10-K405/A 1 j8812601e10-k405a.txt FREEMARKETS, INC. AMENDMENT NO. 2 1 -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K/A AMENDMENT NO. 2 FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO COMMISSION FILE NUMBER 000-27913 FREEMARKETS, INC. (Exact Name of Registrant as Specified in its Charter) DELAWARE 04-3265483 (State or Other Jurisdiction of Incorporation or Organization) (I.R.S. Employer Identification No.) FREEMARKETS CENTER 210 SIXTH AVENUE PITTSBURGH, PA 15222 (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code: (412) 434-0500 Securities registered pursuant to Section 12(b) of the Act: Title of Each Class Name of Each Exchange on Which Registered ----------------- ------------------------------------------ NONE NOT APPLICABLE
Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, PAR VALUE $.01 PER SHARE (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of voting common stock held by non-affiliates of the registrant as of March 1, 2001 (based upon the last reported sale price of such stock as reported by The Nasdaq National Market on such date) was $635,207,401 (calculated by excluding shares owned beneficially by directors and executive officers as a group from total outstanding shares solely for the purpose of this response). The number of shares of the registrant's common stock outstanding as of the close of business on March 1, 2001 was 39,070,187. DOCUMENTS INCORPORATED BY REFERENCE None. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 2 INTRODUCTORY NOTE For purposes of this Form 10-K/A (Amendment No. 2), we have amended and restated in their entirety Parts I, II and IV of the Form 10-K for the year ended December 31, 2000 that was filed on February 23, 2001 (the "Original 10-K"). Amendment No. 2 reflects the reissuance of our consolidated financial statements as of December 31, 2000 and for the year then ended and comments of the staff of the Securities and Exchange Commission on the Original 10-K during its review of our Registration Statement on Form S-4 filed in connection with our proposed acquisition of Adexa, Inc. Form 10-K/A (Amendment No. 1) was filed on April 30, 2001 to provide on a timely basis the information required by Part III of Form 10-K. 3 PART I ITEM 1. BUSINESS Certain statements contained in this Annual Report on Form 10-K ("Form 10-K") constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different than any expressed or implied by these forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as "may," "will," "should," "expects," "plans," "anticipates," "believes," "estimates," "predicts," "potential," "continue," or the negative of these terms or other comparable terminology. Please refer to the risk factors set forth in the section entitled "Additional Factors that May Affect Future Results", as well as to our other filings with the Securities and Exchange Commission (the "SEC") and to the factors discussed elsewhere in this Form 10-K for a description of some of the risk factors that could cause our results to differ materially from our forward-looking statements. OVERVIEW FreeMarkets creates business-to-business online auctions and provides electronic commerce technology and services to buyers of industrial parts, raw materials, commodities and services. We have created more than 9,200 online auctions--which we call "markets"--for more than $14 billion worth of goods and services for our customers. We estimate, based upon the difference between the prices that our customers have historically paid and the lowest prices that are identified in our auctions, that our auctions have resulted in potential savings of over $2.7 billion for our customers. We combine our proprietary technology platform with an in-depth knowledge of the supply markets for direct materials, which are the industrial parts and raw materials that are incorporated into finished products by manufacturing companies. Because direct materials are often custom-made to buyers' specifications, there are no catalogs or price lists to enable buyers to make price comparisons. The purchasing process is further complicated by the fragmentation of many supply markets and the importance of product quality in supplier selection. Because this complexity leads to market inefficiencies, we think that buyers of direct materials often pay prices that are too high. Our online markets help buyers of direct materials obtain lower prices and make better purchasing decisions. In a FreeMarkets online market, suppliers from around the world can submit bids in a real-time, interactive competition that is designed to be fair to all participants. We offer customers our FullSource solution, in which we help the customer to identify and screen suppliers and to assemble a request for quotation that provides detailed, clear and consistent information for suppliers to use as a basis for their competitive bids. We also offer our QuickSource solution, which enables customers to use our technology to run their own online markets. In addition, we operate the FreeMarkets Asset Exchange for buyers and sellers of surplus assets and inventory. RECENT EVENTS On February 7, 2001, we entered into a definitive merger agreement to acquire Adexa, Inc., a leading provider of software products that enable collaborative commerce. Under the merger agreement, we will issue up to 17,250,000 shares of our common stock and options in exchange for all outstanding equity interests of Adexa. We expect the merger to close in the second quarter of 2001. We have filed with the SEC a Registration Statement on Form S-4 relating to the issuance of FreeMarkets common stock in connection with the proposed merger. Please refer to the risk factors set forth in this Form 10-K and in the Form S-4 for risks that could cause the merger not to occur or that could cause the benefits that we expect to gain from the merger not to be realized. As part of its review of our Form S-4, the staff of the SEC raised questions with respect to the classification of certain revenues in our financial statements included in the Original 10-K. Following discussions with the staff of the SEC, we have reissued our consolidated financial statements as of December 31, 2000 and for the year then ended. This reissuance relates to the classification of the fees we earn under a contract with Visteon Corporation ("Visteon") pursuant to which we provide access to our 4 eMarketplace and perform services for Visteon and Visteon pays us fixed monthly fees plus variable fees if specified volume thresholds are exceeded. Because we granted a warrant to Visteon which was valued at $95.5 million at the time we entered into the service contract, we are required to exclude from our revenues the fees we earn from Visteon, and to allocate those fees as payment for the warrant. A description of the reclassification of the fees we earn from Visteon is included in Note 3 of the Notes to Consolidated Financial Statements. In early April 2001, we closed our Austin, Texas office, formerly the headquarters of our subsidiary iMark.com, Inc. which was acquired in March 2000, and relocated our asset recovery division to Pittsburgh, Pennsylvania. As a result of the closing of the Austin office, we will record a restructuring charge of approximately $3 million to $4 million in the second quarter of 2001 relating to lease termination costs, employee severance costs and the non-cash write-off of assets. INDUSTRY BACKGROUND GROWTH OF BUSINESS-TO-BUSINESS ELECTRONIC COMMERCE The Internet is one of the fastest-growing means of communication, globally reaching consumers and businesses. As the number of Internet users has grown, businesses have increasingly recognized the power of the Internet to streamline complex processes, lower costs and improve efficiency. Forrester Research has projected that the market for business-to-business electronic commerce will grow to $2.7 trillion in 2004, and that 53% of this Internet trade will flow through online marketplaces. As businesses increasingly use the Internet to communicate with their trading partners, the demand for online marketplaces and Internet-based procurement solutions should increase. International Data Corporation has projected that the market for Internet-based electronic procurement applications will grow from $1.7 billion in 2000 to almost $9 billion in 2004, and Forrester projects that $1.4 trillion will flow through online markets in 2004. Many Internet-based electronic procurement applications and online markets have focused on automating the process for the purchase of standard supplies that are used to operate a business, such as office supplies. While these applications have proven useful, they do not effectively address the needs of manufacturers who purchase direct materials, which are the industrial parts, raw materials and commodities that are incorporated into finished products. INEFFICIENCIES OF SUPPLY MARKETS FOR DIRECT MATERIALS Based on industry research and government statistics, we estimate that manufacturers worldwide purchase approximately $5 trillion of direct materials each year. Due to inefficiencies in the markets that supply these materials, we think that buyers often pay prices that are too high or have difficulties identifying appropriate suppliers. We believe that these inefficiencies result in part from the following factors: - CUSTOM-MADE PRODUCTS HAVE NO STANDARD PRICES. Direct materials are often custom-made or adapted to a buyer's specifications. Because these materials are typically not standardized, they ordinarily cannot be ordered from catalogs at list prices. Without catalogs or list prices, buyers cannot easily obtain comparative price information. - QUALITY CAN BE AS IMPORTANT AS PRICE. Because manufacturers use direct materials as components in finished products, quality is critical. There is often little standardized information on direct material quality. As a result, when selecting suppliers, buyers frequently must spend significant effort compiling their own information to compare quality as well as price. - SUPPLY MARKETS ARE FRAGMENTED. Supply markets for direct materials often contain hundreds of potential suppliers. This fragmentation makes it difficult for buyers to understand the entire supply market for the products they are buying and to evaluate and select potential new suppliers. The need for customization, the importance of quality and the fragmentation of supply markets complicate the process by which buyers purchase direct materials. This complexity often leads buyers to rely on suppliers with whom they have dealt in the past, making it difficult for new suppliers to compete for 2 5 business. Because these factors limit competition among suppliers, buyers may pay higher prices or obtain lower quality than they would in a more efficient market with better information and more readily available alternative sources of supply. We believe that neither software applications or other technology, nor services alone can provide an adequate solution for buyers of direct materials. Rather, we think that the creation of an efficient market for these materials requires a solution that combines Internet technology with information and services that satisfy buyers' needs. THE FREEMARKETS SOLUTION We combine our proprietary Internet technology platform with our in-depth knowledge of supply markets to help industrial buyers obtain lower prices and make better purchasing decisions. In our marketplace, multiple suppliers from around the world can submit bids for a buyer's purchase order in a real-time, interactive competition. Our markets, in contrast to those designed for sellers, feature "downward price" dynamic bidding in which suppliers continue to lower their prices until the market is closed. In our FullSource and DirectSource offerings, we work with our customers, using our proprietary FreeMarkets Desktop and BidWare technology, to identify and screen suppliers and to assemble a request for quotation that provides detailed, clear and consistent information for suppliers to use as a basis for their competitive bids. This service, which we call "market making," creates a custom market for the goods or services being purchased by our customers. In our QuickSource offering, which is appropriate for less complex sourcing, our customers create their own markets, using our hosted application but not our market making services. Our solution provides: - SUBSTANTIAL SAVINGS. Our online markets can deliver substantial savings to our customers. Depending upon the nature of the direct materials or services being bid, savings typically range from a few percentage points on purchases of commodities to more than 25% on purchases of custom industrial components, with even greater savings at times. Customers often begin to save with the first market we create. - ROBUST INTERACTIVE TECHNOLOGY. Our BidWare Internet technology facilitates dynamic competitive bidding by enabling suppliers to submit bids in real time and to view competing bids within seconds after their submission. Our FreeMarkets Desktop Internet technology facilitates collaboration between our customers and their trading partners. Our technology is flexible and adaptable to our customers' needs. We can easily configure our markets in many different formats to address the characteristics of a specific industrial part or commodity and to achieve the particular objectives of each of our customers. In addition, we engage in a continuous process of improving our technology by adding new functions and features that we develop through our marketplace experience. - TAILORED APPROACH TO CUSTOMERS' NEEDS. Our FullSource and DirectSource offerings are tailored to meet the needs of each customer. Our customers are typically large corporations that purchase a wide variety of industrial parts, raw materials, commodities and services. Each customer has its own unique organizational structure, approach to purchasing and purchasing objectives. We work with each customer to identify the portions of their purchases that are best suited for our solutions, and we design markets that meet their needs. - SELF-SERVICE QUICKSOURCE OFFERING FOR LESS COMPLEX SOURCING. Our QuickSource hosted application enables customers who do not require market making services to take advantage of our technology and platform to run their own markets. This application is appropriate for less complex sourcing and, together with our FullSource and DirectSource offerings, enables us to address the entire range of our customers' sourcing needs. - IN-DEPTH KNOWLEDGE OF SUPPLY MARKETS. We develop and manage specialized information about many different product categories. Each time we create a market, we add to the knowledge we can apply to our business. We maintain a database of tens of thousands of potential suppliers, with information about their manufacturing processes, quality assurance practices, market focus and 3 6 facilities. This in-depth knowledge enables us to provide our customers with market information that they cannot easily generate themselves or obtain from other sources. - MARKET INTEGRITY. We have designed our marketplace to enable our customers to evaluate competing suppliers on the basis of price, quality and performance in a process that is intended to be fair to all participating suppliers. The request for quotation that is distributed to potential suppliers provides detailed and clear specifications, so that all suppliers who participate in our marketplace have consistent information to use as a basis for their bids. Buyers and suppliers who participate in our marketplace agree in advance to a set of rules which are designed to ensure the integrity of the markets that we create. These rules give participating suppliers the confidence to submit their best bids. THE FREEMARKETS STRATEGY We seek to be the world's leading provider of business-to-business online markets and electronic commerce technology, software and services that enable customers to source and operate their supply chains for direct materials. The key elements of our strategy are: - EXTEND OUR CUSTOMER BASE. We intend to extend our customer base in our target market of Global 2000 corporations and other large enterprises, including government agencies. - EXTEND INTO SUPPLY CHAIN COLLABORATION AND OPTIMIZATION. We recently announced that we have signed a definitive agreement to acquire Adexa, Inc., a leading provider of software products for supply chain collaboration and optimization. We believe that with this acquisition, we will provide customers with the ability to source and operate their supply chains for direct materials, in their own private marketplaces, in exchanges with other industry participants, or using our marketplace. - ADD DOMAIN KNOWLEDGE IN ADDITIONAL PRODUCT CATEGORIES. We believe that our domain knowledge of industrial product categories, called "supply verticals," is one of the factors that differentiates us from other participants in the business-to-business electronic commerce industry. We intend to continue to add domain knowledge in additional product categories where our online markets can generate savings for buyers. We plan to identify these markets by working with our existing and prospective customers to determine additional direct material categories that would be appropriate for our solution and by hiring personnel with expertise in a variety of supply verticals. - EXPAND OUR PRODUCT OFFERINGS. We have recently announced our QuickSource hosted application that enables our customers to create their own markets, and we intend to expand the sales of our new QuickSource product and other hosted applications. We also run the FreeMarkets Asset Recovery Marketplace for buyers and sellers of surplus equipment and inventory. - GROW INTERNATIONAL PRESENCE. We maintain offices in 12 countries outside the United States. We plan to continue to expand in global markets to better serve multinational enterprises. We have served buyers in the United States, Europe, Asia, Australia and South America with over 9,300 suppliers from more than 55 countries participating in our online markets. We believe that we can assist buyers in identifying potential suppliers worldwide and that our marketplace will continue to be attractive to buyers based outside the United States. - FOSTER A CULTURE OF EXCELLENCE AND CUSTOMER SERVICE. We intend to continue to employ rigorous recruiting, training and evaluation practices to help us attract and retain employees who dedicate themselves to delivering outstanding results to our customers. Since our inception, we have emphasized the creation of an environment of excellence and customer service. We believe that our commitment to excellence has led and will continue to lead to new customer referrals from satisfied buyers and suppliers who have used our marketplace. - ADD NEW PROPRIETARY TECHNOLOGY. We believe that our proprietary sourcing technology, on which we have applied for more than 25 patents, has functions and features that are unmatched in the business-to-business electronic commerce industry. We intend to continue to develop additional proprietary technology and to seek appropriate patent protection for our technology. 4 7 - GROW THROUGH STRATEGIC RELATIONSHIPS AND ACQUISITIONS. We intend to pursue opportunities to expand our business through strategic relationships and acquisitions, as well as through internal development. THE FREEMARKETS MARKET MAKING PROCESS We help our customers obtain lower prices and make better purchasing decisions through a combination of our proprietary technology, sourcing information, domain knowledge and services. In our FullSource offering and, to a limited extent, our DirectSource offering, we provide "market making" services that create a custom market for the direct materials, commodities or services being purchased through our marketplace. Our market making services are delivered through our FreeMarkets Desktop technology platform, which facilitates collaboration between our customers and their trading partners. Market making consists of the following steps: arrow chart IDENTIFY POTENTIAL SAVINGS. We work with our customers to identify which purchases seem best suited to our market making process. Although our marketplace generates savings on many types of products, the potential savings are particularly dramatic for direct materials that are custom-made to a buyer's specifications and available from many different suppliers. Examples include injection molded plastic components, metal fabrications, commercial machinings, printed circuit boards, fasteners and corrugated packaging. Other types of products, including commodities such as chemicals and coal, can also be appropriate for our process because market conditions are volatile and purchase prices may change with each transaction. PREPARE REQUEST FOR QUOTATION. Once a suitable purchase has been identified, we work with our customers to prepare a request for quotation. The request for quotation, or RFQ, is our customer's specification of the materials to be purchased. This specification is sent to selected suppliers to help them prepare their bids. Our technology automatically matches buyer part specifications with supplier capabilities, facilitating the preparation of the RFQ and the selection of suppliers. Because many direct materials must be custom-made to a buyer's specifications, it is essential for the request for quotation to specify precisely all of our customer's requirements, including the applicable technical characteristics, quality and logistics requirements and commercial terms. A market typically includes components with different characteristics or delivery locations, so we group components into lots with the goal of creating meaningful competition in each lot. SELECT POTENTIAL SUPPLIERS AND DISTRIBUTE REQUEST FOR QUOTATION. While the request for quotation is being prepared, the supplier selection process begins. We start with a target list of suppliers that includes those known to our customers and others we identify from our supplier database of tens of thousands of suppliers. After a detailed screening process, our customer selects a list of potential suppliers. Because most industrial purchases are made from a select group of potential suppliers, our online markets are private, and only those suppliers that our customer ultimately invites may participate. Privacy is important because the information contained in the request for quotation is highly confidential and our customer will award a purchase order only to a qualified supplier. Once our customer has selected potential suppliers, we provide these suppliers with the request for quotation to enable them to prepare for the competitive bidding. We also train suppliers in the use of our software. CONDUCT ONLINE MARKET. After potential suppliers have been selected and trained, we conduct an online market. During the bidding, suppliers remain anonymous to one another but can see competing price bids in real time, while our customer can see both the identity and current bid of each supplier. A market typically lasts for one to three hours. The activity is fast-paced, with suppliers generally submitting bids every few minutes, and often more frequently as the closing time for each lot nears. Our Market Operations Centers in Pittsburgh and Brussels provide continuous support to our customers and suppliers throughout the process. We monitor performance, send real-time messages to participants and strive to ensure that all bidders can 5 8 participate effectively. We believe that our active involvement makes our marketplace more reliable. We can support participants in more than 30 different languages. We consider this to be a critical skill in helping customers to buy from suppliers around the world. IMPLEMENT RESULTS. After the online market has been completed, we assist our customers in analyzing and implementing market results so that purchase orders can be awarded to the suppliers providing the best overall value. In some situations, our customers can make immediate award decisions. In other instances, our customers may perform additional analyses and due diligence before making an award. Because awards may be based not only on price, but also on factors such as quality and delivery capabilities, the low bidder does not always win. Our customers ultimately make the final award decisions. PRODUCT CATEGORIES We create markets for our customers in a wide variety of product categories, ranging from commodities to custom-engineered components. The number of product categories in which we have conducted markets grew to more than 165 by the end of December 31, 2000. The following list includes some of the product categories in which we have had the most experience: Ball bearings Corrugated packaging Injection molded Pallets Chemicals Die castings plastics Printed circuit boards Coal Diesel fuel Metal fabrications Service center metals Commercial machinings Fasteners Metal stampings Sugar Computer monitors Hotel services Molded rubber Transformers Motor freight
Most industrial buyers make purchases in a range of product categories, so we believe it is important that we address a comparable range. We typically conduct multiple markets in each product category, so we gain knowledge and improve productivity over time. CUSTOMERS Our customers are among the world's largest buyers of industrial parts, raw materials, commodities and services. The following companies are among our current customers: Alcoa Inc. Diebold, Incorporated Norsk Hydro ASA Allegheny Technologies Eaton Corporation Pilkington, plc Incorporated Emerson Electric Co. The Quaker Oats Company American Airlines, Inc. FirstEnergy Corp. Raytheon Company Bayer AG FMC Corporation Schering-Plough Corporation Bechtel Corporation Giant Eagle, Inc. Singapore Technologies BP Amoco p.l.c. Glaxo SmithKline plc Engineering Ltd. Commonwealth of Pennsylvania H.J. Heinz Company SPX Corporation Dana Corporation International Truck and Engine United Technologies Deere & Company Corporation Corporation Delphi Automotive Systems Mayne Nickless Limited Valeo Corporation Visteon Corporation
We provide services to our customers under agreements that range from a few months to five years. Each of the customers listed above is party to an agreement with us containing a term of not less than 12 months. Many of these agreements are cancelable by our customers on minimal notice and without substantial penalties. Our agreements typically provide us with revenues from fixed monthly fees. Some of our agreements also include performance incentive payments that are contingent upon our customer achieving specific market volume and/or savings thresholds. We never take title to or possession of any of the products purchased through our marketplace. We also do not oversee delivery of or payment for these products. We serve our customers from our offices in the United States and in 12 foreign countries. Many of our customers are multi national companies. Over 90% of our revenues plus Visteon fees in 2000, 1999 and 1998 were derived from customers whose headquarters are located within the United States. 6 9 SALES AND MARKETING We sell our services through our direct sales organization. As of December 31, 2000, our direct sales force consisted of more than 50 sales professionals, organized along buyer industry lines. We plan to expand our direct sales force and the number of buyer industry sectors for which we have specialists on our staff. We typically target our sales efforts at senior purchasing executives, chief technology officers, and other senior executives within a buying organization. When a prospective customer is interested in working with us, we analyze which portions of its direct material purchases are best suited to our marketplace. Throughout this analysis, we work with the prospective customer to negotiate terms of an agreement. New customers often enter into short-term agreements with us before making a longer-term commitment. Because our technology need not be integrated with the customer's existing information technology infrastructure, short-term agreements can quickly result in savings for our customer. Our short-term agreements typically last three to six months, during which time we prepare and conduct a range of markets. Our goal through this process is to demonstrate our capability to provide savings and to obtain a longer-term agreement with the customer. Our marketing efforts focus on general communications and on obtaining referrals from our existing customers. We participate in trade conferences and purchasing industry forums, and advertise in major airports and business publications. We intend to continue to make advertising and marketing expenditures in an effort to become better known in our target markets. These expenditures will cover the addition of sales, marketing, product management and business development personnel, advertising in professional journals and general business and trade media, media relations, presence at purchasing and technology trade conferences, and continuing improvements to our website. TECHNOLOGY AND OPERATIONS We have built our proprietary technology to create a highly-interactive marketplace tailored to the needs of industrial purchasers. Our Internet-based BidWare technology provides an easy-to-use graphical interface that suppliers use to submit bids and that our customers use to watch the progress of our markets. Suppliers participate from their own offices, where key decision makers submit bids. Our BidWare technology provides nearly instantaneous response, displaying these bids to all users within seconds of submission. A truly dynamic competition results, as buyers watch prices decrease before their eyes. Our BidWare technology is designed for high-value online bidding involving complex market conditions. This Internet-based technology supports global, real-time interactions and has driven more than $14 billion in global business-to-business commerce. Our BidWare technology supports a significant number of market formats, enabling global suppliers to bid in multiple currencies, across multiple countries for multi-year contracts, all over the Internet. Our FreeMarkets Desktop technology consists of a suite of sourcing tools that, together with our BidWare technology, enable our customers, in a secure, password-protected environment, to create complex RFQs, publish specifications, select and collaborate with global suppliers, configure a market, negotiate dynamically in real time with suppliers, and award business to suppliers. We operate Market Operations Centers in Pittsburgh and Brussels to ensure that our marketplace is actively managed and runs smoothly. We strive to make our marketplace extremely reliable, both through our operations methodology and the quality of our technology. Our technology architecture contains many features to monitor and control our marketplace so that our Market Operations Centers can quickly respond in the event of technical or other difficulties. In addition, the staff in our Market Operations Centers actively support bidders before and during markets, helping to further ensure the reliability of our marketplace. Although we have taken extensive measures to ensure the reliability of our marketplace, we cannot guarantee that we will not have technical interruptions or failures in the future. Our BidWare technology includes: real-time price feedback, which allows bidders to see market dynamics at work; an overtime feature that extends the market bid time in highly competitive situations; 7 10 continuous remote connections with bidders worldwide; and advanced security features to protect the confidentiality of online bids. Our technology also incorporates a wide range of bidding features and market formats that we developed to address specific needs of industrial purchasers. Examples of the types of markets we can conduct using our BidWare technology include: - "transformation bidding", where our customers can make direct price comparisons of similar products with unique attributes (such as coal from different mines); - "multi-currency bidding", where our customers and suppliers can choose to conduct bidding in the currency of their choice and to monitor bids in multiple currencies; - "index bidding", where our customers can conduct markets for commodities characterized by volatile pricing, against known indices (such as agricultural commodities); and - "net present value bidding", where our customers can evaluate proposals that have varying prices over time (such as materials for which suppliers bid decreasing costs over time to reflect anticipated productivity improvements). We spent $4.9 million on research and development in 1999 and $19.1 million in 2000. We plan to continue to increase our research and development expenditures to develop new technology and add features to our existing technology. COMPETITION A number of companies provide services or products to the market for business-to-business electronic commerce. Competition in this market is rapidly evolving and intense, and we expect competition to further intensify in the future, which could lead to price reductions, reduced gross margins and loss of market share. We currently or potentially will compete with a number of other companies, including: - providers of electronic commerce technology extending their offerings to include services or technology similar to ours; - well-financed entrepreneurial start-ups that offer similar products and services or products and services perceived by a customer to be similar; - business-to-business exchanges or private marketplaces that are established by industrial companies, acting either in a consortium or unilaterally, which are designed to provide electronic procurement solutions; - professional service and consulting firms and others offering services similar to ours; and - providers of stand-alone software products that make available to buyers technology for conducting online markets. Our online marketplace is one of many alternative approaches to purchasing that buyers may consider. Many of our current and potential competitors are larger and more established, and have significantly greater resources than we do. As a result, some of our current or potential competitors may be able to commit more resources to marketing and promotional campaigns, adopt more aggressive pricing policies and devote more resources to technology development. In order to respond to changes within this competitive environment, we may from time to time make pricing, service, marketing or other strategic decisions that could adversely affect our operating results. In addition, competitors may introduce products or services that appear to be the same as ours, despite actual differences. In such an environment, we face the risk that customers will confuse our services with those of our competitors or choose a competitor with greater resources. We also face the risk that customers may attain poor results with other products or services and lose interest in doing business with us. General economic conditions may also adversely affect demand for our services. We may not be able to keep our current customers or secure new ones in light of these issues. 8 11 INTELLECTUAL PROPERTY We regard the protection of our intellectual property rights to be critical to our success. We rely or expect to rely on a combination of patent, copyright, trademark, service mark and trade secret restrictions and contractual provisions to protect our intellectual property rights. We require employees and independent contractors to enter into confidentiality and invention assignment agreements, and require some of our employees to enter into non-competition agreements. We also have non-disclosure agreements with our customers and suppliers who participate in our marketplace. We do not sell our software to our customers or to suppliers, but rather license it for specified purposes. The contractual provisions and the other steps we have taken to protect our intellectual property may not prevent misappropriation of our technology or deter third parties from developing similar or competing technologies. BidWare, BidServer and FreeMarkets are registered trademarks of FreeMarkets in the United States, and BidWare is a registered trademark of FreeMarkets in Hong Kong and the European Community. In addition, we own a registration for the FreeMarkets trademark in the European Community. We have applied to register the FreeMarkets and BidWare trademarks in other jurisdictions, including Japan and Singapore. We have also applied for United States and foreign registration for our FreeMarkets logo and several other marks associated with our business. We have filed more than 25 patent applications in the United States with respect to proprietary features of our technology that we currently use or intend to use in the future. We cannot assure you that these patents will be issued, or that if they are issued, these patents will not be successfully challenged by others or invalidated or will adequately protect our technology or processes or otherwise result in commercial advantages to us. We cannot be certain that the steps we have taken to protect our intellectual property will be adequate, that third parties will not infringe or misappropriate our proprietary rights or that third parties will not independently develop similar proprietary information. Any such infringement, misappropriation or independent development could harm our future financial results. Additionally, effective patent, trademark, copyright and trade secret protection may not be available in every country where we provide our marketplace and our technology. At times, we may have to incur significant legal costs and spend time defending our trademarks, copyrights and, if issued, our patents. Any such defense efforts, whether successful or not, would divert both time and resources from the operations and growth of our business. There is also significant uncertainty regarding the applicability to the Internet of existing laws regarding matters such as property ownership, copyrights, patents and other intellectual property rights. The vast majority of these laws were adopted prior to the advent of the Internet and, as a result, do not contemplate or address the unique issues of the Internet and related technologies. GOVERNMENT REGULATION As with many Internet-based businesses, we operate in an environment of tremendous uncertainty as to potential government regulation. We believe that we are not currently subject to direct regulation applicable to online commerce, other than regulations applicable to businesses in general. However, the Internet has rapidly emerged as a commerce medium, and governmental agencies have not yet been able to adapt existing regulations to its use. Future laws, regulations and court decisions may affect the Internet or other online services, covering issues such as user pricing, user privacy, freedom of expression, access charges, taxation, content and quality of products and services, advertising, intellectual property rights and information security. In addition, because our services are offered worldwide, and we facilitate sales of goods to customers worldwide, foreign jurisdictions may claim that we are required to comply with their laws. Any future regulation may have a negative impact on our business. Because we are an Internet company, it is unclear in which jurisdictions we are actually conducting business. Our failure to qualify to do business in a jurisdiction that requires us to do so could subject us to fines and penalties and could result in our inability to enforce agreements in that jurisdiction. 9 12 Numerous states have laws and regulations regarding the conduct of auctions and the liability of auctioneers. We do not believe that these laws and regulations, which were enacted for consumer protection many years ago, apply to our online marketplace. However, one or more jurisdictions may attempt to impose these laws and regulations on our operations in the future. EMPLOYEES As of December 31, 2000, we had 968 employees worldwide, including 516 in market making, 112 in research and development, 133 in sales and marketing, 59 in technical operations and 148 in executive management and administration, human resources, legal, finance and facilities management. None of our employees is represented by a collective bargaining agreement, and we believe that we have good relations with our employees. CORPORATE HISTORY We were originally incorporated in 1995 as "Online Markets Corporation". We changed our name to "FreeMarkets OnLine, Inc." shortly after our formation, and then changed our name again in September 1999 to "FreeMarkets, Inc." ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS OUR QUARTERLY OPERATING RESULTS ARE VOLATILE AND DIFFICULT TO PREDICT; IF WE FAIL TO MEET THE EXPECTATIONS OF PUBLIC MARKET ANALYSTS OR INVESTORS, THE MARKET PRICE OF OUR COMMON STOCK MAY DECLINE Our quarterly operating results have varied significantly in the past, are prone to significant fluctuations and will likely vary significantly in the future. For example, our revenues plus Visteon fees have grown at an average sequential rate of 46% over the five quarters commencing October 1, 1999 and ending December 31, 2000. Our cost of revenues as a percent of revenues plus Visteon fees has decreased from 61% in the fourth quarter of 1999 to 50% in the fourth quarter of 2000. In addition, we reported a net loss of $0.43 per share in the fourth quarter of 1999 and a net loss of $1.17 per share in the fourth quarter of 2000. We believe that quarter-to-quarter comparisons of our results of operations are not meaningful, and you should not rely upon them as indicators of future performance. Our operating results will likely fall below the expectations of securities analysts or investors in some future quarter or quarters. As a result, the price of our common stock may fall. We recognize a portion of our revenues from service agreements on a monthly basis as we provide services; the remainder may be contingent on successfully achieving agreed-upon volume and/or savings objectives. As a result, our quarterly operating results may continue to fluctuate significantly based on the size and timing of monthly fees and any contingent compensation we earn. OUR INDUSTRY IS HIGHLY COMPETITIVE AND HAS LOW BARRIERS TO ENTRY, AND WE CANNOT ASSURE YOU THAT WE WILL BE ABLE TO EFFECTIVELY COMPETE The market for business-to-business electronic commerce products and services is intensely competitive. If we cannot compete successfully, our business will suffer reduced revenues and operating results. As one of a number of companies providing services or products to the market for business-to-business electronic commerce, we face the risk that existing and potential customers may choose to purchase competitors' services or products. If they do, then our revenues and operating results will be reduced. Given that barriers to entry are low, we expect competition to intensify as new competitors enter the market. Furthermore, in recent quarters, many companies have announced their intentions to establish their own business-to-business industry exchanges or private marketplaces. Our current customers or prospective customers may also establish their own industry exchanges or private marketplaces. These exchanges or marketplaces may provide online market functionality and other services similar to ours and may diminish the need for our services. While we do not know the effect that these exchanges and marketplaces may have on the market for our online market services, it is possible that the existence of these exchanges and 10 13 marketplaces, or even the anticipated existence of planned exchanges and marketplaces, may result in our losing customers and revenue and may impair our ability to grow our business. WE HAVE EXPERIENCED REVENUE AND FEE CONCENTRATION IN THE PAST; THE LOSS OF OUR LARGEST CUSTOMERS WOULD REDUCE OUR REVENUES AND FEES AND OPERATING RESULTS AND COULD CAUSE OUR STOCK PRICE TO FALL We depend on United Technologies Corporation ("United Technologies") and Visteon for a material portion of our revenues and fees. In October 2000, we entered into a three-year contract extension with United Technologies, but this agreement may be terminated at any time prior to its expiration by United Technologies on 30 days' notice and without substantial penalty. In April 2000, we entered into a five-year agreement with Visteon that provides for a fixed monthly payment stream larger than any other current customer contract. Although this agreement is not cancelable, it may be terminated, subject to cure periods, in the event of a breach. Any termination of our agreements with United Technologies or Visteon, whether or not permitted by the terms of those agreements, would diminish our revenues and operating results. Revenues from United Technologies were $9.0 million in 2000 and $7.0 million in 1999. Fees from Visteon were $7.9 million in 2000. In January 2000, General Motors Corporation ("General Motors"), which contributed $3.1 million of revenues in 1999, notified us that it was exercising its right to terminate its agreement. In the two days following our announcement of the termination of the General Motors contract, our stock price decreased by approximately 28%. The loss of any other significant customers could cause a similar decrease in our stock price. THE ACQUISITION OF ADEXA, INC. INVOLVES A SUBSTANTIAL DEGREE OF RISK; WE CANNOT ASSURE YOU THAT FREEMARKETS WILL REALIZE ANY OF THE EXPECTED BENEFITS OF THE ACQUISITION On February 7, 2001, we entered into an agreement to acquire Adexa, Inc. We expect the acquisition of Adexa to be completed in the second quarter of 2001. The acquisition of Adexa involves a substantial degree of risk. With the acquisition of Adexa, FreeMarkets is entering into the market for supply chain management and collaboration software. We have not previously had experience in this market. We cannot assure you that any of the benefits we expect from the acquisition will be realized. Achieving the benefits of the acquisition will depend in part on the integration of the technology, operations and personnel of FreeMarkets and Adexa in a timely and efficient manner. The failure to do so could result in the loss of key personnel and have a material adverse effect on our business, financial condition and operating results. The market for supply chain management and collaboration software is rapidly evolving and intensely competitive. Among the actual and potential competitors in that market are enterprise application vendors including, among others, i2 Technologies, Inc., Oracle Corporation and SAP Corporation, as well as electronic exchange infrastructure providers such as Ariba, Inc. and Commerce One, Inc. Such competitors are larger and more established and have significantly greater resources than we do. We cannot assure you that FreeMarkets will be able to compete successfully in such an environment. Our ability to integrate the combined businesses and to compete may be adversely affected by the slowdown in the economy. Purchasing decisions for our product offerings may be deferred or postponed as potential customers evaluate their budgets in light of current economic conditions. This would lead to longer sales cycles and result in lower revenues than we had anticipated. WE HAVE ACQUIRED AND MAY IN THE FUTURE ACQUIRE COMPLEMENTARY BUSINESSES OR TECHNOLOGIES In 2000 we acquired iMark.com, Inc., Surplus Record, Inc. and SR Auction, Inc. On February 7, 2001, we entered into an agreement to acquire Adexa, Inc. If appropriate opportunities present themselves, we may acquire additional businesses, technologies, services or products that we believe are strategic, and any such acquisitions may be material in size. We may not be able to successfully identify, negotiate or finance any future acquisition. Even if we do succeed in acquiring a business, technology, service or product, we have limited experience in integrating an acquisition into our business. The process of integration of any acquired 11 14 company may produce unforeseen operating difficulties and expenditures, and may absorb significant attention of our management that would otherwise be available for the ongoing development of our business. Moreover, we may never achieve any of the benefits that we might anticipate from an acquisition. If we make acquisitions, we may issue shares of stock that dilute other stockholders, incur debt, assume contingent liabilities or create additional expenses related to amortizing goodwill and other intangible assets, any of which might harm our financial results and cause our stock price to decline. Any financing that we might need for acquisitions may only be available to us on terms that restrict our business or that impose additional costs that reduce our operating results. The net book value of goodwill on our consolidated balance sheet as of December 31, 2000 was $263.5 million. It is our policy to assess the potential impairment of long-lived assets, such as goodwill, when events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. For example, we may decide to reallocate resources based on potential changes in our business strategy. If such strategic decisions are made and we reduce our commitment level to iMark.com, Inc., we would need to evaluate the goodwill related to iMark.com, Inc. for impairment. The recognition of an impairment loss could have a material adverse effect on our operating results. WE USE SIGNIFICANTLY MORE CASH THAN WE GENERATE Since our inception, our operating and investing activities have used more cash than they have generated. Because we will continue to need substantial amounts of working capital to fund the growth of our business, we expect to continue to experience negative operating and investing cash flows for the foreseeable future. We may need to raise additional capital in the future to meet our operating and investing cash requirements. We may not be able to find additional financing, if required, on favorable terms or at all. If we raise additional funds through the issuance of equity, equity-related or debt securities, these securities may have rights, preferences or privileges senior to those of the rights of our common stock, and our stockholders may experience additional dilution to their equity ownership. WE ANTICIPATE FUTURE LOSSES We experienced losses of $0.9 million, $1.4 million and $1.1 million in 1995, 1996 and 1997, respectively. We achieved a modest profit in 1998, but incurred losses of $21.8 million and $156.4 million in 1999 and 2000, respectively, as a result of our efforts to invest in the actual and anticipated growth of our business. Our accumulated losses to date are $181.4 million. Our profitability will depend on whether we can increase revenues while controlling costs. We may not achieve profitability in the future, or sustain any future profitability. CUSTOMERS MAY NOT PURCHASE OUR SERVICES IF WE ARE UNABLE TO GENERATE SIGNIFICANT SAVINGS If our online market services increase the efficiency of any particular supply market, the future likelihood of significant savings to our customers in that market may decrease. Factors beyond our control may limit our ability to generate savings. If the magnitude of savings in particular product categories decreases, we may have difficulty in the future selling our online market services to buyers in those markets, or attracting willing suppliers in other markets, either of which will reduce our revenues and operating results. OUR SPENDING ON INCREASED CAPACITY PRECEDES OUR RECEIPT OF REVENUES; THIS COULD CAUSE THE PERCENTAGE OF OUR COST OF REVENUES TO REVENUES PLUS VISTEON FEES TO BE VOLATILE We must hire personnel, acquire equipment and expand our facilities in anticipation of receiving revenues and fees in future periods. Because many of our expenses for these activities are components of our cost of revenues, the percentage of our cost of revenues to revenues plus Visteon fees could be volatile. WE MAY NOT BE ABLE TO ADJUST OUR SPENDING QUICKLY; IF WE CANNOT, THEN OUR OPERATING RESULTS WILL BE REDUCED We plan to increase expenditures for our sales and marketing efforts, development of new technology, capital improvements to our facilities and improvement of our operational and financial systems. The historical 12 15 financial information upon which we can base our planned operating costs and capital expenditures is very limited and may not be meaningful. Our planned expense levels are relatively fixed in the short term and are based on our anticipation of future revenues. We may not be able to accurately forecast revenues due to our limited operating history. The difficulty of forecasting our revenues will be increased if a slowdown in the economy causes customers to defer or postpone their purchasing decisions in response to changes in their business. If we fail to accurately predict revenues in relation to our planned expense levels, then we may be unable to adjust our costs in a timely manner in response to lower-than-expected revenues, and our operating results will be negatively affected. WE MAY NOT BE ABLE TO HIRE OR RETAIN QUALIFIED STAFF If we cannot attract and retain adequate qualified and skilled staff, the growth of our business may be limited. Our ability to provide services to customers and grow our business depends, in part, on our ability to attract and retain staff with college and graduate degrees, as well as professional experiences that are relevant for market making, technology development and other functions we perform. Competition for personnel with these skill sets is intense. Some technical job categories are under conditions of severe shortage in the United States. In addition, restrictive immigration quotas could prevent us from recruiting skilled staff from outside the United States. We may not be able to recruit or retain the caliber of staff required to carry out essential functions at the pace necessary to sustain or grow our business. Our ability to recruit and retain qualified personnel may be adversely affected by the decline in the price of our common stock. Stock options are an important component of our overall compensation package and, in current market conditions, may not provide appropriate incentives to our current and prospective employees. THE CAPACITY CONSTRAINTS OF OUR PERSONNEL AND TECHNOLOGY RESOURCES MAY LIMIT OUR GROWTH If we are unable to undertake new business due to a shortage of staff or technology resources, our growth will be impeded. Our customers are typically large enterprises. At times, these customers ask us to pursue projects that put a strain on our resources, both in terms of people and technology. At the same time, penetration of new product categories often requires that we build up a significant database of new information. This, too, often requires a substantial amount of time from our market making staff. If our staff does not have the time to find and assimilate this new information, we may not be able to extend our services to new product categories. Therefore, there may be times when our opportunities for revenue growth may be limited by the capacity of our internal resources rather than by the absence of market demand. FAILURE TO MANAGE OUR GROWTH COULD REDUCE OUR REVENUES OR OPERATING RESULTS Rapid expansion strains our infrastructure, management, internal controls and financial systems. We may not be able to effectively manage our present growth or any future expansion. We have recently experienced significant growth, with our revenues plus Visteon fees for 2000 increasing 337% compared to 1999. To support our growth, we have hired the majority of our employees within the last year. This rapid growth has also strained our ability to integrate and properly train our new employees. Inadequate integration and training of our employees may result in underutilization of our workforce and may reduce our revenues or operating results. OUR SALES CYCLE IS LONG AND UNCERTAIN AND MAY NOT RESULT IN REVENUES; FACTORS OUTSIDE OF OUR CONTROL MAY AFFECT THE DECISION TO PURCHASE OUR SERVICES Our sales cycle is long, typically taking from one to six months from initial customer contact until we sign a contract. Not every potential customer that we solicit actually purchases our services. Because we offer a new method of industrial purchasing, we must educate potential customers on the use and benefits of our services. We need to spend a significant amount of time with multiple decision makers in a prospective 13 16 customer's organization to sell our services. Other factors that contribute to the length and uncertainty of our sales cycle and that may reduce the likelihood that customers will purchase our services include: - budgeting constraints; - incentive structures that do not reward decision makers for savings achieved through cost-cutting; - the strength of pre-existing supplier relationships; - competition from other providers of online market services and electronic procurement services; and - an aversion to new purchasing methods. If we are unable to enter into service agreements with customers on a consistent basis, then our business may suffer from diminished revenues. IF OUR SHORT-TERM SERVICE AGREEMENTS DO NOT LEAD TO LONG-TERM SERVICE AGREEMENTS, OUR BUSINESS MAY NOT BE PROFITABLE Frequently, we begin a relationship with a new customer by entering into a short-term service agreement that we hope will lead to a long-term service agreement. Failure to move a sufficient number of customers from short-term to long-term service agreements would hurt our operating results. Our initial agreement with a customer usually involves a period of trial and evaluation with relatively small volume online markets. This initial period, in which we learn about our customer's business and its related product categories and educate our customer about the best use of our services for its organization, requires a very significant expenditure of our time and resources. A subsequent longer-term service agreement often involves more frequent and larger volume bids. Customers may decide not to enter into a long-term service agreement with us, or may delay entering into such an agreement until a later time. Because we invest a significant amount of time and resources early in a customer relationship, our cost of revenues as a percentage of revenues are typically higher at the outset of a relationship than those which we may incur later. Further, we may be diverting personnel from higher-margin opportunities to develop a new relationship, without any assurance that the new relationship will endure. FACTORS OUTSIDE OUR CONTROL COULD RESULT IN DISAPPOINTING MARKET RESULTS; DISAPPOINTED CUSTOMERS MAY CANCEL OR FAIL TO RENEW THEIR AGREEMENTS WITH US The actual savings achieved in any given market vary widely and depend upon many factors outside of our control. These factors include: - the current state of supply and demand in the supply market for the products being purchased; - the past performance of our customer's purchasing organization in negotiating favorable terms with suppliers; - the willingness of a sufficient number of qualified suppliers to bid for business using our marketplace; - reductions in the number of suppliers in particular markets due to mergers, acquisitions or suppliers exiting from supply industries; and - seasonal and cyclical trends that influence all industrial purchasing decision making. Because factors outside of our control affect a customer's perception of the value of our services, customers may cancel our service agreements or choose not to renew them, even if we have performed well. Any non-renewal or cancellation of service agreements may reduce our revenues and operating results. FAILURES OF HARDWARE SYSTEMS OR SOFTWARE COULD UNDERMINE OUR CUSTOMERS' CONFIDENCE IN OUR RELIABILITY A significant disruption in our marketplace could seriously undermine our customers' confidence in our business. Our customers hold us to a high standard of reliability and performance. From time to time, we have experienced service interruptions in our marketplace, with the most significant being a breakdown in the 14 17 computer network over which our markets are conducted. This computer network is provided to us by an outside vendor, and this kind of interruption may occur in the future. During these disruptions, participants may lose their online connection or we may not receive their bids in a timely manner. Any interruptions in our service may undermine actual and potential customers' confidence in the reliability of our business. Conducting an online market requires the successful technical operation of an entire chain of software, hardware and telecommunications equipment. This chain includes our BidWare software, the personal computers and network connections of bidders, our network servers, operating systems, databases and networking equipment such as routers. A failure of any element in this chain can partially or completely disrupt our marketplace. Some of the elements set forth above are not within our control, such as Internet connectivity and software, hardware and telecommunications equipment we purchase from others. We frequently have market participants from outside North America who may use older or inferior technologies, which may not operate properly. In addition, hardware and software are potentially vulnerable to interruption from power failures, telecommunications outages, network service outages and disruptions, natural disasters and vandalism and other misconduct. Our business interruption insurance would not compensate us fully for any losses that may result from these disruptions. THE LOSS OF OUR KEY EXECUTIVES COULD DISRUPT OUR BUSINESS None of our executive officers or other key employees is bound by an employment agreement. We rely on the leadership and vision of the executive officers identified in the table on page 18 of this Form 10-K and the loss of any of these executives could disrupt the Company's growth. IF WE FAIL TO CONTINUALLY IMPROVE OUR TECHNOLOGY, OUR BUSINESS WILL SUFFER Our services and the business-to-business electronic commerce market are characterized by rapidly changing technologies and frequent new product and service introductions. We may fail to introduce new technology on a timely basis or at all. If we fail to introduce new technology or to improve our existing technology in response to industry developments, we could experience frustration from our customers that could lead to a loss of revenues. Our technology is complex, and accordingly, may contain undetected errors or defects that we may not be able to fix. In the past, we have discovered software errors in new versions of our software after their release. Further, any new technology we introduce, such as our recently announced QuickSource solution, may not achieve the results or gain the market acceptance we anticipate. Reduced market acceptance of our services or our software due to errors or defects in our technology would harm our business by reducing our revenues. IF WE DO NOT ADEQUATELY MAINTAIN OUR CUSTOMERS' CONFIDENTIAL INFORMATION, OUR REPUTATION COULD BE HARMED AND WE COULD INCUR LEGAL LIABILITY Any breach of security relating to our customers' confidential information could result in legal liability for us and a reduction in use or cancellation of our services, either of which could materially harm our business. Our personnel receive highly confidential information from buyers and suppliers that is stored in our files and on our computer systems. For example, we often possess blueprints and product plans that could be valuable to our customers' competitors if misappropriated. Similarly, we receive sensitive pricing information that has historically been maintained as a matter of utmost confidence within buyer and supplier organizations. We enter into standard non-disclosure and confidentiality agreements with virtually all customers with whom we deal. We currently have practices and procedures in place to ensure the confidentiality of our customers' information. However, our security procedures to protect against the risk of inadvertent disclosure or intentional breaches of security might fail to adequately protect information that we are obligated to keep confidential. We may not be successful in adopting more effective systems for maintaining confidential information, so our exposure to the risk of disclosure of the confidential information of others may grow with 15 18 increases in the amount of information we possess. If we fail to adequately maintain our customers' confidential information, some of our customers could end their business relationships with us and we could be subject to legal liability. IF WE ARE NOT ABLE TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, THEN OTHERS MAY BE ABLE TO DUPLICATE OUR SERVICES We rely in part upon our proprietary technology, including our software, to conduct our business. Our failure to adequately protect our intellectual property rights could harm our business by making it easier for others to duplicate our services. We have applied for patents on aspects of our technology and business processes, but we do not know whether any patents will be issued. In addition, even if some or all of these patents are issued, we cannot assure you that they will not be successfully challenged by others or invalidated, that they will adequately protect our technology and processes or that they will result in commercial advantages for us. We have also obtained and applied for Unites States and foreign registrations for certain trademarks, domain names and logos, and our software, documentation and other written materials are copyrighted, but these protections may not be adequate. Although we require each of our employees to enter into a confidentiality agreement and some key employees are subject to non-competition agreements, these agreements may not satisfactorily safeguard our intellectual property against unauthorized disclosure. We cannot be certain that third parties will not infringe or misappropriate our proprietary rights or that third parties will not independently develop similar proprietary information. Any infringement, misappropriation or independent development could harm our future financial results. In addition, effective patent, trademark, copyright and trade secret protection may not be available in every country where we do business. We may, at times, have to incur significant legal costs and spend time defending our trademarks, copyrights and, if issued, our patents. Any defense efforts, whether successful or not, would divert both time and resources from the operation and growth of our business. There is also significant uncertainty regarding the applicability to the Internet of existing laws regarding matters such as property ownership, patents, copyrights and other intellectual property rights. Legislatures adopted the vast majority of these laws prior to the advent of the Internet and, as a result, these laws do not contemplate or address the unique issues of the Internet and related technologies. We cannot be sure what laws and regulations may ultimately affect our business or intellectual property rights. OTHERS MAY ASSERT THAT OUR TECHNOLOGY INFRINGES THEIR INTELLECTUAL PROPERTY RIGHTS We do not believe that we infringe the proprietary rights of others, and to date, no third parties have notified us of infringement, but we may be subject to infringement claims in the future. The defense of any claims of infringement made against us by third parties could involve significant legal costs and require our management to divert time from our business operations. Either of these consequences of an infringement claim could have a material adverse effect on our operating results. If we are unsuccessful in defending any claims of infringement, we may be forced to obtain licenses or to pay royalties to continue to use our technology. We may not be able to obtain any necessary licenses on commercially reasonable terms or at all. If we fail to obtain necessary licenses or other rights, or if these licenses are too costly, our operating results may suffer either from reductions in revenues through our inability to serve customers or from increases in costs to license third-party technology. OTHERS MAY REFUSE TO LICENSE IMPORTANT TECHNOLOGY TO US OR MAY INCREASE THE FEES THEY CHARGE US FOR THIS TECHNOLOGY We rely on third parties to provide us with some software and hardware, for which we pay fees. This software has been readily available, and to date, we have not paid significant fees for its use. These third parties may significantly increase their fees or refuse to license their software or provide their hardware to us. While other vendors may provide the same or similar technology, we cannot be certain that we can obtain the required technology on favorable terms, if at all. If we are unable to obtain required technology at a reasonable 16 19 cost, our growth prospects and operating results may be harmed through impairment of our ability to conduct business or through increased cost. FUTURE GOVERNMENT REGULATION OF THE INTERNET AND ONLINE MARKET SERVICES MAY ADD TO OUR OPERATING COSTS Like many Internet-based businesses, we operate in an environment of tremendous uncertainty as to potential government regulation. We believe that we are not currently subject to direct regulation of online commerce, other than regulations generally applicable to all businesses. However, the Internet has rapidly emerged as a commerce medium, and governmental agencies have not yet been able to adapt all existing regulations to the Internet environment. Laws and regulations may be introduced and court decisions reached that affect the Internet or other online services, covering issues such as user pricing, user privacy, freedom of expression, access charges, content and quality of products and services, advertising, intellectual property rights and information security. In addition, because we offer our services worldwide and globally facilitate sales of goods to customers, foreign jurisdictions may claim that we are required to comply with their laws. Any future regulation may have a negative impact on our business by restricting our method of operation or imposing additional costs. As an Internet company, it is unclear in which jurisdictions we are actually conducting business. Our failure to qualify to do business in a jurisdiction that requires us to do so could subject us to fines or penalties and could result in our inability to enforce contracts in that jurisdiction. Numerous jurisdictions have laws and regulations regarding the conduct of auctions and the liability of auctioneers. We do not believe that these laws and regulations, which were enacted for consumer protection many years ago, apply to our online market services. However, one or more jurisdictions may attempt to impose these laws and regulations on our operations in the future. WE MAY BECOME SUBJECT TO CERTAIN SALES AND OTHER TAXES THAT COULD ADVERSELY AFFECT OUR BUSINESS The imposition of sales, value-added or similar taxes could diminish our competitiveness and harm our business. We do not collect sales or other similar taxes for goods purchased through our online markets. Our customers are large purchasing organizations that typically manage and pay their own sales and use taxes. However, we may be subject to sales tax collection obligations in the future. OUR INTERNATIONAL OPERATIONS SUBJECT US TO RISKS AND UNCERTAINTIES We face risks in doing business internationally. We provide our services to international buyers and often have international suppliers participate in our marketplace. We have international subsidiaries located in Europe, Asia and Australia that serve our customers based abroad, as well as the European, Asian and Australian operations of our multinational customers based in the United States. We also plan to establish similar branches or subsidiaries in other parts of the world. We have experienced, and expect to continue to experience, significant costs for our international operations as we add staff and facilities in foreign countries. These costs, together with the costs of the overhead needed to comply with legal, regulatory and accounting requirements that differ from those in the United States, may reduce our operating results. Finally, our international operations are subject to disruption from political and economic instability in the countries in which they are located, which may interrupt our ability to conduct business and impose additional costs upon us. OUR STOCK PRICE IS VOLATILE, WHICH COULD RESULT IN SUBSTANTIAL LOSSES FOR STOCKHOLDERS The market price for our common stock is highly volatile and subject to wide fluctuations in response to the risks described above and many other factors, some of which are beyond our control. The market prices for stocks of Internet companies and other companies whose businesses are heavily dependent on the Internet have generally proven to be highly volatile, particularly in recent quarters. 17 20 MANAGEMENT The following table sets forth information regarding our executive officers as of March 1, 2001.
NAME AGE POSITION(S) ---------------------------- --- ------------------------------------------------------------ Glen T. Meakem.............. 37 Chief Executive Officer and Chairman of the Board David J. Becker............. 37 President, Chief Operating Officer and Director William R. Blair............ 49 Senior Vice President and Chief Technology Officer Scott D. Grimes............. 38 Senior Vice President of Business Development Joan S. Hooper.............. 43 Senior Vice President and Chief Financial Officer John P. Levis, III.......... 39 Senior Vice President of People Development David H. McCormick.......... 35 Senior Vice President and General Manager of Core Business Markets Douglas M. Wnorowski........ 39 Senior Vice President of Operations
GLEN T. MEAKEM co-founded FreeMarkets in 1995 and has served as its Chief Executive Officer, Chairman of the Board and a director since inception. Mr. Meakem also held the office of President from FreeMarkets' inception until June 2000. Prior to co-founding FreeMarkets, from May 1994 to February 1995, Mr. Meakem was employed as a manager in the Corporate Business Development Group of General Electric Co. DAVID J. BECKER has served as the President of FreeMarkets since June 2000 and as its Chief Operating Officer since March 1998. Prior to becoming President, Mr. Becker served as an Executive Vice President since March 1998. From October 1996 to February 1998, Mr. Becker served as our Vice President of Market Making. Prior to joining FreeMarkets, from March 1992 to September 1996, Mr. Becker was employed with Dole Fresh Fruit International, Ltd., where he worked in key financial and management positions at Dole's Latin and South American headquarters and subsidiaries. Mr. Becker's most recent position with Dole was a Manager, Worldwide Logistics Information Network. WILLIAM R. BLAIR has served as Senior Vice President and Chief Technology Officer of FreeMarkets since June 2000. From March 1999 to June 2000, Mr. Blair served as Vice President of Product Engineering. Mr. Blair joined FreeMarkets in March 1999 from Trost Manufacturing, where he served as Vice President and General Manager. Prior to joining Trost, Mr. Blair held a number of manufacturing and information technology management positions at General Electric, where he built his career for over 20 years. Most recently at GE, Mr. Blair was a key technology executive for the GE Trading Process Network. SCOTT D. GRIMES has served as Senior Vice President of Business Development since February 2000. Prior to joining FreeMarkets, Mr. Grimes was employed by Paging Network Inc., a leading provider of wireless messaging and information services across the United States and Canada; most recently, Mr. Grimes served as senior vice president of corporate development for Vast Solutions, a PageNet subsidiary from April 1998 to February 2000. Prior to joining Paging Network Inc., Mr. Grimes was a principal at McKinsey & Company, Inc. from June 1991 to April 1998. JOAN S. HOOPER has served as Senior Vice President since June 2000 and as Chief Financial Officer and Treasurer since September 1999. Before becoming Senior Vice President, Ms. Hooper served as a Vice President from September 1999. Prior to joining FreeMarkets, Ms. Hooper was employed by AT&T Corp. from March 1979 to September 1999, serving in several key financial and senior management positions within various divisions, including divisions that are now independent companies -- Lucent Technologies, Inc., US West, Inc. and NCR Corp. Ms. Hooper's most recent position was a Financial Vice President of AT&T Business Services. Ms. Hooper is a Certified Public Accountant and Certified Management Accountant. JOHN P. LEVIS, III has served as Senior Vice President of People Development since June 2000 and as Vice President of People Development since September 1998. From January 1997 to September 1998, Mr. Levis served as our Vice President of Client Development. Prior to joining FreeMarkets, from August 1990 to December 1996, Mr. Levis was a consultant with McKinsey & Company, Inc., where he served 18 21 healthcare, financial services, energy, food service and media clients on issues of marketing, channel strategy and cost management. DAVID H. MCCORMICK has served as Senior Vice President and General Manager of Core Business Markets since June 2000 and as Vice President and General Manager of Core Business Markets since December 1999. Prior to joining FreeMarkets, Mr. McCormick was a senior executive with McKinsey & Company, Inc. DOUGLAS M. WNOROWSKI has served as Senior Vice President of Operations of FreeMarkets since June 2000. From June 1999 to June 2000, Mr. Wnorowski served as our Vice President of Supply Markets. Prior to joining FreeMarkets, from August 1992 to June 1999, Mr. Wnorowski was employed by Respironics Inc., a developer, manufacturer and marketer of medical devices for respiratory disorder patients, where he served in several key management and leadership positions in the areas of sales and marketing, operations, mergers and acquisitions, and business development. Mr. Wnorowski's most recent position with Respironics was as Vice President of Sales and Marketing with responsibility for Europe, Africa and the Middle East. ITEM 2. PROPERTIES Our corporate offices are located in leased space at FreeMarkets Center, 210 Sixth Avenue, Pittsburgh, Pennsylvania. The telephone number of our principal executive office is (412) 434-0500. Our headquarters in Pittsburgh, Pennsylvania currently occupies 182,000 square feet of office space under a lease that expires in May 2010. We believe that our existing facilities in Pittsburgh, coupled with options we have to lease additional space, are adequate for our growth needs for the next several years. We also lease office space in six other North American metropolitan areas, as well as four in Europe and six in Asia and Australia. We may add additional offices in the United States and in other countries. ITEM 3. LEGAL PROCEEDINGS In 2000, ten securities fraud class action complaints were filed against the Company and three executive officers in federal court in Pittsburgh, Pennsylvania, which the court consolidated into a single proceeding. The plaintiffs alleged that the Company and the other defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. The Company and the individual defendants moved to dismiss the case on the grounds that the plaintiffs failed to allege facts sufficient to support their claim that the defendants violated the securities laws. On December 27, 2000, the court granted the motion to dismiss, having concluded that the plaintiffs' complaint was legally deficient. Although the court granted the plaintiffs leave to amend their complaint in an attempt to cure its deficiencies, the plaintiffs elected to abandon their claims altogether. On February 16, 2001, the court dismissed the case with prejudice pursuant to a stipulation of voluntary dismissal executed by all parties. The case is now closed. No money or other consideration was given, or will be given, to the plaintiffs or their counsel in exchange for their agreement to dismiss the case. Since April 27, 2001, five securities fraud class action complaints have been filed against the Company and two executive officers in federal court in Pittsburgh, Pennsylvania. The complaints, all of which assert the same claims, stem from the Company's announcement on April 23, 2001 that, as a result of ongoing discussions with the staff of the SEC, the Company was considering amending its 2000 financial statements for the purpose of reclassifying fees earned by the Company under a service contract with Visteon. The Company and the individual defendants believe that the plaintiffs' allegations are completely without merit and they intend to defend these claims vigorously. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. 19 22 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS MARKET FOR THE COMPANY'S COMMON STOCK Our common stock has been quoted on the Nasdaq National Market since December 10, 1999 under the symbol "FMKT". On March 1, 2001, the last sale price of the common stock was $18.25 per share. The following table sets forth the range of high and low bid prices of our common stock for the periods indicated. Such over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.
THREE MONTHS ENDED -------------------------------------------------------------------------- MARCH 31, 2000 JUNE 30, 2000 SEPTEMBER 30, 2000 DECEMBER 31, 2000 -------------- ------------- ------------------ ----------------- PRICE RANGE PER SHARE Low.......................... $119.88 $ 36.75 $37.63 $16.00 High......................... $370.00 $135.00 $92.06 $58.50
As of March 1, 2001, there were approximately 413 holders of record of our common stock. We believe that a substantially larger number of beneficial owners hold shares of our common stock in depository or nominee form. DIVIDEND POLICY We have never declared or paid cash dividends on our capital stock. We do not anticipate paying any cash dividends in the foreseeable future, as we intend to retain any future earnings to finance the expansion of our business. Moreover, our bank credit facility restricts our ability to pay cash dividends. 20 23 ITEM 6. SELECTED FINANCIAL DATA
YEAR ENDED DECEMBER 31, ------------------------------------------------------------------- 2000 1999 1998 1997 1996 ----------- ----------- ----------- ----------- ----------- (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) CONSOLIDATED STATEMENT OF OPERATIONS DATA: Revenues......................... $ 83,339 $ 20,880 $ 7,801 $ 1,783 $ 409 ----------- ----------- ----------- ----------- ----------- Operating costs and expenses: Cost of revenues............... 48,896 12,166 4,258 1,149 506 Research and development, excluding stock compensation................ 19,121 4,913 842 292 394 Sales and marketing, excluding stock compensation and warrant costs............... 41,505 11,939 656 586 321 General and administrative, excluding stock compensation................ 34,081 9,316 2,026 837 630 Stock compensation -- research and development............. 443 283 -- -- -- Stock compensation and warrant costs -- sales and marketing................... 5,965 4,669 -- -- -- Stock compensation -- general and administrative.......... 3 248 -- -- -- Goodwill amortization.......... 90,749 -- -- -- -- Write-off of in-process research and development.... 7,397 -- -- -- -- ----------- ----------- ----------- ----------- ----------- Total operating costs and expenses....................... 248,160 43,534 7,782 2,864 1,851 ----------- ----------- ----------- ----------- ----------- Operating (loss) income.......... (164,821) (22,654) 19 (1,081) (1,442) Interest and other income, net......................... 8,409 833 215 20 11 ----------- ----------- ----------- ----------- ----------- Net (loss) income................ $ (156,412) $ (21,821) $ 234 $ (1,061) $ (1,431) =========== =========== =========== =========== =========== Earnings per share: Basic.......................... $ (4.21) $ (1.46) $ 0.02 $ (0.10) $ (0.14) Diluted........................ (4.21) (1.46) 0.01 (0.10) (0.14) Weighted average shares: Basic.......................... 37,189,440 14,914,189 11,191,670 10,618,481 10,316,599 Diluted........................ 37,189,440 14,914,189 26,776,611 10,618,481 10,316,599
AS OF DECEMBER 31, ------------------------------------------------------------------- 2000 1999 1998 1997 1996 ----------- ----------- ----------- ----------- ----------- (IN THOUSANDS) CONSOLIDATED BALANCE SHEET DATA: Cash and short-term investments.................... $ 121,148 $ 210,244 $ 1,656 $ 1,999 $ 523 Working capital.................. 108,874 208,850 3,814 2,783 505 Total assets..................... 462,546 231,654 6,870 3,336 985 Long-term debt, excluding current portion........................ 544 3,278 413 -- 21 Total stockholders' equity....... 416,798 218,654 4,592 3,052 792
21 24 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes. OVERVIEW FreeMarkets creates business-to-business online auctions and provides electronic commerce technology and services to buyers of industrial parts, raw materials, commodities and services. We have created more than 9,200 online auctions--which we call "markets"--for more than $14 billion worth of goods and services for our customers. We estimate, based upon the difference between the prices that our customers have historically paid and the lowest prices that are identified in our auctions, that our auctions have resulted in potential savings of over $2.7 billion for our customers. We combine our proprietary technology platform with an in-depth knowledge of the supply markets for direct materials. Because direct materials are often custom-made to buyers' specifications, there are no catalogs or price lists to enable buyers to make price comparisons. The purchasing process is further complicated by the fragmentation of many supply markets and the importance of product quality in supplier selection. Because this complexity leads to market inefficiencies, we think that buyers of direct materials often pay prices that are too high. Our online markets help buyers of direct materials obtain lower prices and make better purchasing decisions. In a FreeMarkets online market, suppliers from around the world can submit bids in a real-time, interactive competition that is designed to be fair to all participants. We offer customers our FullSource solution, in which we help the customer to identify and screen suppliers and to assemble a request for quotation that provides detailed, clear and consistent information for suppliers to use as a basis for their competitive bids. We also offer our QuickSource solution, which enables customers to use our technology to run their own online markets. In addition, we operate the FreeMarkets Asset Exchange for buyers and sellers of surplus assets and inventory. DETERMINATION OF ONLINE MARKET VOLUME AND ACHIEVABLE SAVINGS We believe that one indicator of our market acceptance is the dollar volume of materials, commodities and services for which we create online markets on behalf of our customers. We measure this online market volume by multiplying the lowest bid price per unit in each online market by the estimated number of units that our customer expects to purchase. When our customers specify multi-year purchases in a request for quotation, we calculate online market volume for the estimated term. Online market volume does not necessarily correlate with either our revenues or our operating results in any particular period due to the seasonality of our customers' purchasing needs, the timing of the addition of new customers, the length of the customer contracts and the industry in which the items in the online markets will be used. We believe that online market volume may be correlated with revenues and operating results over periods of one year or longer; however, because of our limited operating history, a strong correlation has not yet been demonstrated. Moreover, online market volume has varied in the past, and we expect it to vary in the future. The following table sets forth our online market volume for the periods indicated:
YEAR ENDED DECEMBER 31, ---------------------------------------- 2000 1999 1998 1997 1996 ------ ------ ---- ---- ---- (IN MILLIONS) Online market volume....................... $9,928 $2,725 $979 $257 $124
We believe that the savings achievable by customers through our online markets is an indicator of the effectiveness of our online market services. To estimate these savings, we compare the last price paid by our customer for the items in our online markets against the lowest bid price for those items in our online market. Actual savings that our customers achieve may not equal these estimates because our customer may not select 22 25 the lowest bid price, the parties may agree to change price terms after our online market or our customer may not actually buy all or any of the items for which bids have been received in our online markets. Many of our agreements with customers provide for incentive compensation based on online market volume and/or savings. These agreements may calculate online market volume or savings differently than the methods we use to calculate online market volume and savings for the purposes described above. REVENUES Our selected financial data exclude from revenues the amounts that we earn under a contract with Visteon Corporation pursuant to which we provide access to our eMarketplace and perform services for Visteon. Visteon pays us fixed monthly fees plus variable fees if specified volume thresholds are exceeded. At the time we executed the service contract, we granted a warrant for 1.75 million shares to Visteon with an exercise price of $.01 per share, and we receive marketing and public relations benefits as a result of our relationship with Visteon. The warrant was valued at $95.5 million using the Black-Scholes pricing model at the date of the grant in April 2000. Because of the grant of this warrant, we are required to exclude from our revenues the fees we earn from Visteon, and to allocate those fees as payment for the warrant. However, we view our relationship with Visteon as a customer relationship, and for all business and operational purposes in which revenue is a factor in the decision, including budgets, forecasts, allocation of resources, sales compensation and bonus decisions and other performance indicators, we treat the fees we earn from Visteon in the same manner as revenues from other customers. Accordingly, we have referred, where applicable, to "revenues plus Visteon fees" throughout Management's Discussion and Analysis of Financial Condition and Results of Operations in order to accurately describe our analysis of our operations. Below is a reconciliation of revenues under generally accepted accounting principles with revenues plus the fees under our service contract with Visteon: Revenues plus fees under Visteon service contract characterized as payment for warrant...................... $91,276,346 Less fees under Visteon service contract characterized as payment for warrant....................................... 7,937,500 ----------- Revenues.................................................... $83,338,846 ===========
We generate revenues under service agreements with our customers. Our service agreements typically provide us with revenues from fixed monthly fees, and may also include performance incentive payments based on volume and/or savings. The revenue structure in a particular service agreement may vary, depending upon the needs of our customer and the conventional practices in the supply market where our customer obtains its materials, commodities or services. The monthly fees that we receive are for the use of our technology, supplier and supply market information, market making and market operations staff and facilities. Negotiated monthly fees vary by customer, and reflect both the anticipated online market volume and the staffing, expertise and technology we anticipate committing to complete the services requested by our customers. Fixed monthly fees constitute a majority of our revenues, and we expect that these monthly fees will continue to constitute a majority of our revenues. We recognize revenues from our fixed monthly fees ratably as we provide services. Our agreements range in length from a few months to as many as five years. At any given time, we have agreements of varying lengths with staggered expirations. Some of our service agreements permit early termination by our customers without penalty. Many of our agreements include performance incentive payments that are contingent upon our customer achieving specific online market volume and/or savings, as set forth in the respective agreements. We recognize these revenues as the thresholds are achieved. We expect that as our volume grows, the revenues attributable to these incentive payments will also grow over time in terms of absolute dollars, but not necessarily as a percentage of revenues. Our service contract with Visteon is a standard customer agreement (except for the warrant). The contract with Visteon has a five-year term ending in 2005, and, as of December 31, 2000, provided for a fixed 23 26 monthly payment stream larger than any other customer contract. We do not expect to recognize revenues under our Visteon service contract for either the fixed or any variable fees we earn because we have determined, as a result of a review by the staff of the SEC, that we must allocate those fees as payment for the warrant that we granted to Visteon. We incurred approximately $3 million in direct costs in 2000 to service the Visteon contract. We estimate that the direct costs that we will incur to service the Visteon contract from December 31, 2000 through the expiration of the contract will be approximately $19 million in excess of the revenue that we will recognize under generally accepted accounting principles from that contract. We will recognize the resulting loss over the life of the contract as costs are incurred to service the contract. LIMITED OPERATING HISTORY Our limited operating history makes predicting future operating results very difficult. We believe that you should not rely on the period-to-period comparison of our operating results to predict our future performance. You must consider our prospects in light of the risks, expenses and difficulties encountered by companies in new and rapidly evolving markets. We may not be successful in addressing these risks and difficulties. Although we have experienced significant percentage growth in revenues in recent periods, we may not be able to sustain our prior growth rates. Our prior growth may not be indicative of future operating results. The recent slowdown in the economy may cause customers to defer or postpone their purchasing decisions, increasing sales cycles for our products and services and possibly reducing our revenue and income. In addition, the amount of fixed monthly fees that we are able to negotiate for new contracts may be adversely affected based on lower anticipated market volume from our customers. The amount of revenue we earn from variable fees, such as performance incentive payments based on volume and/or savings, may also decline as a result of lower volumes. CUSTOMER CONCENTRATION We depend on United Technologies and Visteon for a material portion of our revenues and fees. In October 2000, we entered into a three-year contract extension with United Technologies. In April 2000, we entered into a five-year agreement with Visteon that provides for a fixed monthly payment stream larger than any other current customer contract. Revenues from United Technologies were $9,014,000 in 2000 and $7,006,000 in 1999. Fees from Visteon were $7,937,500 in 2000. We anticipate that we will continue to diversify our base of customers by adding new customers and increasing sales to existing customers, and that the percentage of total revenues and fees that we derive from United Technologies and Visteon will decrease. 24 27 RESULTS OF OPERATIONS The following table sets forth consolidated statement of operations data as a percentage of revenues for the periods indicated:
YEAR ENDED DECEMBER 31, ------------------------- 2000 1999 1998 ------ ------ ----- Revenues plus fees under Visteon service contract characterized as payment for warrant.................... 100.0% 100.0% 100.0% Less fees under Visteon service contract characterized as payment for warrant............................... 8.7 -- -- ------ ------ ----- Revenues.................................................. 91.3 100.0 100.0 ------ ------ ----- Operating costs and expenses: Cost of revenues........................................ 53.6 58.3 54.6 Research and development, excluding stock compensation......................................... 21.0 23.5 10.8 Sales and marketing, excluding stock compensation and warrant costs........................................ 45.5 57.2 8.4 General and administrative, excluding stock compensation......................................... 37.3 44.6 26.0 Stock compensation--research and development............ 0.5 1.3 -- Stock compensation and warrant costs--sales and marketing............................................ 6.5 22.4 -- Stock compensation--general and administrative.......... 0.0 1.2 -- Goodwill amortization................................... 99.4 -- -- Write-off of in-process research and development........ 8.1 -- -- ------ ------ ----- Operating (loss) income................................... (180.6) (108.5) 0.2 Interest and other income, net.......................... 9.2 4.0 2.8 ------ ------ ----- Net (loss) income......................................... (171.4%) (104.5%) 3.0% ====== ====== =====
YEARS ENDED DECEMBER 31, 2000 AND 1999 REVENUES Revenues plus Visteon fees increased 337% from $20.9 million in 1999 to $91.3 million in 2000. The increase in revenues plus Visteon fees is primarily attributable to a larger number of new customers for which we conducted online markets, as well as increased use of our services by existing customers. The number of customers served increased 186% from 35 in 1999 to 100 in 2000. Online market volume grew 264% from $2.7 billion in 1999 to $9.9 billion in 2000. Revenues in 2000 exclude Visteon fees of $7,937,500. OPERATING COSTS AND EXPENSES COST OF REVENUES. Cost of revenues increased from $12.2 million in 1999 to $48.9 million in 2000. As a percentage of revenues plus Visteon fees, cost of revenues decreased from 58% in 1999 to 54% in 2000. The increase in absolute dollar amounts from 1999 to 2000 reflects an increase in the number of market making staff to serve our growing customer base and the increased cost of our operations due to the expansion of our office space and our services into international locations. Cost of revenues includes the costs we incur in performing our obligations under the Visteon service contract, even though the fees we earn under that contract are excluded from revenues. The decrease in cost of revenues as a percentage of revenues plus Visteon fees from 1999 to 2000 is primarily the result of increased staff productivity as our personnel became more specialized in various market making activities. Also, we have attained some operating efficiencies from our investments in information tools to automate portions of our market making process, as well as organizing our market making staff in such a way to take advantage of our domain supply vertical expertise. Although we will continue to invest in the 25 28 growth of our business, we expect our cost of revenues as a percentage of revenues plus Visteon fees to continue to decrease in the future. RESEARCH AND DEVELOPMENT, EXCLUDING STOCK COMPENSATION. Research and development costs increased from $4.9 million, or 24% of revenues in 1999, to $19.1 million, or 21% of revenues plus Visteon fees in 2000. The increase in absolute dollars relates primarily to an increase in the number of research and development staff and associated costs for the continued development of our BidWare software and other market making technology, which is designed to further improve staff productivity. As a result of a change in certain information technology initiatives, we recognized additional depreciation and other charges of $1.6 million in the third quarter of 2000 related to capitalized software and other computer equipment. We expect to increase our research and development costs in absolute dollars in future periods to invest in new technology for future product and service offerings, particularly our e-Sourcing platform, and to adapt and add features to our existing technology; however, we anticipate these costs will continue to decrease as a percentage of revenues plus Visteon fees in future periods. SALES AND MARKETING, EXCLUDING STOCK COMPENSATION AND WARRANT COSTS. Sales and marketing costs increased from $11.9 million, or 57% of revenues in 1999, to $41.5 million, or 46% of revenues plus Visteon fees in 2000. The increase in absolute dollars reflects a significant growth in sales and marketing staff, public relations costs, trade shows and advertising as we pursued our brand and business development strategy and accelerated our spending on potential future growth. We expect to continue to increase our sales and marketing costs in absolute dollars in future periods to promote our brand, to pursue our business development strategy and to increase the size of our sales force; however, we anticipate these costs will continue to decrease as a percentage of revenues plus Visteon fees in future periods. GENERAL AND ADMINISTRATIVE, EXCLUDING STOCK COMPENSATION. General and administrative costs increased from $9.3 million, or 45% of revenues in 1999, to $34.1 million, or 37% of revenues plus Visteon fees in 2000. The increase in absolute dollars is primarily attributable to the addition of personnel to our general and administrative staff in the areas of technical operations, human resources, legal, finance and facilities management. The increase can also be attributed to the expansion of our infrastructure from four offices at the end of 1999 to eighteen offices at the end of 2000, many of which are international offices to support our growing customer base. As a result of our transition to a globally-integrated enterprise resource planning ("ERP") system, we recognized additional depreciation and other charges of $1.2 million in the third quarter of 2000 related to software and other computer equipment. We expect that general and administrative costs will continue to increase in absolute dollars in future periods as we continue to add staff and infrastructure to support our domestic and international business growth and bear the increased costs associated with being a public company; however, we anticipate these costs will continue to decrease as a percentage of revenues plus Visteon fees in future periods. STOCK COMPENSATION AND WARRANT COSTS. We recorded $2.0 million of unearned stock compensation related to employee stock options granted in June and July 1999, which is being amortized over a five-year period ending June 2004. In 1999 and 2000, $451,000 and $414,000, respectively, was amortized related to these grants. In September 1999, we recorded $4.5 million of warrant costs related to a warrant granted to a customer. In April 2000, we recorded $95.5 million of unearned warrant costs related to a warrant granted to Visteon. This value was calculated using the Black-Scholes pricing model at the date of grant and is being amortized over a five-year period ending April 2005. In 2000, $13.5 million was amortized related to this warrant, with $7.9 million reflected as a reduction to our revenues (reducing the revenues under the Visteon service contract to zero) and $5.6 million as stock compensation and warrant costs -- sales and marketing. In April 2000, we also recorded $196,000 of unearned stock compensation related to stock options granted to a consultant, which is being amortized over a one-year period ending March 2001. In 2000, $147,000 was amortized related to this grant. In 2000, we also recorded $314,000 of stock compensation related to a modification of stock options held by a former employee. GOODWILL AMORTIZATION. In connection with our acquisitions of iMark.com, Inc. ("iMark") and Surplus Record, Inc. and SR Auction, Inc. (collectively, "Surplus Record") in March 2000, we recorded goodwill of $354.3 million, of which $90.7 million was amortized in 2000. 26 29 WRITE-OFF OF IN-PROCESS RESEARCH AND DEVELOPMENT. Also in connection with our acquisition of iMark in March 2000, we recorded a one-time write-off of in-process research and development of $7.4 million. INTEREST AND OTHER INCOME, NET Interest and other income was $833,000 in 1999 compared to $8.4 million in 2000. The increase was primarily attributable to increased interest income from the investment of proceeds from our initial public offering ("IPO") into interest-bearing, investment grade securities. In 2000, we earned $10.1 million of interest income at a weighted-average rate of return of 6.1%. Interest and other income was partially offset by $1.0 million of asset write-offs in 2000. YEARS ENDED DECEMBER 31, 1999 AND 1998 REVENUES Revenues increased 168% from $7.8 million in 1998 to $20.9 million in 1999. The increase in revenues is primarily attributable to an increased number of new customers for which we conducted online markets, as well as increased use of our services by existing customers. The number of customers served increased 192% from 12 in 1998 to 35 in 1999. Revenues in both periods were concentrated in two customers, United Technologies and General Motors. Revenues from United Technologies increased 56% from $4.5 million in 1998 to $7.0 million in 1999 due to its increased use of our online market services and technology. Revenues from General Motors increased 107% from $1.5 million in 1998 to $3.1 million in 1999 due to the incremental effect of its long-term agreement with us beginning in June 1998, as well as the growth of the revenues earned under this agreement from Delphi Automotive Systems, a former subsidiary of General Motors. OPERATING COSTS AND EXPENSES COST OF REVENUES. Cost of revenues increased from $4.3 million in 1998 to $12.2 million in 1999. As a percentage of revenues, cost of revenues increased from 55% to 58%. The increase in absolute dollar amounts from 1998 to 1999 reflects an increase in the number of market making staff and the increased cost of our operations due to a relocation of our headquarters to a larger facility. The increase in cost of revenues as a percentage of revenues is primarily the result of our rapid growth in the number of customers served from 12 in 1998 to 35 in 1999, many of which enter into short-term agreements with us initially in order to try our services before committing to longer-term relationships. Generally, we do not achieve economies of scale early in a customer relationship. Therefore, our cost of revenues as a percentage of revenues are typically higher in the early stages of a customer relationship. Also, cost of revenues as a percentage of revenues in 1998 was favorably affected by a $1.6 million performance incentive from United Technologies. RESEARCH AND DEVELOPMENT, EXCLUDING STOCK COMPENSATION. Research and development costs increased from $842,000, or 11% of revenues in 1998, to $4.9 million, or 24% of revenues in 1999. The increase in both absolute dollars and as a percentage of revenues relates primarily to an increase in the number of research and development staff and associated costs for the continued development of our BidWare software and other market making technology, which is designed to further improve staff productivity. SALES AND MARKETING, EXCLUDING STOCK COMPENSATION AND WARRANT COSTS. Sales and marketing costs increased from $656,000, or 8% of revenues in 1998, to $11.9 million, or 57% of revenues in 1999. The increase in both absolute dollars and as a percentage of revenues reflects a significant ramp-up in sales and marketing staff, public relations costs, trade shows and advertising as we pursued our brand and business development strategy and accelerated our spending on potential future growth. As a result, sales and marketing costs in 1999 included certain costs not incurred in the same period in 1998, such as those for advertising in professional trade magazines, airport advertising and other promotions. GENERAL AND ADMINISTRATIVE, EXCLUDING STOCK COMPENSATION. General and administrative costs increased from $2.0 million, or 26% of revenues in 1998, to $9.3 million, or 45% of revenues in 1999. The increase in both absolute dollars and as a percentage of revenues is primarily attributable to the addition of 27 30 personnel to our general and administrative staff in the areas of technical operations, human resources, legal, finance and facilities management. The increase is also attributable to start-up costs of $200,000 and other recurring costs of $1.3 million associated with our European subsidiary, which we established in late 1998. STOCK COMPENSATION AND WARRANT COSTS. In September 1999, we issued a warrant to a customer to purchase 304,431 shares of Series D preferred stock at an exercise price of $.01 per share, in exchange for the customer's agreement to delete from its contract with us provisions that limited our ability to render services to its competitors. As a result, we recorded an expense of $4.5 million in September 1999. Additionally, we recorded $2.0 million of unearned stock compensation related to employee stock options granted in June and July 1999. In 1999, $451,000 was amortized related to these grants. We also recorded a one-time charge of $246,000 to stock compensation related to options granted to our Assistant Secretary, who is neither an employee nor a director. INTEREST AND OTHER INCOME, NET Interest and other income was $215,000 in 1998 compared to $833,000 in 1999. The increase was primarily attributable to increased interest income from the investment of proceeds from our IPO into interest-bearing, investment grade securities. Additionally, we received an economic development grant from the Commonwealth of Pennsylvania for $150,000 during 1998 and wrote off property and equipment of $119,000 related to our move to our new headquarters in 1999. LIQUIDITY AND CAPITAL RESOURCES We have historically satisfied our cash requirements primarily through a combination of revenues, equity financing transactions and bank borrowings. In December 1999, we completed our IPO, which resulted in net proceeds of $182.2 million. As of December 31, 2000, we had cash and cash equivalents of $53.0 million, short-term investments of $68.2 million and working capital of $108.9 million. Net cash used in operating activities totaled $1.2 million in 1998, $15.9 million in 1999 and $40.2 million in 2000. Our use of cash in 1998 was primarily attributable to an increase in working capital. The use of cash in 1999 and 2000 related primarily to the operating loss generated by our investment in the growth of our business, including an increase in personnel from 376 at the end of 1999 to 968 at the end of 2000. In addition, in March 1999, we began leasing a significantly larger corporate headquarters facility. The lease, which runs through May 2010, currently requires an annual lease payment of $3.8 million. Our lease payments will grow as we take additional office space. Net cash used in operating activities in 2000 does not reflect $5.0 million received under our service contract with Visteon. Net cash used in investing activities totaled $859,000 in 1998, $43.7 million in 1999 and $91.5 in 2000. Our use of cash in investing activities in 1998 resulted primarily from our continued additions to and upgrade of computing and telecommunications equipment. At the end of 1998, we began purchasing equipment and reduced our use of leased equipment. During 1999 and 2000, we spent approximately $10.4 million and $39.6 million, respectively, to furnish our new facility and purchase computing and telecommunications equipment to accommodate our increase in personnel. We also spent $33.0 million and $167.7 million in 1999 and 2000, respectively, to purchase short-term investments, partially offset by the maturity of short-term investments totaling $132.6 million in 2000. We also used $16.7 million related to acquisitions that closed in March 2000. Net cash provided by financing activities totaled $1.7 million in 1998, $235.1 million in 1999 and $7.5 million in 2000. The positive financing cash flows in 1998, 1999 and 2000 primarily reflect the net proceeds from the issuance of stock, bank borrowings and the exercise of stock options and warrants. Cash provided by financing activities in 2000 includes $5.0 million received under our service contract with Visteon. We are required to classify these receipts as payment for the warrant that we granted to Visteon in April 2000. Cash provided by financing activities in 2000 was partially offset by the repayment of debt assumed in the iMark acquisition. Prior to November 2000, we had in place a $10.0 million bank facility, consisting of a $5.0 million revolving line of credit and two equipment loans originally totaling $5.0 million. In November 2000, we 28 31 terminated the $10.0 million facility and entered into a one-year revolving credit facility with a maximum borrowing base of $25.0 million. At December 31, 2000, $16.2 million was available based on eligible accounts receivable. Borrowings under the new facility bear interest at the lender's prime rate. As of December 31, 2000, $3.7 million was outstanding under the facility and the interest rate was 9.5%. Our current bank credit facility contains restrictive covenants, including a limitation on incurring additional indebtedness and paying dividends. Our bank credit facility also includes requirements as to minimum tangible net worth and current and debt service ratios. We have pledged substantially all of our tangible assets as collateral for the current credit facility. Capital expenditures were $10.4 million in 1999 and $39.6 million in 2000. Capital expenditures over these periods were primarily made to purchase computer and telecommunications equipment and furnishings in our new corporate headquarters and other offices, as well as to expand our network and server capacity. In 2000, we implemented an ERP that more fully integrates our financial systems and other operational reporting. This system went live in October 2000. We funded these capital expenditures through a combination of sales of our equity securities and bank borrowings. We intend to fund future capital expenditures through a combination of proceeds from our IPO, bank borrowings and cash from operations. As a result of the significant investments we have made in our operations, infrastructure and personnel in 2000, we anticipate a decrease in our capital expenditures in future periods. We expect to experience growth in our operating costs for the foreseeable future in order to execute our business plan, particularly in the areas of research and development and sales and marketing. We also expect to open new domestic and international offices in order to support the needs of our existing and anticipated customers. As a result, we estimate that these operating costs, as well as other planned expenditures, will constitute a significant use of our cash resources. In addition, we may use cash resources to fund acquisitions of complementary businesses and technologies. We believe that our current cash resources will be sufficient to meet our working capital and capital expenditures for at least the next 18 to 24 months. Thereafter, we may find it necessary to obtain additional financing. In the event that additional financing is required, we may not be able to raise it on terms acceptable to us, if at all. INCOME TAXES We incurred a net taxable loss in 2000 and 1999, and therefore did not record a provision for income taxes in those periods. In 1998, we offset our net taxable income through the use of net operating loss carryforwards. As of December 31, 2000, we had $83.9 million of federal and state net operating loss carryforwards for tax reporting purposes available to offset future taxable income. We may use these operating loss carryforwards to offset future federal and state income taxes through 2020 and 2010, respectively. However, in 1996 we sold a sufficient amount of our convertible preferred stock to constitute an "ownership change" under the Internal Revenue Code; as a result, our future utilization of these net operating loss carryforwards that we accumulated prior to that change in ownership, amounting to $2.2 million, will be subject to a limitation of $441,000 per year. We may generate additional net operating loss carryforwards in the future; however, there is no guarantee that we will be able to fully utilize all of them. RECENT ACCOUNTING PRONOUNCEMENT In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities". SFAS No. 133, which is effective for all quarters beginning January 1, 2001, establishes accounting and reporting standards for derivative financial instruments and hedging activities related to those instruments. The adoption of this standard did not have a material impact on our consolidated financial statements. 29 32 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK FOREIGN CURRENCY RISK Nearly all of our revenues recognized to date have been denominated in United States dollars and are primarily from customers headquartered in the United States. We have several subsidiaries located in Europe, Asia and Australia, and we intend to establish additional foreign subsidiaries. In the future, a portion of the revenues we derive from international operations may be denominated in foreign currencies. We incur costs for our overseas offices in the local currency of those offices for staffing, rent, telecommunications and other services. As a result, our operating results could become subject to significant fluctuations based upon changes in the exchange rates of those currencies in relation to the United States dollar. Furthermore, to the extent that we engage in international sales denominated in United States dollars, an increase in the value of the United States dollar relative to foreign currencies could make our services less competitive in international markets. We believe that our only significant risk related to foreign currency is cash flow risk. Since the majority of our foreign currency denominated cash flows relate to funding the operations of our Belgian subsidiary and that currency relative to the United States dollar did not materially fluctuate during 2000, we do not believe this risk is material. We have and will continue to monitor our exposure to currency fluctuations and when appropriate, we will continue to use financial hedging techniques to minimize the effect of these fluctuations in the future. We cannot assure you that exchange rate fluctuations will not harm our business in the future. INTEREST RATE RISK Our interest income is sensitive to changes in the general level of United States interest rates, particularly because all of our investments are in short-term instruments. Borrowings under our existing credit lines are also interest rate sensitive, because the interest rate charged by our bank varies with changes in the prime rate of lending. At December 31, 2000, our short-term investments were $68.2 million and our average rate of return was 6.1%. Assuming a 10% hypothetical change in this average rate, our investment income would change by approximately $400,000. As it relates to our credit lines, we do not believe that our interest rate risk is material since the balance outstanding under our credit line was $3.7 million at December 31, 2000. 30 33 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Report of Independent Accountants........................... 32 Consolidated Balance Sheets as of December 31, 2000 and 1999...................................................... 33 Consolidated Statements of Operations for each of the three years in the period ended December 31, 2000............... 34 Consolidated Statements of Stockholders' Equity for each of the three years in the period ended December 31, 2000..... 35 Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2000............... 36 Notes to Consolidated Financial Statements.................. 37
31 34 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of FreeMarkets, Inc. and Subsidiaries: In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, stockholders' equity and cash flows present fairly, in all material respects, the financial position of FreeMarkets, Inc. and Subsidiaries (the Company) at December 31, 2000 and 1999 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000, 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 3, the Company has restated its 2000 financial statements for the classification of certain revenues. /s/ PricewaterhouseCoopers LLP Pittsburgh, Pennsylvania January 22, 2001, except for Notes 3 and 14, as to which the date is May 9, 2001 32 35 FREEMARKETS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
DECEMBER 31, ----------------------------- 2000 1999 ------------- ------------ ASSETS Current assets: Cash and cash equivalents................................. $ 52,991,185 $177,204,143 Short-term investments.................................... 68,156,811 33,040,205 Accounts receivable, net of allowance for doubtful accounts of $903,000 and $100,000 as of December 31, 2000 and 1999, respectively............................ 27,861,466 6,887,270 Other current assets...................................... 5,069,210 1,441,111 ------------- ------------ Total current assets................................... 154,078,672 218,572,729 Property and equipment, net............................... 43,713,700 12,541,404 Goodwill and other assets, net............................ 264,753,956 539,948 ------------- ------------ Total assets........................................... $ 462,546,328 $231,654,081 ============= ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable.......................................... $ 9,516,850 $ 4,763,795 Accrued incentive compensation............................ 10,234,665 899,410 Accrued acquisition costs................................. 4,676,058 -- Other current liabilities................................. 16,890,096 2,559,462 Short-term borrowings..................................... 3,703,071 -- Current portion of long-term debt......................... 184,061 1,499,962 ------------- ------------ Total current liabilities.............................. 45,204,801 9,722,629 Long-term debt.............................................. 543,782 3,277,716 ------------- ------------ Total liabilities...................................... 45,748,583 13,000,345 ------------- ------------ Commitments and contingencies Stockholders' equity: Preferred stock, $.01 par value, 5,000,000 shares authorized; zero shares issued and outstanding as of December 31, 2000 and 1999............................. -- -- Common stock, $.01 par value, 500,000,000 and 200,000,000 shares authorized; 38,787,966 and 35,139,147 shares issued and outstanding as of December 31, 2000 and 1999, respectively..................................... 387,880 351,391 Additional capital........................................ 503,064,928 244,909,299 Unearned stock-based compensation......................... (555,696) (1,525,194) Stock purchase warrants................................... 95,484,375 30,000 Accumulated other comprehensive loss...................... (170,848) (110,409) Accumulated deficit....................................... (181,412,894) (25,001,351) ------------- ------------ Total stockholders' equity............................. 416,797,745 218,653,736 ------------- ------------ Total liabilities and stockholders' equity............. $ 462,546,328 $231,654,081 ============= ============
The accompanying notes are an integral part of the consolidated financial statements. 33 36 FREEMARKETS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31, ------------------------------------------- 2000 1999 1998 ------------- ------------ ---------- Revenues.......................................... $ 83,338,846 $ 20,880,024 $7,801,250 ------------- ------------ ---------- Operating costs and expenses: Cost of revenues................................ 48,896,061 12,166,097 4,258,403 Research and development, excluding stock compensation................................. 19,120,783 4,912,672 841,874 Sales and marketing, excluding stock compensation and warrant costs............... 41,505,610 11,938,960 656,183 General and administrative, excluding stock compensation................................. 34,080,916 9,316,266 2,025,899 Stock compensation -- research and development.................................. 442,817 283,485 -- Stock compensation and warrant costs -- sales and marketing................................ 5,965,215 4,669,071 -- Stock compensation -- general and administrative............................... 2,695 247,765 -- Goodwill amortization........................... 90,748,939 -- -- Write-off of in-process research and development.................................. 7,396,853 -- -- ------------- ------------ ---------- Total operating costs and expenses.............. 248,159,889 43,534,316 7,782,359 ------------- ------------ ---------- Operating (loss) income...................... (164,821,043) (22,654,292) 18,891 Interest and other income, net.................. 8,409,500 832,883 214,856 ------------- ------------ ---------- Net (loss) income............................ $(156,411,543) $(21,821,409) $ 233,747 ============= ============ ========== Earnings per share: Basic........................................ $ (4.21) $ (1.46) $ .02 ============= ============ ========== Diluted...................................... $ (4.21) $ (1.46) $ .01 ============= ============ ==========
The accompanying notes are an integral part of the consolidated financial statements. 34 37 FREEMARKETS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
ACCUMULATED CONVERTIBLE UNEARNED STOCK OTHER PREFERRED COMMON ADDITIONAL STOCK-BASED PURCHASE COMPREHENSIVE ACCUMULATED STOCK STOCK CAPITAL COMPENSATION WARRANTS LOSS DEFICIT ----------- -------- ------------ ------------ ----------- ------------- ------------- Balance at December 31, 1997... $ 37,946 $ 36,586 $ 5,992,982 $ -- $ 398,000 $ -- $ (3,413,689) Employee common stock purchases, net of offering costs of $14,173........... -- 2,600 1,283,227 -- -- -- -- Options exercised............ -- 182 20,584 -- -- -- -- Net income................... -- -- -- -- -- -- 233,747 --------- -------- ------------ ----------- ----------- --------- ------------- Balance at December 31, 1998... 37,946 39,368 7,296,793 -- 398,000 -- (3,179,942) Stock purchase warrants exercised.................. -- 8,030 1,664,845 -- (368,000) -- -- Issuance of Series C preferred stock, net of offering costs of $737,044................... 7,685 -- 10,252,191 -- -- -- -- Options exercised............ -- 100 16,150 -- -- -- -- 3-for-1 stock split.......... 91,261 94,996 (186,257) -- -- -- -- Issuance of Series D preferred stock, net of offering costs of $197,840................... 20,578 -- 30,236,622 -- -- -- -- Issuance of Series D stock purchase warrants.......... -- -- -- -- 4,502,534 -- -- Stock purchase warrants exercised.................. 3,044 -- 4,502,534 -- (4,502,534) -- -- Options exercised............ -- 6,983 6,717,608 -- -- -- -- Unearned stock-based compensation............... -- -- 2,222,981 (1,525,194) -- -- -- Other comprehensive loss..... -- -- -- -- -- (110,409) -- Initial public offering, net of offering costs of $16,492,768................ (160,514) 201,914 182,185,832 -- -- -- -- Net loss..................... -- -- -- -- -- -- (21,821,409) --------- -------- ------------ ----------- ----------- --------- ------------- Balance at December 31, 1999... -- 351,391 244,909,299 (1,525,194) 30,000 (110,409) (25,001,351) Stock purchase warrants exercised.................. -- 1,956 133,994 -- (30,000) -- -- Options exercised............ -- 18,121 3,999,453 -- -- -- -- Unearned stock-based compensation............... -- -- (95,177) 969,498 -- -- -- Issuance of stock purchase warrants................... -- -- (95,484,375) -- 95,484,375 -- -- Amortization of stock purchase warrants, including $7,937,500 of customer fees.............. -- -- 13,473,906 -- -- -- -- Common stock issuance under Employee Stock Purchase Plan....................... -- 675 2,550,062 -- -- -- -- Other comprehensive loss..... -- -- -- -- -- (60,439) -- Common stock issued for purchase of iMark.......... -- 15,737 333,577,766 -- -- -- -- Net loss..................... -- -- -- -- -- -- (156,411,543) --------- -------- ------------ ----------- ----------- --------- ------------- Balance at December 31, 2000... $ -- $387,880 $503,064,928 $ (555,696) $95,484,375 $(170,848) $(181,412,894) ========= ======== ============ =========== =========== ========= ============= TOTAL ------------- Balance at December 31, 1997... $ 3,051,825 Employee common stock purchases, net of offering costs of $14,173........... 1,285,827 Options exercised............ 20,766 Net income................... 233,747 ------------- Balance at December 31, 1998... 4,592,165 Stock purchase warrants exercised.................. 1,304,875 Issuance of Series C preferred stock, net of offering costs of $737,044................... 10,259,876 Options exercised............ 16,250 3-for-1 stock split.......... -- Issuance of Series D preferred stock, net of offering costs of $197,840................... 30,257,200 Issuance of Series D stock purchase warrants.......... 4,502,534 Stock purchase warrants exercised.................. 3,044 Options exercised............ 6,724,591 Unearned stock-based compensation............... 697,787 Other comprehensive loss..... (110,409) Initial public offering, net of offering costs of $16,492,768................ 182,227,232 Net loss..................... (21,821,409) ------------- Balance at December 31, 1999... 218,653,736 Stock purchase warrants exercised.................. 105,950 Options exercised............ 4,017,574 Unearned stock-based compensation............... 874,321 Issuance of stock purchase warrants................... -- Amortization of stock purchase warrants, including $7,937,500 of customer fees.............. 13,473,906 Common stock issuance under Employee Stock Purchase Plan....................... 2,550,737 Other comprehensive loss..... (60,439) Common stock issued for purchase of iMark.......... 333,593,503 Net loss..................... (156,411,543) ------------- Balance at December 31, 2000... $ 416,797,745 =============
The accompanying notes are an integral part of the consolidated financial statements. 35 38 FREEMARKETS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, ------------------------------------------ 2000 1999 1998 ------------- ------------ ----------- Cash flows from operating activities: Net (loss) income................................ $(156,411,543) $(21,821,409) $ 233,747 Adjustments to reconcile net (loss) income to net cash used in operating activities: Write-off of in-process research and development................................. 7,396,853 -- -- Depreciation and amortization................. 9,629,793 1,185,690 191,052 Provision for bad debts....................... 1,367,044 172,666 5,000 Stock compensation and warrant costs.......... 6,410,727 5,200,321 -- Goodwill amortization......................... 90,748,939 -- -- Loss (gain) on disposal of property and equipment................................... 2,501,245 118,797 (3,443) Cash (used in) provided by changes in: Accounts receivable........................... (18,914,760) (3,120,631) (2,883,651) Other assets.................................. (3,878,120) (1,508,222) (78,516) Accounts payable.............................. 255,652 1,877,079 320,437 Other liabilities............................. 20,737,493 2,010,128 1,057,983 ------------- ------------ ----------- Net cash used in operating activities....... (40,156,677) (15,885,581) (1,157,391) ------------- ------------ ----------- Cash flows from investing activities: Acquisitions, net of cash acquired............ (16,660,333) -- -- Purchases of short-term investments........... (167,701,544) (33,030,851) -- Maturities of short-term investments.......... 132,590,112 -- -- Capital expenditures, net..................... (39,580,953) (10,383,125) (775,598) Patent and trademark costs.................... (179,657) (297,593) (83,610) ------------- ------------ ----------- Net cash used in investing activities....... (91,532,375) (43,711,569) (859,208) ------------- ------------ ----------- Cash flows from financing activities: Proceeds from debt............................ 3,703,071 6,527,910 444,000 Repayment of debt............................. (7,919,738) (2,175,618) (76,946) Proceeds from issuance of preferred stock, net......................................... -- 40,517,076 -- Proceeds from issuance of common stock, net... 2,550,737 182,227,232 1,285,827 Proceeds from fees applied to customer warrant..................................... 5,018,500 -- -- Options and warrants exercised................ 4,123,524 8,048,761 20,766 ------------- ------------ ----------- Net cash provided by financing activities... 7,476,094 235,145,361 1,673,647 ------------- ------------ ----------- Net change in cash and cash equivalents.......... (124,212,958) 175,548,211 (342,952) Cash and cash equivalents at beginning of period........................................ 177,204,143 1,655,932 1,998,884 ------------- ------------ ----------- Cash and cash equivalents at end of period....... $ 52,991,185 $177,204,143 $ 1,655,932 ============= ============ =========== Supplemental disclosure: Cash paid for interest........................ $ 421,089 $ 175,988 $ 27,783 ============= ============ =========== Supplemental non-cash disclosure: Fixed asset additions included in current liabilities................................. $ 4,292,884 $ 2,363,700 $ 247,731 ============= ============ =========== Amounts due from customer characterized as payment for warrant......................... $ 2,919,000 -- -- ============= ============ ===========
The accompanying notes are an integral part of the consolidated financial statements. 36 39 FREEMARKETS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. DESCRIPTION OF BUSINESS FreeMarkets, Inc. and Subsidiaries ("the Company") creates business-to-business online markets and provides electronic commerce technology and services for the procurement of industrial parts, raw materials, commodities and services. The Company's business-to-business online marketplace enables buyers to find, screen and qualify suppliers, to negotiate prices and terms with those suppliers through a dynamic, real-time comprehensive bidding process. The Company's marketplace includes proprietary technology, technical operations, market making services, access to a global database of suppliers and supplier research, call center support to buyers and suppliers in over 30 languages and marketplace rules that facilitate the ethical operation of the competitive bidding process. In December 1999, the Company completed an IPO of 4,140,000 shares of common stock at $48 per share. Total proceeds from the IPO were $182,227,000, net of offering costs of $16,493,000. In connection with the IPO, all of the Company's outstanding convertible preferred stock was automatically converted into 16,051,438 shares of common stock. NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. The Company has five subsidiaries in Europe and six subsidiaries in Asia and Australia. There are also five in North America, three of which represent Delaware holding companies. All material intercompany accounts and transactions have been eliminated. CASH AND CASH EQUIVALENTS The Company considers all unrestricted, highly liquid investments with a maturity of three months or less at the time of purchase to be cash equivalents. SHORT-TERM INVESTMENTS As of December 31, 2000 and 1999, short-term investments primarily consisted of commercial paper and corporate bonds. The Company classifies its short-term investments as available for sale. Such investments are recorded at fair value based on quoted market prices, with unrealized gains and losses, which are considered to be temporary, recorded as accumulated other comprehensive income or loss until realized. Realized gains and losses are recorded based on the specific identification method. Short-term investments consisted of the following:
DECEMBER 31, 2000 DECEMBER 31, 1999 ----------------------------------------- ----------------------------------------- AMORTIZED FAIR UNREALIZED AMORTIZED FAIR UNREALIZED COST VALUE GAIN (LOSS) COST VALUE GAIN (LOSS) ----------- ----------- ----------- ----------- ----------- ----------- Commercial paper..... $39,811,626 $39,786,824 $(24,802) $24,580,197 $24,610,100 $ 29,903 Corporate obligations........ 28,330,657 28,369,987 39,330 8,188,233 8,167,684 (20,549) Other................ -- -- -- 262,421 262,421 -- ----------- ----------- -------- ----------- ----------- -------- $68,142,283 $68,156,811 $ 14,528 $33,030,851 $33,040,205 $ 9,354 =========== =========== ======== =========== =========== ========
Investment income included in interest and other income, net was $10,137,000 in 2000, $816,000 in 1999 and $93,000 in 1998. 37 40 FREEMARKETS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED: FINANCIAL INSTRUMENTS The carrying values of cash and cash equivalents, accounts receivable and accounts payable approximate fair market value because of the short-term maturity of these financial instruments. The carrying value of long-term debt approximates fair value because the interest rates on these obligations are comparable to the interest rates that could have been obtained at the date of the balance sheet. The Company's short-term investments are recorded at fair market value based on quoted market prices. Management believes the financial risks associated with all of these financial instruments are minimal. PROPERTY AND EQUIPMENT Property and equipment are recorded at cost and depreciated on the straight-line method over their estimated useful lives. Qualified internally developed software costs for external use are capitalized subsequent to the determination of technological feasibility; this capitalization continues until the product becomes available for general release in accordance with SFAS No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed". To date, the Company's software has been available for general release concurrent with the establishment of technological feasibility and, accordingly, no material development costs have been capitalized. Qualified internally developed software costs for internal use are capitalized subsequent to both the preliminary project stage and when management has committed to funding, in accordance with Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use". Repairs and maintenance expenditures, which are not considered improvements and do not extend the useful life of the property and equipment, are expensed as incurred. The cost and related accumulated depreciation applicable to property and equipment no longer in service are eliminated from the accounts and any gain or loss is included in operations. GOODWILL AND OTHER ASSETS The excess of costs over net assets acquired (goodwill) is being amortized on the straight-line method over three years. Patents and trademarks are being amortized on the straight-line method over their estimated useful lives of seventeen years. IMPAIRMENT OF LONG-LIVED ASSETS The carrying values of long-lived assets, which include property and equipment and goodwill and other intangible assets, are evaluated for impairment whenever events or changes in circumstances indicate the carrying amount may not be recoverable. An impairment would be determined based on a comparison of future undiscounted cash flows to the underlying assets. If required, adjustments would be measured based on discounted cash flows. LONG-TERM CONTRACTS Long-term non-cancellable executory contracts are evaluated to determine if service costs over the life of the contract exceed revenues. If losses are expected under such contracts, these are recorded as the service costs are incurred. REVENUE RECOGNITION The Company recognizes revenue from fixed monthly fees for providing services to customers ratably as those services are provided over the related contract periods. In the case of contracts with performance incentive payments based on auction volume and/or savings generated, as defined in the respective contracts, 38 41 FREEMARKETS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED: revenue is recognized as those thresholds are achieved. As discussed in Note 3, revenue excludes fees earned under a service contract with Visteon. In the fourth quarter of 2000, the Company adopted Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements". There was no impact to our consolidated financial statements. Below is a reconciliation of revenues under generally accepted accounting principles with revenues plus the fees under the service contract with Visteon: Revenues plus fees under Visteon service contract characterized as payment for warrant...................... $91,276,346 Less fees under Visteon service contract characterized as payment for warrant....................................... 7,937,500 ----------- Revenues.................................................... $83,338,846 ===========
REVENUE AND FEE CONCENTRATION AND RELATED PARTIES Revenues from United Technologies were $9,014,000 in 2000 and $7,006,000 in 1999. In October 2000, the Company entered into a three-year contract extension with United Technologies that extends through December 2003. As further discussed in Note 10, United Technologies invested $20,938,000 in the Company in September 1999. Amounts due from United Technologies were $2,388,000 at December 31, 2000. Fees from Visteon were $7,937,500 in 2000 (see Note 3). Amounts due from Visteon were $2,919,000 at December 31, 2000. COST OF REVENUES Cost of revenues consists primarily of the expenses related to staffing and operation of the Company's market making service organization and market operations centers. Staffing costs include a proportional allocation of overhead costs. RESEARCH AND DEVELOPMENT COSTS Research and development costs are expensed as incurred, and include costs to develop, enhance and manage the Company's proprietary technology. The fair value of purchased in-process research and development is estimated by assessing the percentage-of-completion of the research project, costs required to complete the project, and expected future revenues from the related products and discounting such amounts using an appropriate risk-weighted discount rate. Amounts allocated to in-process research and development are expensed in the period in which the acquisition is consummated. ADVERTISING COSTS Advertising costs are expensed at the time the advertisement is first aired or the promotion is held, and amounted to $13,142,000 in 2000, $6,538,000 in 1999 and $162,000 in 1998. START-UP COSTS Start-up costs are expensed as incurred, and include costs to establish new locations, operations or subsidiaries. 39 42 FREEMARKETS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED: STOCK COMPENSATION The Company accounts for the grant of stock options to employees in accordance with SFAS No. 123, "Accounting for Stock-Based Compensation". SFAS No. 123 gives companies the option to adopt the fair value method for expense recognition of employee stock options or to continue to account for employee stock options using the intrinsic value method, as outlined under Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees". The Company has elected to continue to apply the intrinsic value method to account for employee stock options and discloses the pro forma effect as if the fair value method had been applied in Note 11. The Company records unearned stock compensation for stock options granted at exercise prices less than fair value. Such unearned stock compensation is amortized on an accelerated basis over the vesting period of each individual award in accordance with Financial Accounting Standards Board ("FASB") Interpretation No. 28. The Company records stock compensation in the respective line items of the Consolidated Statements of Operations. Total stock compensation was $874,000 and $698,000 for the year ended December 31, 2000 and 1999, respectively. INCOME TAXES Deferred income taxes are recorded using the liability method. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. INTERNATIONAL OPERATIONS The local currency is the functional currency for the Company's operations outside of the United States. Assets and liabilities are translated using the exchange rate at the balance sheet date. Revenues, expenses, gains and losses are translated at the exchange rate on the date those elements are recognized. Other comprehensive loss includes $66,000 and $120,000 in 2000 and 1999, respectively, related to currency translations. EARNINGS PER SHARE The Company computes earnings per share in accordance with SFAS No. 128, "Earnings per Share". Under the provisions of SFAS No. 128, basic earnings per share is computed by dividing the net (loss) income for the period by the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed by dividing the net (loss) income for the period by the weighted average number of common and potentially dilutive common shares outstanding during the period. Potentially dilutive common shares consist of the common shares issuable upon the exercise of stock options and warrants (using the treasury stock method) and upon the conversion of convertible preferred stock (using the if-converted method). Potentially dilutive common shares are excluded from the calculation if their effect is antidilutive. 40 43 FREEMARKETS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED: The computation of earnings per share is as follows:
YEAR ENDED DECEMBER 31, -------------------------------------------- 2000 1999 1998 ------------- ------------ ----------- Numerator: Net (loss) income...................... $(156,411,543) $(21,821,409) $ 233,747 ============= ============ =========== Denominator: Weighted average common shares......... 37,189,440 14,914,189 11,191,670 (Denominator for basic calculation) Weighted average effect of dilutive securities: Convertible preferred stock......... -- -- 11,383,800 Stock options and warrants.......... -- -- 4,201,141 ------------- ------------ ----------- Denominator for diluted calculation....................... 37,189,440 14,914,189 26,776,611 ============= ============ =========== Earnings per share: Basic............................... $ (4.21) $ (1.46) $ .02 ============= ============ =========== Diluted............................. $ (4.21) $ (1.46) $ .01 ============= ============ ===========
For 2000 and 1999, potentially dilutive common shares of 10,997,006 and 21,922,820, respectively, were excluded because their effect was antidilutive. COMPREHENSIVE INCOME OR LOSS Other comprehensive loss includes net (loss) income from the consolidated statements of operations, the net effect of foreign currency translation adjustments and unrealized gains and losses on short-term investments. Comprehensive loss was $156,472,000 and $21,932,000 in 2000 and 1999, respectively, and comprehensive income was $234,000 in 1998. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. SEGMENT REPORTING Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. The Company operates in one segment, business-to-business electronic commerce. The Company markets its products in the United States and in foreign countries through its sales personnel and its subsidiaries. The Company serves its customers from offices in the United States and 12 foreign countries. Many of the Company's customers are multi-national companies. Over 90% of the Company's revenues and assets in 2000, 1999 and 1998 were derived from customers whose headquarters are located in the United States. 41 44 FREEMARKETS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED: RECLASSIFICATION Certain prior year amounts have been reclassified to conform with the current presentation. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities". SFAS No. 133, which is effective for all quarters beginning January 1, 2001, establishes accounting and reporting standards for derivative financial instruments and hedging activities related to those instruments. The adoption of this standard did not have a material impact on the Company's consolidated financial statements. NOTE 3. REISSUANCE OF 2000 FINANCIAL STATEMENTS A recent review of the Company's 2000 Form 10-K by the Securities and Exchange Commission staff included the accounting related to the issuance of a warrant in 2000 to Visteon and a related service contract. As a result of this review, the Company has determined that it must first allocate the fees it earns from Visteon under the service contract as payment for the warrant as follows: Fees under Visteon service contract......................... $ 7,937,500 Less required characterization as payment for warrant....... (7,937,500) ----------- Revenues from Visteon service contract...................... $ -- ===========
Accordingly, the reissued 2000 financial statements reclassify $7,937,500 from stock compensation and warrant costs -- sales and marketing to a reduction of revenues. The remaining warrant amortization of $5,536,000 in excess of the fees earned from Visteon in 2000 remains in stock compensation and warrant costs -- sales and marketing. The $82,010,000 unamortized value of the warrant will be amortized over the remainder of the five-year term of the service contract. This amortization will first be allocated to a reduction of the revenues that the Company would otherwise have earned under the service contract had it not granted the warrant, and any remaining portion will be allocated to stock compensation and warrant costs -- sales and marketing. This reclassification has no effect on net income. In addition, due to this reclassification, cash flows from operating activities and financing activities have changed accordingly. As a result of the above, the Company has restated the following line items in the consolidated financial statements:
AS PREVIOUSLY REPORTED AS RESTATED -------------- ----------- Revenues............................................... $91,276,346 $83,338,846 Stock compensation and warrant costs -- sales and marketing............................................ 13,902,715 5,965,215 Cash flows used in operating activities................ 35,138,177 40,156,677 Cash flows provided by financing activities............ 2,457,594 7,476,094
NOTE 4. ACQUISITIONS In March 2000, the Company acquired iMark, a business-to-business online marketplace for surplus equipment and inventory. The Company issued 1,573,725 shares of its common stock and assumed 176,275 options with an aggregate total value of $333,594,000, in exchange for all of the outstanding shares and options of iMark. The acquisition was accounted for as a purchase business combination, and the purchase price was $339,684,000, including estimated transaction costs of $6,000,000. The accrued acquisition costs at 42 45 FREEMARKETS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) NOTE 4. ACQUISITIONS, CONTINUED: December 31, 2000 consist primarily of $4,000,000 in fees that are under negotiation and are expected to be settled in 2001. The purchase price was allocated as follows: Goodwill and other intangible assets........................ $336,334,000 In-process research and development......................... 7,397,000 Liabilities assumed in excess of the fair value of assets acquired.................................................. (4,047,000) ------------ Total purchase price........................................ $339,684,000 ============
At the time of the acquisition of iMark, there was one in-process research and development project. The software applications resulting from this development project have subsequently been integrated into our products. The efforts required to complete the acquired in-process research and development project included the completion of all planning, designing and testing activities that were necessary to establish that the product can be produced to meet its design requirements, including functions, features and technical performance requirements. The value of the acquired in-process research and development was computed using a discount rate of 34% on the anticipated cash flow stream from sales of the related product revenues, less the estimated costs to complete the development efforts. At the time of the acquisition, the product was approximately 70% complete. The majority of the costs to complete the project were incurred in 2000, and the remaining costs are not material. The value assigned to the in-process research and development was $7,397,000, and was charged to expense during the first quarter of 2000 when the acquisition was consummated. Also in March 2000, the Company purchased substantially all of the assets of Surplus Record, Inc. and SR Auction, Inc. (collectively, "Surplus Record") for $18,000,000 in cash. Surplus Record consists of a directory and network of dealers and buyers and an online surplus asset trade site for business surplus, new and used industrial equipment, machinery and machine tools. The acquisition was accounted for as a purchase business combination, and the excess of the purchase price over the fair value of the net assets acquired of $17,942,000 was allocated to goodwill, which is being amortized on a straight-line basis over 36 months. Final allocation of the purchase price for iMark and Surplus Record is not expected to differ significantly from the preliminary allocations, and is expected to be completed in 2001. The following unaudited pro forma financial information presents the Company's results of operations as if the acquisitions of iMark and Surplus Record occurred at the beginning of each period presented. The write-off of in-process research and development has been excluded because it is non-recurring. The unaudited pro forma financial information does not necessarily reflect the results of operations that would have occurred had the Company, iMark and Surplus Record constituted a single entity during such periods.
YEAR ENDED DECEMBER 31, ------------------------------ 2000 1999 ------------- ------------- (UNAUDITED) Revenues.............................................. $ 84,160,459 $ 24,090,397 Goodwill amortization................................. 118,091,841 118,091,841 Net loss.............................................. (182,997,853) (145,534,440) Basic and diluted earnings per share.................. (4.72) (8.83)
43 46 FREEMARKETS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) NOTE 5. PROPERTY AND EQUIPMENT Property and equipment (and their related useful lives) consisted of the following:
DECEMBER 31, -------------------------- 2000 1999 ----------- ----------- Computer and office equipment (2 to 5 years).............. $25,466,600 $ 7,231,574 Furniture and fixtures (5 years).......................... 4,838,770 2,254,839 Leasehold improvements (5 years).......................... 12,477,840 2,426,514 Software and development costs (3 years).................. 8,339,598 1,988,482 ----------- ----------- 51,122,808 13,901,409 Less accumulated depreciation............................. 7,409,108 1,360,005 ----------- ----------- $43,713,700 $12,541,404 =========== ===========
Depreciation expense was $9,585,000 in 2000, $1,145,000 in 1999 and $142,000 in 1998. As a result of a change in certain information technology initiatives and our transition to a globally-integrated ERP, the Company recognized additional depreciation and other charges of $2,037,000. NOTE 6. GOODWILL AND OTHER ASSETS Goodwill and other assets (and their related useful lives) consisted of the following:
DECEMBER 31, ------------------------ 2000 1999 ------------ -------- Goodwill (3 years)......................................... $354,275,972 $ -- Other (17 years)........................................... 1,271,474 555,206 ------------ -------- 355,547,446 555,206 Less accumulated amortization.............................. 90,793,490 15,258 ------------ -------- $264,753,956 $539,948 ============ ========
Other is primarily comprised of patent and trademark costs. NOTE 7. DEBT Debt consisted of the following:
DECEMBER 31, ------------------------ 2000 1999 ---------- ---------- (A) Revolver................................................ $3,703,071 $ -- (A) Equipment term note..................................... -- 1,777,678 (A) Equipment term note #2.................................. -- 3,000,000 (B) Equipment term note #3.................................. 574,790 -- Other.................................................. 153,053 -- ---------- ---------- 4,430,914 4,777,678 Less current portion................................... 3,887,132 1,499,962 ---------- ---------- $ 543,782 $3,277,716 ========== ==========
44 47 FREEMARKETS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) NOTE 7. DEBT, CONTINUED: (A) In November 2000, the Company entered into a one-year Revolving Credit Facility (the "Revolving Credit Facility") with a maximum borrowing base of $25.0 million. At December 31, 2000, $16.2 million as available based on eligible accounts receivable. The Revolving Credit Facility bears interest at the lender's prime rate, which was 9.5% at December 31, 2000. The Revolving Credit facility was used to replace the Equipment Term Note and the Equipment Term Note #2. These notes were part of a $10.0 million facility, which also included a $5.0 million line of credit. (B) In connection with the acquisition of iMark, the Company assumed an Equipment Term Note ("Equipment Term Note #3). The Equipment Term Note #3 bears interest at a rate of 8% and is payable in 48 monthly installments through January 2004. The Revolving Credit Facility contains restrictive covenants, including a limitation on incurring additional indebtedness and paying dividends. The Company is also required to satisfy minimum tangible net worth and current and debt service ratios each month, as defined in the underlying agreement. The Company has pledged substantially all of its tangible assets as collateral for the Revolving Credit Facility. Interest expense was $478,000 in 2000, $176,000 in 1999 and $28,000 in 1998. The weighted average interest rate was 9.9% in 2000, 6.7% in 1999 and 6.9% in 1998. Scheduled maturities of debt for each of the years ending December 31 are as follows: 2001........................................................ $3,887,132 2002........................................................ 201,012 2003........................................................ 219,570 2004........................................................ 123,200 ---------- $4,430,914 ==========
NOTE 8. COMMITMENTS AND CONTINGENCIES The Company leases office space and equipment under operating leases expiring through 2010. In October 1998, the Company entered into a new Office Lease Agreement (the "Lease"), as amended in March and June 1999 and March 2000, that significantly expands the Company's office space within the City of Pittsburgh, Pennsylvania. The Lease, which currently provides for 182,000 square feet and provides for additional expansion within the same building, expires in May 2010. Operating lease rental expense amounted to $4,488,000 in 2000, $960,000 in 1999 and $280,000 in 1998. The following is a schedule of future minimum lease payments under all operating leases through December 31 of each of the following years: 2001........................................................ $ 5,832,000 2002........................................................ 5,459,000 2003........................................................ 5,078,000 2004........................................................ 4,772,000 2005........................................................ 4,673,000 Thereafter.................................................. 20,686,000
Under the Visteon service contract, the Company expects to incur approximately $19 million in direct costs over the remaining life of the contract. The Company is subject to various legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business. While the outcome of these claims cannot be predicted with certainty, 45 48 FREEMARKETS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) NOTE 8. COMMITMENTS AND CONTINGENCIES, CONTINUED: management does not believe that the outcome of any of these legal matters will have a material adverse effect on the Company's consolidated results of operations or consolidated financial position. NOTE 9. INCOME TAXES The Company had no income tax provision in 2000 and 1999 since the Company had a net taxable loss in each of those periods. Deferred tax assets and liabilities consisted of the following:
DECEMBER 31, ------------------------- 2000 1999 ----------- ---------- Net operating losses....................................... $33,550,000 $8,202,000 Research and experimentation credits....................... 1,292,000 395,000 Deferred stock-based expense............................... 2,270,000 1,942,000 Goodwill................................................... 1,395,000 -- Depreciation and other..................................... (236,000) (797,000) ----------- ---------- Net deferred tax assets.................................... 38,271,000 9,742,000 Less valuation allowance................................... (38,271,000) (9,742,000) ----------- ---------- $ -- $ -- =========== ==========
In assessing the realizability of net deferred tax assets, management considers whether it is more likely than not that some portion of the net deferred tax assets will not be realized. The ultimate realization of net deferred tax assets is dependent upon the generation of future taxable income during the periods in which temporary differences representing net future deductible amounts become deductible. Management has established a full valuation allowance against the net deferred tax assets at December 31, 2000 and December 31, 1999 since the realization of these assets in future periods is uncertain. As of December 31, 2000, the Company had available federal and state net operating loss carryforwards of approximately $83,874,000. These net operating loss carryforwards may be used to offset future federal and state income taxes through 2020 and 2010, respectively. As a result of the Series B convertible preferred stock offering in December 1996 and concurrent ownership change, Section 382 of the Internal Revenue Code limits the federal net operating losses incurred prior to December 1996, which amounted to $2,245,000, available to the Company to $441,000 per year. Any unused annual limitation may be carried forward to future years for the balance of the federal net operating loss carryforward period. In addition, the Company has research and experimentation credit carryforwards available to offset future federal tax liabilities through 2020. 46 49 FREEMARKETS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) NOTE 10. STOCKHOLDERS' EQUITY The following is a summary of share activity for all classes of stock:
CONVERTIBLE COMMON STOCK PURCHASE PREFERRED STOCK STOCK WARRANTS --------------- ---------- -------------- Outstanding at December 31, 1997........... 11,383,800 10,975,799 2,604,600 Shares issued............................ -- 780,000 -- Options exercised........................ -- 54,600 -- ----------- ---------- ---------- Outstanding at December 31, 1998........... 11,383,800 11,810,399 2,604,600 Shares issued............................ 4,363,207 4,140,000 -- Stock purchase warrants issued........... -- -- 304,431 Stock purchase warrants exercised........ 304,431 2,409,000 (2,713,431) Options exercised........................ -- 728,310 -- Conversion of preferred stock............ (16,051,438) 16,051,438 -- ----------- ---------- ---------- Outstanding at December 31, 1999........... -- 35,139,147 195,600 Shares issued............................ -- 1,641,076 Stock purchase warrants issued........... -- -- 1,750,000 Stock purchase warrants exercised........ -- 195,600 (195,600) Options exercised........................ -- 1,812,143 -- ----------- ---------- ---------- Outstanding at December 31, 2000........... -- 38,787,966 1,750,000 =========== ========== ==========
STOCK SPLITS In January 1998, the Company's Board of Directors declared a 200-for-1 stock split in the form of a stock dividend for the then-outstanding shares of common stock and preferred stock. In June 1999, the Company's Board of Directors declared a 3-for-1 stock split in the form of a stock dividend for the then-outstanding shares of common stock and preferred stock. The Company has presented each split as a separate issuance of shares occurring at the time of the split. Accordingly, share amounts presented in the consolidated balance sheets and statements of stockholders' equity reflect the actual shares outstanding for each period presented prior to the stock splits. All references to the number of shares and per share amounts elsewhere in the consolidated financial statements and related notes have been restated to reflect both stock splits. PREFERRED STOCK In April 1999, the Company completed an offering of 2,305,434 shares of Series C convertible preferred stock at $4.77 per share. Total proceeds from the offering were $10,260,000, net of offering costs of $737,000. In September 1999, the Company completed an offering of 2,057,773 shares of Series D convertible preferred stock at $14.80 per share, of which 1,414,552 shares were purchased by United Technologies. Proceeds from the offering were $30,257,000, net of offering costs of $198,000. In addition, the Company granted 304,431 stock purchases warrants ("Series D warrants") at an exercise price of $.01 per share to United Technologies in exchange for release of restrictions that limited the Company from serving certain competitors of United Technologies. In connection with this grant, the Company recognized warrant costs of $4,503,000 in September 1999, as determined using the Black-Scholes pricing model. United Technologies exercised the Series D warrants in September 1999, resulting in total proceeds of $3,000 and a $4,503,000 transfer from stock purchase warrants to additional capital. 47 50 FREEMARKETS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) NOTE 10. STOCKHOLDERS' EQUITY, CONTINUED: As discussed in Note 1, all of the Company's outstanding convertible preferred stock automatically converted into 16,051,438 shares of common stock in connection with the IPO. Additionally, the Company's Board of Directors has the authority, without further action by the stockholders, to issue up to 5,000,000 shares of preferred stock in one or more series and to designate the rights, preferences, privileges and restrictions of each series. COMMON STOCK In 1998, employees purchased 780,000 shares of common stock at $1.67 per share under a qualified stock purchase plan (the "1998 Purchase Plan"), resulting in total proceeds of $1,286,000, net of offering costs of $14,000. No further shares may be purchased under the 1998 Purchase Plan. As discussed in Note 1, the Company completed an IPO of 4,140,000 shares of common stock at $48 per share in December 1999. STOCK PURCHASE WARRANTS In April 2000, the Company entered into a five-year service contract with Visteon. Under the terms of the contract, Visteon pays the Company a fixed monthly fee for services and access to the Company's business-to-business eMarketplace and may pay the Company variable fees if specified volume thresholds are exceeded. At the time the Company entered into the service contract, the Company granted a warrant to Visteon, with an exercise price of $.01 per share, to purchase 1,750,000 shares of the Company's common stock. The Company receives marketing and public relations benefits as a result of its relationship with Visteon. The warrant was valued at $95,484,000 using the Black-Scholes pricing model. This value is being amortized on a straight-line basis over the five-year term of the contract, of which $13,474,000 was amortized in 2000. This amortization has been reclassified as a reduction to revenues to the extent of the $7,937,500 in fees earned from Visteon, and the remaining $5,536,000 as stock compensation and warrant costs -- sales and marketing. NOTE 11. EMPLOYEE BENEFIT PLANS 401(k) SAVINGS PLAN In January 1999, the Company adopted a savings plan (the "Savings Plan") that qualifies as a deferred salary arrangement under Section 401(k) of the Internal Revenue Code. Under the Savings Plan, eligible employees may contribute a certain percentage of their pre-tax earnings up to the annual limit set by the Internal Revenue Service. The Company is not required to contribute to the Savings Plan, and has made no contributions since its inception. EMPLOYEE STOCK PURCHASE PLAN In 1999, the Board of Directors adopted, and the stockholders of the Company approved, the Company's Amended and Restated Employee Stock Purchase Plan (the "1999 Purchase Plan"), under which 500,000 shares have been reserved for issuance, subject to increases as provided in the 1999 Purchase Plan. The 1999 Purchase Plan is intended to qualify under Section 423 of the Internal Revenue Code. Under the 1999 Purchase Plan, eligible employees may purchase common stock each year in an amount not to exceed 20% of the employee's annual cash compensation. The purchase price per share will be 85% of the lowest fair value at certain dates defined in the 1999 Purchase Plan. The 1999 Purchase Plan became effective in December 1999. 48 51 FREEMARKETS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) NOTE 11. EMPLOYEE BENEFIT PLANS, CONTINUED: STOCK OPTION PLANS Prior to March 1998, the Company maintained a stock incentive plan (the "1996 Option Plan"), which provided for the issuance of stock options and stock appreciation rights to employees. Under the 1996 Option Plan, options were granted at prices determined by the Board of Directors. The options granted are exercisable in accordance with a vesting schedule, not to exceed 10 years. No further stock options may be granted under the 1996 Option Plan. In March 1998, the Company adopted the 1998 Stock Option Plan (the "1998 Option Plan"). All available options in the 1996 Option Plan were transferred into the 1998 Option Plan. All options outstanding under the 1996 Option Plan as of the termination date continue in effect under their original terms. The 1998 Option Plan provides for the issuance of stock options to employees, directors, consultants and advisors, which are granted at prices determined by the Board of Directors. The options granted are exercisable in accordance with a vesting schedule, not to exceed 10 years. Options held by certain executives immediately vested 30% in connection with the IPO. In June 1999, the Company adopted an Amended and Restated Stock Incentive Plan (the "Stock Incentive Plan"). The Stock Incentive Plan amended the 1998 Option Plan to increase the amount of shares reserved for the future issuance of stock options and add certain change-of-control provisions, as well as make other minor modifications. As of December 31, 2000, 15,450,000 stock options were authorized for issuance, of which 2,341,380 remained available for future issuance. The following is a summary of stock option activity:
NUMBER WEIGHTED AVERAGE OF OPTIONS EXERCISE PRICE ---------- ---------------- Outstanding at December 31, 1997........................ 1,062,600 $0.47 Granted............................................... 6,150,900 1.06 Forfeited............................................. (44,700) 0.55 Exercised............................................. (54,600) 0.38 ---------- Outstanding at December 31, 1998........................ 7,114,200 0.98 Granted............................................... 5,426,300 10.69 Forfeited............................................. (204,800) 3.31 Exercised............................................. (728,310) 9.25 ---------- Outstanding at December 31, 1999........................ 11,607,390 4.96 Granted............................................... 2,325,345 61.25 Assumed............................................... 176,275 6.02 Forfeited............................................. (1,691,654) 9.57 Exercised............................................. (1,812,143) 2.22 ---------- Outstanding at December 31, 2000........................ 10,605,213 17.36 ========== Shares exercisable as of December 31, 2000.............. 1,948,475 4.89
49 52 FREEMARKETS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) NOTE 11. EMPLOYEE BENEFIT PLANS, CONTINUED: The following is a summary of the options outstanding as of December 31, 2000:
RANGE 1 RANGE 2 RANGE 3 RANGE 4 RANGE 5 RANGE 6 TOTAL ----------- --------- ----------- ----------- ------------- -------------- ------------- Range of exercise prices................ $0.07-$0.80 $ 1.08 $1.59-$1.67 $2.50-$4.77 $12.50-$40.69 $41.00-$341.88 $0. 07-$341.88 Weighted average exercise price........ 0.53 1.08 1.67 4.72 18.26 70.68 17.36 Weighted average contractual life (in years)................ 6.8 7.4 7.8 8.3 8.8 9.3 8.2 Exercisable............. 697,324 452,600 153,225 150,165 482,661 12,500 1,948,475 Outstanding............. 1,392,547 2,477,000 812,022 1,408,365 2,794,360 1,720,919 10,605,213
All options were granted at exercise prices determined by the Board of Directors. In 1999, the Company recorded $1,976,000 of unearned stock compensation related to employee stock option grants with exercise prices lower than the deemed fair value of the underlying shares at the time of grant, of which $414,000 and $451,000 was amortized in 2000 and 1999, respectively. If compensation costs had been recognized pursuant to SFAS No. 123, the Company's net (loss) income and earnings per share would have been as follows:
YEAR ENDED DECEMBER 31, ------------------------------------------ 2000 1999 1998 ------------- ------------ --------- Net (loss) income: As reported............................. $(156,411,543) $(21,821,409) $ 233,747 Pro forma............................... (205,413,339) (25,390,296) (208,581) Earnings per share: Basic: As reported.......................... $ (4.21) $ (1.46) $ .02 Pro forma............................ (5.52) (1.70) (.02) Diluted: As reported.......................... $ (4.21) $ (1.46) .01 Pro forma............................ (5.52) (1.70) (.02)
The weighted average fair value per option grant to employees was $57.49 in 2000, $4.05 in 1999 and $.23 in 1998. The fair value of each option grant was determined using the minimum value method prior to the IPO and using the Black-Scholes pricing model subsequent to the IPO with the following assumptions for all grants:
YEAR ENDED DECEMBER 31, ------------------------ 2000 1999 1998 ------ ----- ----- Weighted average risk-free interest rate.................... 6.5% 5.3% 5.0% Expected life (number of years)............................. 5 5 5 Volatility.................................................. 146.1% 100% --
In October 1999, 30,000 options were granted to the Company's Assistant Secretary, who is neither an employee nor a director. In accordance with SFAS No. 123, the Company recorded stock compensation of $246,000, as determined using the Black-Scholes pricing model with the following assumptions: weighted average risk-free interest rate of 6.0%, expected life of three years and volatility of 80%. 50 53 FREEMARKETS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) NOTE 11. EMPLOYEE BENEFIT PLANS, CONTINUED: In April 2000, 3,000 options were granted to a consultant. In accordance with SFAS No. 123, the Company recorded unearned stock compensation of $196,000, of which $147,000 was amortized in 2000, as determined using the Black-Scholes pricing model with the following assumptions: weighted average risk-free interest rate of 6.2%, expected life of one year and volatility of 125%. NOTE 12. SECURITIES CLASS ACTION COMPLAINT Ten securities fraud class action complaints were filed against the Company and three executive officers in federal court in Pittsburgh, Pennsylvania, which the court consolidated into a single proceeding. The plaintiffs alleged that the Company and the other defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. The Company and the individual defendants moved to dismiss the case on the grounds that the plaintiffs failed to allege facts sufficient to support their claim that the defendants violated the securities laws. On December 27, 2000, the court granted the motion to dismiss, having concluded that the plaintiffs' complaint was legally deficient. The court granted the plaintiffs leave to amend their complaint. NOTE 13. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) The Company's quarterly results for 2000 and 1999 are as follows:
FIRST SECOND THIRD FOURTH 2000: QUARTER QUARTER QUARTER QUARTER TOTAL ----- ------------ ------------ ------------ ------------ ------------- Revenues(1)............... $ 10,808,039 $ 17,061,764 $ 23,771,798 $ 31,697,245 $ 83,338,846 Net loss.................. (18,137,239) (46,522,141) (47,132,150) (44,620,013) (156,411,543) Earnings per share: Basic and diluted....... (.51) (1.25) (1.25) (1.17) (4.21)
------------------------ (1) Excludes service fees from Visteon of $2,312,500 for the second quarter and $2,812,500 for the third and fourth quarters, respectively.
FIRST SECOND THIRD FOURTH 1999: QUARTER QUARTER QUARTER QUARTER TOTAL ----- ------------ ------------ ------------ ------------ ------------- Revenues.................. $ 3,498,705 $ 4,183,294 $ 5,355,298 $ 7,842,727 $ 20,880,024 Gross profit.............. 1,933,381 1,599,758 2,137,079 3,043,709 8,713,927 Net loss.................. (492,166) (3,264,928) (9,722,382) (8,341,933) (21,821,409) Earnings per share: Basic and diluted....... (.04) (.23) (.68) (.43) (1.46)
NOTE 14. SUBSEQUENT EVENTS In February 2001, the Company entered into a definitive agreement to acquire Adexa, Inc., a leading provider of software products that enable collaborative commerce. Under this agreement, the Company will issue up to 17,250,000 shares of its common stock and options in exchange for all outstanding equity interests of Adexa. The merger will be accounted for as a purchase, and is expected to close in the second quarter of 2001. Also in February 2001, the court dismissed the securities class action complaint discussed in Note 12 with prejudice pursuant to a stipulation of voluntary dismissal executed by all parties. The case is now closed. Since April 27, 2001, five securities fraud class action complaints have been filed against the Company and two executive officers in federal court in Pittsburgh, Pennsylvania. The complaints, all of which assert the 51 54 FREEMARKETS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) NOTE 14. SUBSEQUENT EVENTS, CONTINUED: same claims, stem from the Company's announcement on April 23, 2001 that, as a result of ongoing discussions with the staff of the SEC, the Company was considering amending its 2000 financial statements for the purpose of reclassifying fees earned by the Company under a service contract with Visteon. The Company and the individual defendants believe that the plaintiffs' allegations are completely without merit and they intend to defend these claims vigorously. 52 55 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Previously filed in Form 10-K/A (Amendment No. 1), as filed with the SEC on April 30, 2001. ITEM 11. EXECUTIVE COMPENSATION Previously filed in Form 10-K/A (Amendment No. 1), as filed with the SEC on April 30, 2001. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Previously filed in Form 10-K/A (Amendment No. 1), as filed with the SEC on April 30, 2001. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Previously filed in Form 10-K/A (Amendment No. 1), as filed with the SEC on April 30, 2001. 53 56 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (A) DOCUMENTS FILED AS PART OF THIS REPORT: 1. Financial Statements and Supplementary Data. The following Financial Statements of the Company are filed with this Form 10-K: Report of Independent Accountants........................... 32 Consolidated Balance Sheets as of December 31, 2000 and 1999...................................................... 33 Consolidated Statements of Operations for each of the three years in the period ended December 31, 2000............... 34 Consolidated Statements of Stockholders' Equity for each of the three years in the period ended December 31, 2000..... 35 Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2000............... 36 Notes to Consolidated Financial Statements.................. 37
2. Financial Statement Schedules. The following financial statement schedule is filed as part of this Annual Report on Form 10-K: Schedule II -- Valuation and Qualifying Accounts 3. Exhibits. The Exhibits listed below are filed or incorporated by reference as part of this Form 10-K. Where so indicated by footnote, exhibits which were previously filed are incorporated by reference.
EXHIBIT NUMBER DESCRIPTION ------- ----------- 3.1 Registrant's Amended and Restated Certificate of Incorporation, as amended by Certificate of Amendment dated May 12, 2000. (1) 3.2 Registrant's Amended and Restated Bylaws. (2) 4.1(b) Second Amended and Restated Registration Rights Agreement dated as of March 23, 2000. (3) 10.1++ Service and Market Access Agreement made as of October 19, 2000 and effective as of January 1, 2001 by and between the registrant and United Technologies Corporation. * 10.2(a) Lease Agreement between the registrant and One Oliver Associates Limited Partnership dated October 21, 1998. (4) 10.2(b) First Amendment to Lease between the registrant and One Oliver Associates Limited Partnership dated March 30, 1999. (4) 10.2(c) Second Amendment to Lease between the registrant and One Oliver Associates Limited Partnership dated June, 1999. (5) 10.3(a) Credit Agreement dated as of November 3, 2000 by and among the registrant and the banks party thereto and PNC Bank, National Association, as administrative agent, and Silicon Valley Bank, as syndication agent. * 10.3(b) First Amendment to Credit Agreement dated as of December 8, 2000 by and among the registrant, the banks party thereto, Silicon Valley Bank, as syndication agent, and PNC Bank, National Association, as administrative agent. * 10.4 Registrant's 1996 Stock Incentive Plan. (4) 10.5 Registrant's Amended and Restated Stock Incentive Plan. (6) 10.6 Registrant's Amended and Restated Employee Stock Purchase Plan. (7)
54 57
EXHIBIT NUMBER DESCRIPTION ------- ----------- 10.7 Form of Indemnification Agreement between the registrant and each of its directors and officers. (8) 10.8 Restricted Stock Purchase Agreement between Thomas J. Meredith and the registrant dated as of November 23, 1999. (9) 10.9++ Long Term Access and Services Agreement dated as of April 17, 2000 by and between the registrant and Visteon Corporation. (2) 10.10 Common Stock Purchase Warrant of the registrant issued to Visteon Corporation dated April 17, 2000. (2) 21.1 Subsidiaries of the registrant. (7) 23.1 Consent of PricewaterhouseCoopers LLP.
--------------- * Previously filed. ++ Portions of this exhibit have been omitted based on a request for confidential treatment filed with the SEC. The omitted portions of the exhibit have been filed separately with the SEC. (1) Incorporated by reference to exhibit filed with the registrant's Registration Statement on Form S-8, as filed with the SEC on May 26, 2000. (2) Incorporated by reference to exhibit filed with the registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2000, as filed with the SEC on August 2, 2000. (3) Incorporated by reference to exhibit filed with the registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2000, as filed with the SEC on May 10, 2000. (4) Incorporated by reference to exhibit filed with the Registration Statement as filed with the SEC on September 8, 1999. (5) Incorporated by reference to exhibit filed with Amendment No. 2 to the Registration Statement, as filed with the SEC on November 1, 1999. (6) Incorporated by reference to exhibit filed with Amendment No. 1 to the Registration Statement, as filed with the SEC on October 15, 1999. (7) Incorporated by reference to exhibit filed with the registrant's Annual Report on Form 10-K for the year ended December 31, 1999, as filed with the SEC on March 16, 2000. (8) Incorporated by reference to exhibit filed with Amendment No. 5 to the Registration Statement, as filed with the SEC on November 18, 1999. (9) Incorporated by reference to exhibit filed with Amendment No. 6 to the Registration Statement, as filed with the SEC on November 23, 1999. (b) REPORTS ON FORM 8-K The Company did not file any Reports on Form 8-K during the quarter ended December 31, 2000. * * * * * * 55 58 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. FREEMARKETS, INC. Dated: May 9, 2001 By: /s/ JOAN S. HOOPER ------------------------------------ Joan S. Hooper Senior Vice President and Chief Financial Officer 56 59 EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION ------- ----------- 23.1 Consent of PricewaterhouseCoopers LLP.
60 REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE To the Board of Directors of FreeMarkets, Inc. and Subsidiaries: Our audits of the consolidated financial statements referred to in our report dated January 22, 2001, except for Notes 3 and 14 as to which the date is May 9, 2001, appearing in this Form 10-K also included an audit of the financial statement schedule listed in Item 14(a)(2) of this Form 10-K. In our opinion, this financial statement schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. /s/ PricewaterhouseCoopers LLP Pittsburgh, Pennsylvania January 22, 2001, except for Notes 3 and 14, as to which the date is May 9, 2001 61 SCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F ---------------------------------- ---------- ---------- ---------- ---------- ----------- ADDITIONS ----------------------- BALANCE AT CHARGED TO BALANCE AT BEGINNING CHARGED TO OTHER END OF OF PERIOD EXPENSE ACCOUNTS DEDUCTIONS PERIOD ---------- ---------- ---------- ---------- ----------- ALLOWANCE FOR DOUBTFUL ACCOUNTS: Year ended December 31, 2000.... $ 100,000 $1,367,044 $ -- $(564,044) $ 903,000 Year ended December 31, 1999.... 25,000 172,666 -- (97,666) 100,000 Year ended December 31, 1998.... 20,000 5,000 -- -- 25,000 ALLOWANCE FOR DEFERRED TAX ASSETS: Year ended December 31, 2000.... 9,742,000 -- 28,529,000 -- 38,271,000 Year ended December 31, 1999.... 1,337,000 -- 8,405,000 -- 9,742,000 Year ended December 31, 1998.... 1,336,000 -- 1,000 -- 1,337,000