



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##### Table of Contents



NET PERCEPTIONS, INC.


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Continued)

(in thousands, except per share
amounts)


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,
|                                          |  |                        
|                                          |  | 2002                    |         | 2001 |  | 2000
|                                          |  |                         |         |      |  |     
|Reported net loss                         |  | $                       | (16,734 | )    |  | $    | (123,798 | ) |  | $ | (53,547 | )
|Addback: Goodwill amortization            |  |                         |        |      |  |      | 9,317    |   |  |   | 24,519  |  
|                                          |  |                         |         |      |  |      |          |   |  |   |         |  
|Adjusted net loss                         |  | $                       | (16,734 | )    |  | $    | (114,481 | ) |  | $ | (29,028 | )
|                                          |  |                         |         |      |  |      |          |   |  |   |         |  
|Basic and diluted earnings per
    share: |  |                         |         |      |  |      |          |   |  |   |         |  
|Reported net loss                         |  | $                       | (0.61   | )    |  | $    | (4.59    | ) |  | $ | (2.12   | )
|Goodwill amortization                     |  |                         |        |      |  |      | 0.34     |   |  |   | 0.97    |  
|                                          |  |                         |         |      |  |      |          |   |  |   |         |  
|Adjusted net loss                         |  | $                       | (0.61   | )    |  | $    | (4.25    | ) |  | $ | (1.15   | )
|                                          |  |                         |         |      |  |      |          |   |  |   |         |  

6. Restructuring related charges

During 2002 and 2001, the Company instituted
certain restructuring plans to better align its cost structure
with its business outlook and general economic conditions. The
Company recorded restructuring related charges totaling $15,551
in 2001 and $768 in 2002, 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.

A total of $8,118 was charged against the
restructuring reserve during 2001, lowering the accrued
restructuring liability to $7,433. These charges included $2,887
of non-cash leasehold write-offs, $2,908 of other non-cash fixed
assets write-offs, $1,523 in employee severance payments, $1,869
in rent payments, $301 of real estate broker fees and $258 in
other office consolidation expenses. These charges were
partially offset by the application of $1,087 in deferred rent
against the charge, $261 of proceeds on the sale of fixed assets
and $280 of sublease income.

A total of approximately $3,912 was charged
against the restructuring reserve during 2002, lowering the
accrued restructuring liability to $4,289. Charges against the
reserve during 2002 included $642 of non-cash fixed asset
write-offs, $547 in employee severance payments, $2,865 in rent
payments, $1,159 in costs relating to subletting facilities and
$66 in costs relating to facility closures. These charges were
partially offset by $1,299 of sublease income and $68 in
proceeds from the sale of fixed assets. In

F-15



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##### Table of Contents



NET PERCEPTIONS, INC.


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Continued)

(in thousands, except per share
amounts)


conjunction with the restructuring related
charges recorded, the Company made certain estimates regarding
future sublease income that have a significant impact on its
anticipated cash obligations. Although the Company believes that
the lease commitment estimates are appropriate in the current
circumstances, future changes in real estate markets could
impact the ultimate amount of cash paid to discharge these
obligations. As of December 31, 2002, we estimated total
future sublease income of $16,752 of which $13,918 is covered by
known sublease arrangements.

The following table presents a summary of our
real estate related contractual obligations as of
December 31, 2002:

|                                |  |      |       |      |  |      |       |           |  |       |       |  |  |   |        |  |  |   |        | 
|------------------------------- |  | ---- | ----- | ---- |  | ---- | ----- | --------- |  | ----- | ----- |  |  | - | ------ |  |  | - | ------ | 
|                                |  | 2003 |       | 2004 |  | 2005 |       | 2006-2010 |  | Total
|                                |  |      |       |      |  |      |       |           |  |      
|Operating leases                |  | $    | 4,187 |      |  | $    | 3,374 |           |  | $     | 3,168 |  |  | $ | 13,779 |  |  | $ | 24,508 | 
|Executed sublease agreements    |  |      | 2,482 |      |  |      | 1,956 |           |  |       | 1,671 |  |  |   | 7,809  |  |  |   | 13,918 | 
|                                |  |      |       |      |  |      |       |           |  |       |       |  |  |   |        |  |  |   |        | 
|Net contractual cash obligation |  | $    | 1,705 |      |  | $    | 1,418 |           |  | $     | 1,497 |  |  | $ | 5,970  |  |  | $ | 10,590 | 
|                                |  |      |       |      |  |      |       |           |  |       |       |  |  |   |        |  |  |   |        | 

The following table presents a summary of the
restructuring related activities and accrued restructuring
charges as of December 31, 2002:

|                                         |          |               |        |               |  |          |        |           |   |               |     |               |  |               |        |          |   |           |       |               |  |   |     |     |  |   |        |        |   |   |       |       |  |   |      |   |  |   |       |       | 
|---------------------------------------- | -------- | ------------- | ------ | ------------- |  | -------- | ------ | --------- | - | ------------- | --- | ------------- |  | ------------- | ------ | -------- | - | --------- | ----- | ------------- |  | - | --- | --- |  | - | ------ | ------ | - | - | ----- | ----- |  | - | ---- | - |  | - | ----- | ----- | 
|                                         |          |               |        |               |  | Sublease |        |           |   |               |     |               |  |               |        | Sublease |   |           |       |              
|                                         |          |               |        |               |  | Income   |        | Non-Cash  |   |               |     |               |  |               |        | Income   |   |           |       |              
|                                         |          |               |        |               |  | and      |        | Asset     |   |               |     |               |  |               |        | and      |   |           |       |              
|                                         |          | 2001          |        |               |  | Proceeds |        | Disposals |   |               |     |               |  |               |        | Proceeds |   |           |       |              
|                                         |          | Restructuring |        |               |  | from the |        | and       |   | Accrued       |     |               |  |               |        | from the |   |           |       | Accrued      
|                                         |          | Charges       |        |               |  | Sale of  |        | Deferred  |   | Restructuring |     |               |  |               |        | Sale of  |   | Non Cash  |       | Restructuring
|                                         |          | Net of        |        | Restructuring |  | Fixed    |        | Rent      |   | as of         |     | Restructuring |  | Restructuring |        | Fixed    |   | Asset     |       | as of        
|Description                              |          | Reversal      |        | Payments      |  | Assets   |        | Write-Off |   | Dec 31, 2001  |     | Charges       |  | Payments      |        | Assets   |   | Disposals |       | Dec 31, 2002 
|                                         |          |               |        |               |  |          |        |           |   |               |     |               |  |               |        |          |   |           |       |              
|Lease commitments and related items      |          | $             | 10,649 |               |  | $        | (2,233 | )         |   | $             | 280 |               |  | $             | (1,800 | )        |   | $         | 6,896 |               |  | $ |    |     |  | $ | (4,024 | )      |   | $ | 1,299 |       |  | $ |     |   |  | $ | 4,171 |      
|Employee Severance and termination costs |          |               | 1,634  |               |  |          | (1,523 | )         |   |               |    |               |  |               |       |          |   |           | 111   |               |  |   | 506 |     |  |   | (547   | )      |   |   |      |       |  |   |     |   |  |   | 70    |      
|                                         |          |               |        |               |  |          |        |           |   |               |     |               |  |               |        |          |   |           |       |               |  |   |     |     |  |   |        |        |   |   |       |       |  |   |      |   |  |   |       |      
|                                         | Subtotal |               |        | 12,283        |  |          |        | (3,756    | ) |               |     | 280           |  |               |        | (1,800   | ) |           |       | 7,007         |  |   |     | 506 |  |   |        | (4,571 | ) |   |       | 1,299 |  |   |      |  |  |   |       | 4,241 | 
|Fixed Asset Disposals and Other Costs    |          |               | 3,268  |               |  |          | (195   | )         |   |               | 261 |               |  |               | (2,908 | )        |   |           | 426   |               |  |   | 262 |     |  |   | (66    | )      |   |   | 68    |       |  |   | (642 | ) |  |   | 48    |      
|                                         |          |               |        |               |  |          |        |           |   |               |     |               |  |               |        |          |   |           |       |               |  |   |     |     |  |   |        |        |   |   |       |       |  |   |      |   |  |   |       |      
|                                         |          | $             | 15,551 |               |  | $        | (3,951 | )         |   | $             | 541 |               |  | $             | (4,708 | )        |   | $         | 7,433 |               |  | $ | 768 |     |  | $ | (4,637 | )      |   | $ | 1,367 |       |  | $ | (642 | ) |  | $ | 4,289 |      
|                                         |          |               |        |               |  |          |        |           |   |               |     |               |  |               |        |          |   |           |       |               |  |   |     |     |  |   |        |        |   |   |       |       |  |   |      |   |  |   |       |      

7. Income taxes

For income tax purposes, the Company has
available federal net operating loss carry-forwards of
approximately $107,400 and research and development credit
carry-forwards of $146 at December 31, 2002. The net
operating loss and research and development credit
carry-forwards expire in 2011 through 2022 if not previously
utilized. The utilization of these carry-forwards may be subject
to limitations based on 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.

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##### Table of Contents



NET PERCEPTIONS, INC.


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Continued)

(in thousands, except per share
amounts)


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,                   
|                     |                                                |                                
|                     |                                                | 2002                            |         | 2001  
|                     |                                                |                                 |         |       
|Deferred tax assets: |                                                |                                 |         |        |        |  |         |       
|                     | Net operating loss carry-forwards              |                                 | $       | 39,791 |        |  | $       | 32,646 |       
|                     | Restructuring related costs                    |                                 |         | 2,109  |        |  |         | 5,530  |       
|                     | Research and development credit carry-forwards |                                 |         | 146    |        |  |         | 195    |       
|                     | Accrued vacation and other current liabilities |                                 |         | 1,355  |        |  |         | 403    |       
|                     | Accounts receivable allowance                  |                                 |         | 33     |        |  |         | 58     |       
|                     |                                                |                                 |         |        |        |  |         |       
|                     |                                                | Total deferred tax assets       |         |        | 43,434 |  |         |        | 38,832 | 
|Valuation allowance  |                                                |                                 | (43,434 | )      |        |  | (38,832 | )     
|                     |                                                |                                 |         |        |        |  |         |       
|                     |                                                | Total net deferred income taxes |         | $      |       |  |         | $      |       | 
|                     |                                                |                                 |         |        |        |  |         |       

8. Long-term liabilities

Long-term liabilities consist of the following:

|                      |  |              |     |      |  |   |     |  
|--------------------- |  | ------------ | --- | ---- |  | - | --- | -
|                      |  |             
|                      |  | December 31,
|                      |  |             
|                      |  | 2002         |     | 2001
|                      |  |              |     |     
|Capital leases        |  | $            |    |      |  | $ | 97  |  
|Deferred rent         |  |              | 510 |      |  |   | 577 |  
|                      |  |              |     |      |  |   |     |  
|                      |  |              | 510 |      |  |   | 674 |  
|Less: Current portion |  |              |    |      |  |   | (97 | )
|                      |  |              |     |      |  |   |     |  
|                      |  | $            | 510 |      |  | $ | 577 |  
|                      |  |              |     |      |  |   |     |  

Capital leases

The Company has maintained lease lines of credit
with leasing companies for the acquisition of property and
equipment under capital lease arrangements. The lease lines of
credit expired on December 31, 1999. As of
December 31, 2002, the Company had no material long-term
commitments for capital expenditures.

9. Stockholders equity

The Company is authorized to issue two classes of
stock designated as common and preferred. As of
December 31, 2002, 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. The
Company has completed two public stock offerings. In
March 2000, the Company completed a follow-on public stock
offering, selling 2,000 shares of common stock at a price
of $45.25 per share, raising a total of $84,647 in net proceeds
after payment of underwriting discounts, commissions and
offering expenses. In April and May 1999, the Company
completed an initial public offering (IPO), selling
4,198 shares of common stock at a price of $14 per share,
including 548 shares sold pursuant to the exercise of an
over-allotment option, raising a total of $53,213 in net
proceeds after payment of underwriting discounts, commissions
and offering expenses.

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##### Table of Contents



NET PERCEPTIONS, INC.


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Continued)

(in thousands, except per share
amounts)


Preferred stock

There was no preferred stock outstanding at
December 31, 2002 or December 31, 2001.

Common stock

Total shares of common stock outstanding at
December 31, 2002 were 27,332, of which 1 are subject to a
repurchase option, which is at the Companys discretion, at
the original sale price in the event the employee holding the
shares terminates employment with the Company. The
Companys repurchase option will expire with respect to
these shares on or before September 8, 2003 (but will lapse
in the event of an earlier change in control).

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 not less than 85% of 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 grant under the 2000 Plan was 396 at December 31,
2002. 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
2002, 215 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
1,356 and 1,344 shares in 2002 and 2001, respectively. The total
number of options available for future grant under the 1999 Plan
was 2,424 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 2002, 2001
and 2000, respectively. As of December 31, 2002, 205
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

F-18



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##### Table of Contents



NET PERCEPTIONS, INC.


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Continued)

(in thousands, except per share
amounts)


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.

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 $42, $173, and $625 in fiscal
years 2002, 2001 and 2000, respectively.

Stock compensation expense related to accelerated
vesting of stock options was $12 and $42 in 2002 and 2001,
respectively. In 2001, the Company recognized $15 of other stock
compensation expense.

Stock compensation expense recorded in the
functional expense categories within operating expenses in 2002,
2001 and 2000, was allocated as follows:

|                           |  |      |    |      |  |      |     |  |  |   |       | 
|-------------------------- |  | ---- | -- | ---- |  | ---- | --- |  |  | - | ----- | 
|                           |  | 2002 |    | 2001 |  | 2000
|                           |  |      |    |      |  |     
|Sales and marketing        |  | $    | 24 |      |  | $    | 39  |  |  | $ | 516   | 
|Research and development   |  |      | 8  |      |  |      | 154 |  |  |   | 459   | 
|General and administrative |  |      | 10 |      |  |      | 37  |  |  |   | 77    | 
|Restructuring              |  |      | 12 |      |  |      | 0   |  |  |   | 0     | 
|                           |  |      |    |      |  |      |     |  |  |   |       | 
|                           |  | $    | 54 |      |  | $    | 230 |  |  | $ | 1,052 | 
|                           |  |      |    |      |  |      |     |  |  |   |       | 

A summary of activity of the Companys stock
option plans is presented below:

|                                 |  |                           |        |          |  |        |      |          |  |        |        |          |  |   |       |  |  |  |        |   |  |   |       | 
|-------------------------------- |  | ------------------------- | ------ | -------- |  | ------ | ---- | -------- |  | ------ | ------ | -------- |  | - | ----- |  |  |  | ------ | - |  | - | ----- | 
|                                 |  |                          
|                                 |  | Years Ending December 31,
|                                 |  |                          
|                                 |  |                           |        |          |  |       
|                                 |  | 2002                      |        | 2001     |  | 2000  
|                                 |  |                           |        |          |  |       
|                                 |  |                           |        | Weighted |  |        |      | Weighted |  |        |        | Weighted
|                                 |  |                           |        | Average  |  |        |      | Average  |  |        |        | Average 
|                                 |  |                           |        | Exercise |  |        |      | Exercise |  |        |        | Exercise
|                                 |  | Shares                    |        | Price    |  | Shares |      | Price    |  | Shares |        | Price   
|                                 |  |                           |        |          |  |        |      |          |  |        |        |         
|Outstanding at beginning of year |  |                           | 3,719  |          |  | $      | 4.97 |          |  |        | 3,452  |          |  | $ | 14.16 |  |  |  | 2,549  |   |  | $ | 8.04  | 
|Granted                          |  |                           | 275    |          |  |        | 1.37 |          |  |        | 2,846  |          |  |   | 1.40  |  |  |  | 2,759  |   |  |   | 19.97 | 
|KD1 options assumed              |  |                           |       |          |  |        |     |          |  |        |       |          |  |   |      |  |  |  | 266    |   |  |   | 2.31  | 
|Exercised                        |  |                           | (136   | )        |  |        | .47  |          |  |        | (115   | )        |  |   | .53   |  |  |  | (765   | ) |  |   | 1.02  | 
|Canceled                         |  |                           | (1,101 | )        |  |        | 8.91 |          |  |        | (2,464 | )        |  |   | 13.74 |  |  |  | (1,357 | ) |  |   | 19.49 | 
|                                 |  |                           |        |          |  |        |      |          |  |        |        |          |  |   |       |  |  |  |        |   |  |   |       | 
|Outstanding at end of year       |  |                           | 2,757  |          |  | $      | 3.26 |          |  |        | 3,719  |          |  | $ | 4.97  |  |  |  | 3,452  |   |  | $ | 14.16 | 
|                                 |  |                           |        |          |  |        |      |          |  |        |        |          |  |   |       |  |  |  |        |   |  |   |       | 

F-19



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##### Table of Contents



NET PERCEPTIONS, INC.


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Continued)

(in thousands, except per share
amounts)


The following table summarizes information about
fixed-price stock options outstanding at December 31, 2002:

|                |  |                     |       |                     |  |                  |      |        |  |                  |       |  |  |  |       |  |  |   |       | 
|--------------- |  | ------------------- | ----- | ------------------- |  | ---------------- | ---- | ------ |  | ---------------- | ----- |  |  |  | ----- |  |  | - | ----- | 
|                |  |                     |       |                    
|                |  | Options Outstanding |       | Options Exercisable
|                |  |                     |       |                    
|                |  |                     |       | Weighted-Average    |  |                  |      |       
|Range Of        |  |                     |       | Remaining           |  | Weighted-Average |      |        |  | Weighted-Average
|Exercise Prices |  | Shares              |       | Contractual Life    |  | Exercise Price   |      | Shares |  | Exercise Price  
|                |  |                     |       |                     |  |                  |      |        |  |                 
|$0.13   $1.08  |  |                     | 148   |                     |  |                  | 6.16 |        |  | $                | 0.80  |  |  |  | 133   |  |  | $ | 0.78  | 
|$1.09   $1.09  |  |                     | 358   |                     |  |                  | 8.24 |        |  | $                | 1.09  |  |  |  | 224   |  |  | $ | 1.09  | 
|$1.10   $1.10  |  |                     | 379   |                     |  |                  | 8.82 |        |  | $                | 1.10  |  |  |  | 117   |  |  | $ | 1.10  | 
|$1.12   $1.19  |  |                     | 206   |                     |  |                  | 8.58 |        |  | $                | 1.15  |  |  |  | 123   |  |  | $ | 1.16  | 
|$1.40   $1.40  |  |                     | 300   |                     |  |                  | 8.58 |        |  | $                | 1.40  |  |  |  | 100   |  |  | $ | 1.40  | 
|$1.46   $1.53  |  |                     | 77    |                     |  |                  | 9.20 |        |  | $                | 1.49  |  |  |  | 15    |  |  | $ | 1.46  | 
|$1.72   $1.72  |  |                     | 750   |                     |  |                  | 8.39 |        |  | $                | 1.72  |  |  |  | 297   |  |  | $ | 1.72  | 
|$1.75   $5.50  |  |                     | 344   |                     |  |                  | 7.50 |        |  | $                | 3.62  |  |  |  | 242   |  |  | $ | 3.76  | 
|$12.06  $50.00 |  |                     | 195   |                     |  |                  | 7.02 |        |  | $                | 24.27 |  |  |  | 156   |  |  | $ | 23.60 | 
|                |  |                     |       |                     |  |                  |      |        |  |                  |       |  |  |  |       |  |  |   |       | 
|                |  |                     | 2,757 |                     |  |                  | 8.16 |        |  | $                | 3.26  |  |  |  | 1,407 |  |  | $ | 4.19  | 
|                |  |                     |       |                     |  |                  |      |        |  |                  |       |  |  |  |       |  |  |   |       | 

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 is, 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 2002, 2001 and 440 in 2000. As of
December 31, 2002, 1,568 shares were available for future
purchase under the Employee Stock Purchase Plan. During 2002,
2001 and 2000, 68, 146 and 216 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 14, 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,

F-20



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##### Table of Contents



NET PERCEPTIONS, INC.


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Continued)

(in thousands, except per share
amounts)


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.

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.

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
subleased a significant portion of its office space and is
actively seeking to sublease remaining excess space. However,
the Company remains obligated under these lease agreements.
Minimum future lease payments due under the agreements are as
follows:

|                         |  |   |        | 
|------------------------ |  | - | ------ | 
|Year Ending December 31, |  |  
|                         |  |  
|2003                     |  | $ | 4,187  | 
|2004                     |  |   | 3,374  | 
|2005                     |  |   | 3,168  | 
|2006                     |  |   | 2,930  | 
|2007                     |  |   | 2,973  | 
|2008 and after           |  |   | 7,876  | 
|                         |  |   |        | 
|                         |  | $ | 24,508 | 
|                         |  |   |        | 

Under the terms of existing sublease agreements,
the Company expects to receive sublease payments of $2,482,
$1,956, $1,671, $1,671, $1,693 and $4,445 in 2003, 2004, 2005,
2006, 2007 and 2008 and thereafter, respectively. However, there
is a risk that one or more of the subtenants may breach the
terms of the sublease agreements and the Company may not receive
all of the expected payments.

Rent expense totaled $720, $1,709, and $2,333 for
the years ended December 31, 2002, 2001 and 2000, respectively.

Contingencies

On or about 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 IPO, several other
underwriters who participated in the Companys IPO, Steven
J. Snyder, the Companys then president and chief executive
officer, and Thomas M. Donnelly, the Companys chief
operating officer and chief financial officer. The suit
generally alleges that the defendants violated federal
securities laws

F-21



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##### Table of Contents



NET PERCEPTIONS, INC.


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Continued)

(in thousands, except per share
amounts)


by not disclosing certain actions taken by the
underwriter defendants in connection with the IPO. The suit
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 the Companys
initial public offering by requiring their customers, in
exchange for receiving allocations of shares of common stock
sold in the Companys initial public offering, to pay
excessive commissions on transactions in other securities and 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. The suit 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, through
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 and the case may proceed to discovery.

Management believes that the allegations against
the Company are without merit, and the Company intends to
vigorously defend against the plaintiffs claims. As this
litigation is in an initial stage, management is unable to
predict its outcome or its ultimate effect, if any, on the
Companys financial condition.

12. 401(k) plan

The Company has a 401(k) employee retirement plan
under which eligible employees may contribute up to 20% of their
annual compensation, subject to certain limitations. Employees
vest immediately in their contributions and earnings thereon.
The plan allows for, but does not require, the Company to match
employee contributions. The Company has not made any such
matching contributions.

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 14%, 20% and 22% of total revenues in 2002, 2001
and 2000 respectively. International sales to customers in any
one individual foreign country did not exceed 10% of total
revenues in 2002, 2001 or 2000.

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

F-22



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##### Table of Contents



NET PERCEPTIONS, INC.


NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Continued)

(in thousands, except per share
amounts)


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, 2002, the
balance of $107 is included in prepaid expenses and other
current assets.

F-23



---



##### 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/ DONALD C. PETERSON

| |                                      
| | -------------------------------------
| |                                      
| | Donald C. Peterson                   
| | President and Chief Executive Officer

Date: March 26, 2003

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 March 26, 2003.

|                                         |  |                                                                                                                                      
|---------------------------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------
|Signature                                |  | Title                                                                                                                                
|                                         |  |                                                                                                                                      
|/s/ DONALD C. PETERSONDonald C. Peterson |  | President, Chief Executive Officer, and Director
    (Principal Executive Officer)                                                   
|                                        
|/s/ THOMAS M. DONNELLYThomas M. Donnelly |  | Chief Operating Officer, Chief Financial Officer
    and Secretary (Principal Financial Officer and Principal
    Accounting Officer)
|                                        
|/s/ JOHN T. RIEDLJohn T. Riedl           |  | Director                                                                                                                             
|                                        
|/s/ JOHN F. KENNEDYJohn F. Kennedy       |  | Director                                                                                                                             
|                                        
|/s/ WILLIAM LANSINGWilliam Lansing       |  | Director                                                                                                                             
|                                        
|/s/ ANN L. WINBLADAnn L. Winblad         |  | Director                                                                                                                             



---



##### Table of Contents



CERTIFICATIONS

I, Donald C. Peterson, certify that:

1. I have reviewed this annual report on
Form 10-K of Net Perceptions, Inc.;

2. Based on my knowledge, this annual report
does not contain any untrue statement of a material fact or omit
to state a material fact necessary to make the statements made,
in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this
annual report;

3. Based on my knowledge, the financial
statements, and other financial information included in this
annual report, fairly present in all material respects the
financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual
report;

4. The registrants other certifying
officer and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and have:



| |                                                                                                                                                                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a) Designed such disclosure controls and
    procedures to ensure that material information relating to the
    registrant, including its consolidated subsidiaries, is made
    known to us by others within those entities, particularly during
    the period in which this annual report is being prepared;
|
| | b) Evaluated the effectiveness of the
    registrants disclosure controls and procedures as of a
    date within 90 days prior to the filing date of this annual
    report (the Evaluation Date); and                                                                                                      
|
| | c) Presented in this annual report our
    conclusions about the effectiveness of the disclosure controls
    and procedures based on our evaluation as of the Evaluation Date;                                                                                                                                

5. The registrants other certifying
officer and I have disclosed, based on our most recent
evaluation, to the registrants auditors and the audit
committee of registrants Board of Directors (or persons
performing the equivalent functions):



| |                                                                                                                                                                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a) All significant deficiencies in the
    design or operation of internal controls which could adversely
    affect the registrants ability to record, process,
    summarize and report financial data and have identified for the
    registrants auditors any material weaknesses in internal
    controls; and
|
| | b) Any fraud, whether or not material, that
    involves management or other employees who have a significant
    role in the registrants internal controls; and                                                                                                                                                    

6. The registrants other certifying
officer and I have indicated in this annual report whether there
were significant changes in internal controls or in other
factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies
and material weaknesses.



| |                        
| | -----------------------
| | /s/ DONALD C. PETERSON 
| |                        
| | Donald C. Peterson     
| | Chief Executive Officer

Date: March 26, 2003



---



##### Table of Contents



I, Thomas M. Donnelly, certify that:

1. I have reviewed this annual report on
Form 10-K of Net Perceptions, Inc.;

2. Based on my knowledge, this annual report
does not contain any untrue statement of a material fact or omit
to state a material fact necessary to make the statements made,
in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this
annual report;

3. Based on my knowledge, the financial
statements, and other financial information included in this
annual report, fairly present in all material respects the
financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual
report;

4. The registrants other certifying
officer and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and have:



| |                                                                                                                                                                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a) Designed such disclosure controls and
    procedures to ensure that material information relating to the
    registrant, including its consolidated subsidiaries, is made
    known to us by others within those entities, particularly during
    the period in which this annual report is being prepared;
|
| | b) Evaluated the effectiveness of the
    registrants disclosure controls and procedures as of a
    date within 90 days prior to the filing date of this annual
    report (the Evaluation Date); and                                                                                                      
|
| | c) Presented in this annual report our
    conclusions about the effectiveness of the disclosure controls
    and procedures based on our evaluation as of the Evaluation Date;                                                                                                                                

5. The registrants other certifying
officer and I have disclosed, based on our most recent
evaluation, to the registrants auditors and the audit
committee of registrants Board of Directors (or persons
performing the equivalent functions):



| |                                                                                                                                                                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a) All significant deficiencies in the
    design or operation of internal controls which could adversely
    affect the registrants ability to record, process,
    summarize and report financial data and have identified for the
    registrants auditors any material weaknesses in internal
    controls; and
|
| | b) Any fraud, whether or not material, that
    involves management or other employees who have a significant
    role in the registrants internal controls; and                                                                                                                                                    

6. The registrants other certifying
officer and I have indicated in this annual report whether there
were significant changes in internal controls or in other
factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies
and material weaknesses.



| |                        
| | -----------------------
| | /s/ THOMAS M. DONNELLY 
| |                        
| | Thomas M. Donnelly     
| | Chief Financial Officer

Date: March 26, 2003



---



##### Table of Contents



EXHIBIT INDEX

|        |        |             |  |                                                                                                                                                                                
|------- | ------ | ----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |        |            
|Number  |        | Description
|        |        |            
|        | 3.1(a) |             |  | Amended and Restated Certificate of
    Incorporation(1).                                                                                                                      
|        | 3.1(b) |             |  | Certificate of Amendment to the Amended and
    Restated Certificate of Incorporation(2).                                                                                      
|        | 3.2    |             |  | Amended and Restated Bylaws as amended through
    April 18, 2001(4).                                                                                                          
|        | 4.1    |             |  | Amended and Restated Investor Rights Agreement,
    dated December 18, 1997, among Net Perceptions, Inc. and
    the investors and founders named therein, as amended(1).      
|        | 4.2    |             |  | Specimen common stock certificate(1).                                                                                                                                          
|        | 4.3    |             |  | Specimen common stock certificate (including
    Rights Agreement Legend)(5).                                                                                                  
|        | 4.4    |             |  | Rights Agreement between Net Perceptions, Inc.
    and Wells Fargo Bank Minnesota, as Rights Agent(6).                                                                         
|        | 4.5    |             |  | Form of Certificate of Designation of
    Series A Junior Participating Preferred Stock (attached as
    Exhibit A to the Rights Agreement filed as Exhibit 4.4
    hereto)(6).
|        | 4.6    |             |  | 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(1).                                                            
|        | 10.2*  |             |  | 1996 Stock Plan(1).                                                                                                                                                            
|        | 10.3*  |             |  | 1999 Equity Incentive Plan(1).                                                                                                                                                 
|        | 10.4*  |             |  | Amended and Restated 1999 Non-Employee Director
    Option Plan, as amended through April 2, 2001(4).                                                                          
|        | 10.5*  |             |  | Employee Stock Purchase Plan(1).                                                                                                                                               
|        | 10.6*  |             |  | Knowledge Discovery One, Inc. 1996 Stock
    Option/Stock Issuance Plan(7).                                                                                                    
|        | 10.7   |             |  | Office Lease Agreement between DRF Holding LLC
    and Net Perceptions, Inc. dated April 5, 2000(8).                                                                           
|        | 10.8*  |             |  | 2000 Stock Plan(3).                                                                                                                                                            
|        | 10.9*  |             |  | Change in Control Severance Plan and Summary Plan
    Description(1).                                                                                                          
|        | 10.10* |             |  | Employment Agreement, dated as of May 24, 2001,
    between Net Perceptions, Inc. and Donald C. Peterson(5).                                                                   
|        | 10.11* |             |  | Severance Agreement, dated as of November 9,
    2001, between Net Perceptions, Inc. and Thomas M.
    Donnelly(9).                                                            
|        | 21.1   |             |  | List of Subsidiaries(9).                                                                                                                                                       
|        | 23.1   |             |  | Consent of PricewaterhouseCoopers LLP,
    independent accountants.                                                                                                            
|        | 99.1   |             |  | Certification of the Chief Executive Officer
    pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
    Section 906 of the Sarbanes-Oxley Act of 2002.                 
|        | 99.2   |             |  | Certification of the Chief Financial Officer
    pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
    Section 906 of the Sarbanes-Oxley Act of 2002.                 




*     Represents a
management contract or compensatory plan or arrangement.




|    |                                                                                                                       
|--- | ----------------------------------------------------------------------------------------------------------------------
|(1) | Incorporated by reference to Net
    Perceptions Registration Statement on Form S-1
    (Registration No. 333-71919).



---



##### Table of Contents





|    |                                                                                                                                                                                                                          
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(2) | Filed solely to correct a typographical error in
    the same exhibit, previously filed as an exhibit to Net
    Perceptions Quarterly Report on Form 10-Q for the
    Quarter ended June 30, 2000 (File No. 000-25781).
|   
|(3) | Incorporated by reference to Net
    Perceptions Quarterly Report on Form 10-Q for the
    Quarter Ended June 30, 2000 (File No. 000-25781).                                                                            
|   
|(4) | Incorporated by reference to Net
    Perceptions Quarterly Report on Form 10-Q for the
    Quarter Ended March 31, 2001 (File No. 000-25781).                                                                           
|   
|(5) | Incorporated by reference to Net
    Perceptions Quarterly Report on Form 10-Q for the
    Quarter Ended June 30, 2001 (File No. 000-25781).                                                                            
|   
|(6) | Incorporated by reference to Net
    Perceptions Registration Statement on Form 8-A filed
    June 6, 2001 (File No. 000-25781).                                                                                        
|   
|(7) | Incorporated by reference to Net
    Perceptions Registration Statement on Form S-1
    (Registration No. 333-31230).                                                                                                   
|   
|(8) | Incorporated by reference to Net
    Perceptions Quarterly Report on Form 10-Q for the
    Quarter Ended March 31, 2000 (File No. 000-25781).                                                                           
|   
|(9) | Incorporated by reference to Net
    Perceptions Annual Report on Form 10-K for the Fiscal
    Year Ended December 31, 2001 (File No. 000-25781).