<PAGE> 1
Filed Pursuant to Rule 424(b)(1)
Registration No. 333-86755
3,600,000 Shares
FreeMarkets Logo
Common Stock
------------------------
This is an initial public offering of shares of common stock of
FreeMarkets, Inc. All of the shares of common stock are being sold by
FreeMarkets.
Before this offering, there has been no public market for our common stock.
Our common stock has been approved for quotation on the Nasdaq National Market
under the symbol "FMKT".
See "Risk Factors" beginning on page 7 to read about factors you should
consider before buying shares of our common stock.
------------------------
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY OTHER REGULATORY
BODY HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ACCURACY
OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
------------------------
<TABLE>
<CAPTION>
Per Share Total
--------- -----
<S> <C> <C>
Initial public offering price............................... $48.00 $172,800,000
Underwriting discount....................................... $ 3.36 $ 12,096,000
Proceeds, before expenses, to FreeMarkets................... $44.64 $160,704,000
</TABLE>
If the underwriters sell more than 3,600,000 shares of common stock, the
underwriters have the option to purchase up to an additional 540,000 shares from
FreeMarkets at the initial public offering price less the underwriting discount.
At our request, the underwriters have reserved for sale at the initial
public offering price an aggregate of 885,000 shares in this offering as
follows:
- up to 360,000 shares for a subsidiary of United Technologies Corporation,
which is one of our largest stockholders and our largest customer
- up to 350,000 shares for Kleiner Perkins Caufield & Byers IX L.P., an
entity affiliated with one of our directors
- up to 175,000 shares for our employees and directors
The underwriters expect to deliver the shares against payment in New York,
New York on December 15, 1999.
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GOLDMAN, SACHS & CO. MORGAN STANLEY DEAN WITTER
------------------------
DONALDSON, LUFKIN & JENRETTE
WIT CAPITAL CORPORATION
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Prospectus dated December 9, 1999.
<PAGE> 2
INSIDE FRONT COVER
The front of the gatefold includes a picture of a die cast metal piston
with the following text above it: "At 8:01 am, this piston cost $3.02. At 8:39
am, it cost $1.95."
A pull-out text box appears at the upper left-hand corner of the inside
gatefold with the following text: "In November 1998, FreeMarkets conducted an
online auction for die cast parts, including this piston."
The inside gatefold pages also include three pictures of computer screens,
each showing a graph generated by our BidWare software that illustrates prices
declining as a FreeMarkets online auction progresses.
The following text appears under the first picture of a bid graph generated
at the start of the auction: "At 8:00 am, the online auction for all 17 lots, or
groups of parts, opened. The first bid for Lot 1, which included this piston and
other parts, was above the previous price our client paid. One second later, a
new bid was 6% below the previous price paid." A pull-out text box appears over
the right-hand corner of the picture and indicates the time the bid graph was
generated and the market bid for the contract at that time. The text that
appears reads as follows: "8:01 am. 2 Bids Received for Lot 1."
The following text appears under the second picture of a bid graph
generated during the middle of the auction: "Sixteen minutes later, 30 bids had
been received for Lot 1, with the low bid at 20% below previous price paid." A
pull-out text box appears over the right-hand corner of the picture and
indicates the time the bid graph was generated and the market bid for the
contract at that time. The text that appears reads as follows: "8:16 am. 30 Bids
Received for Lot 1."
The following text appears under the third picture of a bid graph generated
at the end of the auction: "By the time the bidding for Lot 1 closed, less than
40 minutes after opening, the lowest bid price was 23% below the previous price
paid for all of the parts in this lot." A pull out text box appears over the
right-hand corner of the picture and indicates the time the bid graph was
generated and the market bid for the contract at that time. The text that
appears reads as follows: "8:39 am. 41 Bids Received for Lot 1."
A paragraph appears in the lower left-hand corner of the inside gatefold
with the following text: "Before many people had even heard of the Internet,
FreeMarkets was creating successful business-to-business online auctions, such
as the one illustrated here."
A pull-out text box appears at the lower right-hand corner of the inside
gatefold with the following text: "Total potential savings for this client that
day: $3.7 million."
Our logo, with the word "FreeMarkets" beside it, appears in the lower
left-hand corner of the inside gatefold with the following tag-line text below
it: "Redefining purchasing power for the Global 1000."
The following text appears at the bottom left of the inside gatefold:
"FreeMarkets(R), BidWare(R) and BidServer(R) are registered trademarks and
SmartRFI(TM), SmartRFQ(TM) and CBE(TM) are trademarks of FreeMarkets, Inc. in
the United States. All other trademarks and service marks mentioned in this
prospectus are the property of their respective owners."
The following text appears at the bottom left of the inside gatefold: "Each
auction is a distinct event. The results of any auction cannot be predicted, and
may not be replicated."
<PAGE> 3
PROSPECTUS SUMMARY
You should read the following summary together with the more detailed
information regarding FreeMarkets, Inc. and our consolidated financial
statements and the related notes appearing elsewhere in this prospectus. Unless
otherwise indicated, this prospectus assumes the automatic conversion of our
outstanding preferred stock into 16,051,438 shares of common stock, effective as
of the closing of this offering. This prospectus also assumes no exercise of the
underwriters' over-allotment option.
FREEMARKETS, INC.
FreeMarkets creates customized business-to-business online auctions for
buyers of industrial parts, raw materials and commodities. We created online
auctions covering $1.0 billion worth of purchase orders in 1998 and $1.4 billion
worth of purchase orders in the nine months ended September 30, 1999. We
estimate that the resulting savings for our clients ranged from 2% to more than
25%. Since 1995, we have created online auctions for more than 30 clients in
over 50 product categories, including injection molded plastic parts, commercial
machinings, metal fabrications, chemicals, printed circuit boards, corrugated
packaging and coal. More than 2,000 suppliers from over 30 countries have
participated in our auctions. Our current clients include United Technologies
Corporation, General Motors Corporation, The Quaker Oats Company, Emerson
Electric Company, Honeywell International Inc. and the Commonwealth of
Pennsylvania. Two of our clients accounted for 58% of our revenues during the
first nine months of 1999.
Based on industry research and government statistics, we estimate that
manufacturers worldwide purchase approximately $5 trillion each year of "direct
materials" -- the industrial parts and raw materials that they incorporate into
finished products. Because these direct materials are often custom-made to
buyers' specifications, there are no catalogs or price lists to enable buyers to
make price comparisons. The process of purchasing direct materials is further
complicated by the fragmentation of 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.
The Internet offers an opportunity to create more efficient markets for
direct materials. As the number of Internet users has grown, large companies
have increasingly adopted electronic commerce as a way to do business. Forrester
Research estimates that United States business-to-business electronic commerce
will grow from $109 billion in 1999 to $1.3 trillion in 2003, accounting for 90%
of the dollar value of all electronic commerce by 2003. However, because of the
complexity of direct materials purchasing, we believe that Internet technology
alone cannot solve the problems faced by large industrial buyers. To solve these
problems, we think that Internet technology must be combined with services that
are customized to buyers' needs.
We combine our proprietary BidWare Internet technology with our in-depth
knowledge of supply markets to help industrial buyers obtain lower prices and
make better purchasing decisions. In a FreeMarkets online auction, suppliers
from around the world can submit bids in a real-time, interactive competition.
Our auctions are "downward price" auctions in which suppliers continue to lower
their prices until the auction is closed. Before each auction, we work with our
client to identify and screen suppliers and assemble a request for quotation
that provides detailed, clear and consistent information for suppliers to use as
a basis for their competitive bids. Our service, which we call "market making",
creates a custom market for the direct materials or other goods or services that
our client purchases in a particular auction.
We seek to be the world's leading provider of business-to-business online
auctions. Our strategy is to extend our client base in our target market of
large purchasing organizations. We also intend to expand into additional product
categories where our online auctions can generate savings for buyers and to add
new functions and features to our BidWare technology to further automate
portions of our market making process.
3
<PAGE> 4
THE OFFERING
Shares offered by FreeMarkets...... 3,600,000 shares
Shares to be outstanding after the
offering........................... 33,954,958 shares
Use of Proceeds.................... For working capital and general corporate
purposes. See "Use of Proceeds".
Nasdaq National Market Symbol...... "FMKT"
The number of shares to be outstanding after this offering is based on our
shares of common stock and preferred stock outstanding as of September 30, 1999.
This number excludes 11,396,830 shares issuable upon the exercise of options and
Series A and Series B warrants outstanding as of September 30, 1999.
4
<PAGE> 5
SUMMARY CONSOLIDATED FINANCIAL DATA
The following tables summarize the consolidated financial data for our
business. You should read this data along with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and our consolidated
financial statements and related notes. Potentially dilutive common shares have
been excluded from the shares used to compute earnings per share in each loss
year because their inclusion would be antidilutive. Pro forma earnings per share
data reflect the conversion of all outstanding preferred stock into common
stock, even if the effect of the conversion is antidilutive. As adjusted
consolidated balance sheet data reflect the issuance of shares in this offering
at an initial public offering price of $48.00 per share and after deducting the
underwriting discount and the estimated expenses of this offering.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
--------------------------------------- -------------------------
1996 1997 1998 1998 1999
----------- ----------- ----------- ----------- -----------
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Revenues......................... $ 409 $ 1,783 $ 7,801 $ 4,802 $ 13,037
Gross (loss) profit.............. (97) 634 3,543 1,972 5,670
Operating costs:
Research and development....... 394 292 842 563 2,960
Sales and marketing............ 321 586 656 387 5,625
General and administrative..... 630 837 2,026 1,129 5,890
Stock-based expense............ -- -- -- -- 4,728
Operating (loss) income.......... (1,442) (1,081) 19 (107) (13,533)
Net (loss) income................ (1,431) (1,061) 234 89 (13,479)
Earnings per share:
Basic.......................... (.14) (.10) .02 .01 (1.00)
Diluted........................ (.14) (.10) .01 .00 (1.00)
Shares used to compute earnings
per share:
Basic.......................... 10,316,599 10,618,481 11,191,670 10,990,053 13,451,407
Diluted........................ 10,316,599 10,618,481 26,776,611 25,224,247 13,451,407
Pro forma earnings per share:
Basic.......................... $ .01 $ (.51)
Diluted........................ .01 (.51)
Shares used to compute pro forma
earnings per share:
Basic.......................... 22,575,470 26,394,512
Diluted........................ 26,776,611 26,394,512
</TABLE>
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30, 1999
--------------------------
ACTUAL AS ADJUSTED
------ -----------
<S> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents................................... $22,259 $180,795
Working capital............................................. 33,717 192,253
Total assets................................................ 45,677 204,213
Long-term debt, excluding current portion................... 1,976 1,976
Total stockholders' equity.................................. 37,761 196,297
</TABLE>
5
<PAGE> 6
AUCTION VOLUME AND CLIENT DATA
The following data represent the aggregate volume of all direct materials,
commodities and services for which we have conducted an online auction, and the
number of clients that we have served, in the periods presented.
<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
-------------------- ------------------
1996 1997 1998 1998 1999
---- ---- ---- ------ --------
<S> <C> <C> <C> <C> <C>
Auction volume (in millions)................... $124 $257 $979 $615 $1,363
Number of clients.............................. 8 13 12 11 21
</TABLE>
Please see "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Determination of Auction Volume and Achievable Savings"
for a discussion of how we calculate auction volume.
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Our executive offices are located at One Oliver Plaza, 22nd Floor, 210
Sixth Avenue, Pittsburgh, PA 15222. Our telephone number is (412) 434-0500, our
facsimile number is (412) 434-0508, and our Internet address is
www.freemarkets.com. The information on our website is not a part of this
prospectus.
6
<PAGE> 7
RISK FACTORS
You should carefully consider the risks and uncertainties described below
and the other information in this prospectus before deciding whether to invest
in shares of our common stock. The risks and uncertainties described below are
not the only ones we face. Additional risks and uncertainties not known to us or
that we now believe to be unimportant could also impair our business. If any of
the following risks actually occurs, our business, financial condition or
operating results could be negatively affected. If this happens, the trading
price of our common stock could decline, and you may lose part or all of your
investment.
OUR LIMITED OPERATING HISTORY MAKES EVALUATING OUR BUSINESS AND FUTURE PROSPECTS
DIFFICULT
FreeMarkets has a very limited operating history. Our company was founded
in 1995 and did not generate a significant amount of revenues until 1998.
Because our operating history is so limited, it is very difficult to evaluate
our business and our future prospects. We will encounter risks and difficulties
frequently encountered by companies in an early stage of commercial development
in new and rapidly evolving markets. In order to overcome these risks and
difficulties, we must, among other things:
- execute our business and marketing strategy successfully;
- increase the number of industrial buyers that use our online auction
services;
- attract a sufficient number of suppliers to participate in our online
auctions to sustain competitive auctions;
- enter into long-term agreements with clients who have tried our service
under initial short-term agreements;
- upgrade our technology and information processing systems so that we can
create a wider variety and greater number of online auctions; and
- continue to attract, hire, motivate and retain qualified personnel.
If we fail to achieve these objectives, we may not realize sufficient
revenues or net income to succeed.
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 significant 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 for the partial year 1995 and in 1996 and 1997. We
achieved a modest profit in 1998, but are incurring losses in 1999 as a result
of our efforts to invest in the actual and anticipated growth of our business.
Our profitability will depend on whether we can increase revenues while
controlling expenses. We may not achieve profitability in the future, or sustain
any future profitability.
7
<PAGE> 8
WE DEPEND PRIMARILY ON TWO CLIENTS; THE LOSS OF EITHER WOULD SIGNIFICANTLY
REDUCE OUR REVENUES AND NET INCOME
We depend on two clients, United Technologies Corporation and General
Motors Corporation, for a substantial portion of our revenues. These two clients
represented 77% of our revenues in 1998 and 58% of our revenues in the nine
months ended September 30, 1999. Our agreement with United Technologies expires
in December 2000, and our agreement with General Motors expires in September
2001. The agreements can be terminated by the respective clients at any time
upon prior notice. Although United Technologies would be required to pay us a
substantial fee if it terminates its agreement, the fee would not make up for
the resulting loss of revenues. General Motors is not required to pay any
termination fee if it terminates its agreement.
We may not be able to keep either United Technologies or General Motors as
a client in the future. The loss or partial loss of either of these clients
would significantly diminish our revenues and operating results, forcing us to
curtail our growth plans and incur greater losses. Even if we keep one or both
of these clients, we may not be successful in growing and diversifying our
client base.
INDUSTRIAL PURCHASERS MAY NOT ADOPT OUR ONLINE AUCTION METHOD OF PURCHASING AT
LEVELS SUFFICIENT TO SUSTAIN OUR BUSINESS
Business-to-business online auction services are a novel method of
industrial purchasing, which potential clients may not adopt. If not enough
companies adopt our auction method of purchasing, then our business could be
harmed. In order to accept our method, buyers must adopt new purchasing
practices that are different from their traditional practices. Traditional
purchasing is often based on long-standing relationships between a buyer and a
few suppliers. Buyers and their suppliers often negotiate prices face-to-face,
with buyers frequently directing their business to chosen suppliers based on
factors in addition to price. Our services may be disruptive to existing,
long-standing supplier relationships because, in order to use our services, a
buyer must be willing to open the bidding process to multiple suppliers.
Moreover, buyers must be willing to rely less upon personal relationships in
making purchasing decisions. We cannot assure you that enough industrial
purchasers will choose to adopt our method or do so at sufficient levels to
sustain our business.
CLIENTS MAY NOT PURCHASE OUR SERVICES IF WE ARE UNABLE TO GENERATE SIGNIFICANT
SAVINGS
If our online auction services increase the efficiency of any particular
supply market, the future likelihood of significant savings to our clients 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 auction services to
buyers in those markets, or attracting willing suppliers in other markets,
either of which will reduce our revenues and net income.
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 and
will likely vary significantly in the future. We believe that period-to-period
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. Our failure to meet these expectations may result in
a decrease in the market price of our common stock.
Our quarterly revenues often fluctuate because we depend on a small number
of relatively large clients. 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 savings objectives.
As a result, our quarterly operating results may continue to fluctuate
significantly based on the size and timing of monthly fees and based on any
contingent compensation we earn.
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<PAGE> 9
OUR SPENDING ON INCREASED CAPACITY PRECEDES OUR RECEIPT OF REVENUES; THIS COULD
CAUSE OUR GROSS MARGINS TO BE VOLATILE
We must hire personnel, acquire equipment and expand our facilities in
anticipation of receiving revenues in future periods. Because many of our
expenses for these activities are components of our cost of revenues, our gross
margins are likely to be volatile.
WE MAY NOT BE ABLE TO ADJUST OUR SPENDING QUICKLY; IF WE CANNOT, THEN OUR NET
INCOME 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 financial
data 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 forecast revenues accurately due to our limited
operating history. If we fail to predict revenues accurately 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 net income will be
negatively affected.
WE MAY NOT BE ABLE TO HIRE OR RETAIN QUALIFIED STAFF
If we cannot attract and retain enough qualified and skilled staff, the
growth of our business may be limited. Our ability to provide services to
clients 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.
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 clients are typically
large companies. At times, these clients ask us to pursue large 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 NET INCOME
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 for the nine months ended September 30, 1999 increasing over
170% compared to the same period in 1998. 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 net income.
9
<PAGE> 10
WE MAY ACQUIRE OTHER BUSINESSES OR TECHNOLOGIES; IF WE DO, WE MAY BE UNABLE TO
INTEGRATE THEM WITH OUR BUSINESS, OR WE MAY IMPAIR OUR FINANCIAL PERFORMANCE
If appropriate opportunities present themselves, we may acquire businesses,
technologies, services or products that we believe are strategic. We do not
currently have any understandings, commitments or agreements with respect to any
acquisition, nor are we currently pursuing any acquisition. We may not be able
to identify, negotiate or finance any future acquisition successfully. Even if
we do succeed in acquiring a business, technology, service or product, we have
no experience in integrating an acquisition into our business; the process of
integration 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 have not
made any acquisitions, and we may never achieve any of the benefits that we
might anticipate from a future acquisition. If we make future 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 future acquisitions may only be available to us on terms that restrict our
business or that impose on us costs that reduce our net income.
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 two to 12 months from
initial client contact until we sign a contract. Not every potential client 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 client'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 clients 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; and
- an aversion to new purchasing methods.
If we are unable to enter into service agreements with clients 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 client 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 clients from short-term to
long-term service agreements would hurt our operating results. Our initial
agreement with a client usually involves a period of trial and evaluation with
relatively small volume auctions. This initial period, in which we learn about
our client's business and its related product categories and educate our client
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 auctions.
Clients 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 do not
achieve economies of scale early in a client relationship, our gross margins are
typically lower at the outset than the margins we may achieve 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.
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<PAGE> 11
FACTORS OUTSIDE OUR CONTROL COULD RESULT IN DISAPPOINTING AUCTION RESULTS;
DISAPPOINTED CLIENTS MAY CANCEL OR FAIL TO RENEW THEIR AGREEMENTS WITH US
The actual savings achieved in any given auction 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 auctioned;
- the past performance of our client's purchasing organization in
negotiating favorable terms with suppliers;
- the willingness of a sufficient number of qualified suppliers to bid for
business using our auction services;
- 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 client's perception of the
value of our services, clients 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 net income.
FAILURES OF HARDWARE SYSTEMS OR SOFTWARE COULD UNDERMINE OUR CLIENTS' CONFIDENCE
IN OUR RELIABILITY
A significant disruption in our online auction service could seriously
undermine our clients' confidence in our business. Our clients hold us to a high
standard of reliability and performance. From time to time, we have experienced
service interruptions during online auctions, with the most significant being a
breakdown in the computer network over which our auctions 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
clients' confidence in the reliability of our business.
Conducting an online auction 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 an online auction.
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 auction 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 WOULD DISRUPT OUR BUSINESS
The loss of any member of our key management team would significantly
disrupt our business. We rely on the leadership and vision of key members of our
senior management team, including:
- Glen Meakem, our President, Chairman, Chief Executive Officer and a
co-founder;
- Sam Kinney, an Executive Vice President, our Secretary and a co-founder;
and
- David Becker, an Executive Vice President and our Chief Operating
Officer.
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<PAGE> 12
Messrs. Meakem and Kinney created FreeMarkets, and they and Mr. Becker have
been instrumental in the management and growth of our business. The loss of any
of these executives could disrupt the Company's growth or result in lost
revenues or a decrease in net income.
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 online auction 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 clients that could lead to a loss of revenues.
Our online auction 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 BidWare software after
their release. Reduced market acceptance of our services due to errors or
defects in our technology would harm our business by reducing our revenues.
IF WE DO NOT ADEQUATELY MAINTAIN OUR CLIENTS' CONFIDENTIAL INFORMATION, OUR
REPUTATION COULD BE HARMED AND WE COULD INCUR LEGAL LIABILITY
Any breach of security relating to our clients' confidential information
could result in legal liability for us and a reduction in use or cancellation of
our online auction 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 clients'
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 clients with
whom we deal.
We currently have practices and procedures in place to ensure the
confidentiality of our clients' 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 increases in
the amount of information we possess. If we fail to adequately maintain our
clients' confidential information, some of our clients could end their business
relationships with us and we could be subject to legal liability.
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 NET INCOME
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 clients may choose to purchase competitors' services. If
they do, then our revenues and net income will be reduced. For a more detailed
discussion of our competitive environment, please see "Business -- Competition".
OUR BUSINESS WILL SUFFER IF OUR PROSPECTIVE CLIENTS DO NOT ACCEPT ELECTRONIC
COMMERCE AND THE INTERNET AS A MEANS OF PURCHASING
Our online auction services depend on the increased acceptance and use of
the Internet as a medium of commerce. Our business will suffer if potential
clients do not accept electronic commerce and the Internet as a means of
purchasing. Business-to-business electronic commerce is a new and emerging
business practice that remains largely untested in the marketplace. Rapid growth
in the use of the Internet and electronic commerce is a recent phenomenon. As a
result, acceptance and use may
12
<PAGE> 13
not continue to develop at recent rates and a sufficiently broad base of
business customers may not adopt or continue to use the Internet as a medium of
commerce. Demand for and market acceptance of services and products recently
introduced over the Internet are subject to a high level of uncertainty, and few
proven services and products yet exist.
Electronic commerce may not prove to be a viable medium for
business-to-business purchasing for the following reasons, any of which could
seriously harm our business:
- the necessary infrastructure for Internet communications may not develop
adequately;
- buyer clients and suppliers may have security and confidentiality
concerns;
- complementary products, such as high-speed modems and high-speed
communication lines, may not be developed;
- alternative purchasing solutions may be implemented;
- buyers may dislike a reduction in the human contact that traditional
purchasing methods provide;
- use of the Internet and other online services may not continue to
increase or may increase more slowly than expected;
- the development or adoption of new standards and protocols may be
delayed; and
- new and burdensome governmental regulations may be imposed.
SECURITY RISKS AND CONCERNS MAY DETER THE USE OF THE INTERNET FOR CONDUCTING
COMMERCE
Concern about the security of the transmission of confidential information
over public networks is a significant barrier to electronic commerce and
communication. Advances in computer capabilities, new discoveries in the field
of cryptography or other events or developments could result in compromises or
breaches of Internet security systems that protect proprietary information. If
any well-publicized compromises of security were to occur, they could
substantially reduce the use of the Internet for commerce and communications.
Anyone who circumvents our security measures could misappropriate
proprietary information or cause interruptions in our services or operations.
Our activities involve the storage and transmission of proprietary information,
such as confidential buyer and supplier specifications. The Internet is a public
network, and data is sent over this network from many sources. In the past,
computer viruses have been distributed and have rapidly spread over the
Internet. Computer viruses could be introduced into our systems or those of our
clients or suppliers, which could disrupt our online auction technology or make
it inaccessible to our clients or suppliers. We may be required to expend
significant capital and other resources to protect against the threat of, or to
alleviate problems caused by, security breaches and the introduction of computer
viruses. Our security measures may be inadequate to prevent security breaches or
combat the introduction of computer viruses, either of which may result in loss
of data, increased operating costs, litigation and possible liability.
IF WE ARE NOT ABLE TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, THEN
OUR COMPETITORS MAY BE ABLE TO DUPLICATE OUR SERVICES
We rely in part upon our proprietary technology, including our BidWare
software, to conduct auctions. Our failure to adequately protect our
intellectual property rights could harm our business by making it easier for our
competitors to duplicate our services. We have applied for patents on aspects of
our technology and 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
trademark registrations for some of our brand names and our marketing materials
are copyrighted, but these protections may not
13
<PAGE> 14
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.
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 provide online auction services. 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,
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 clients 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 increase their
fees significantly 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 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 AUCTIONS 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 applicable to businesses generally. 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 facilitate
sales of goods to clients globally, foreign jurisdictions may claim that
14
<PAGE> 15
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 auction 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 auctions. Our clients 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.
WE MAY SUFFER SERVICE INTERRUPTIONS OR TECHNICAL FAILURES DUE TO THE YEAR 2000
COMPUTER PROBLEM ON OUR OWN SYSTEMS OR SYSTEMS OF THIRD PARTIES
Our business is dependent upon computers and networks, both voice and data.
As a result, interruptions and breakdowns in computer and network services can
completely disrupt our business. Many computer systems and the networks over
which they operate are coded to accept only two-digit entries in date code
fields. These systems may be unable to distinguish whether "00" means 1900 or
2000, which may result in failures or the creation of erroneous results by, at
or beyond the year 2000. Many companies' computer and/or software systems may
need to be upgraded or replaced in order to process dates correctly beginning on
January 1, 2000 and to comply with the so-called "Year 2000" requirements.
We rely on our internally developed software as well as software, hardware
and other computer technology developed by third parties. The failure of any of
this software, hardware or computer technology could result in the interruption
of our auction services, delay or loss of revenues, diversion of development
resources, damage to our reputation and/or liability to our clients.
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
auctions. We have a subsidiary in Brussels, Belgium that serves our clients
based in Europe and the European operations of our multinational clients based
in the United States. We 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 net income. 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 MANAGEMENT HAS BROAD DISCRETION OVER HOW TO USE THE PROCEEDS OF THIS
OFFERING; WE MAY NOT USE THE PROCEEDS IN WAYS THAT HELP OUR BUSINESS SUCCEED
We estimate that our net proceeds from this offering will be $158.5
million, at an initial public offering price of $48.00 per share and after
deducting the underwriting discount and our estimated offering expenses. Our
primary purposes in making this offering are to increase our working capital,
create a public market for our common stock, facilitate our future access to the
public capital markets
15
<PAGE> 16
and increase our visibility in the marketplace. We have no specific plans for
the net proceeds of this offering other than working capital and general
corporate purposes. Accordingly, our management will have broad discretion as to
how to apply the net proceeds of this offering. If we fail to use these proceeds
effectively, our business may not grow and our revenues and net income may
decline.
OTHER COMPANIES MAY HAVE DIFFICULTY ACQUIRING US, EVEN IF DOING SO WOULD BENEFIT
OUR STOCKHOLDERS, DUE TO PROVISIONS OF OUR CORPORATE CHARTER AND BYLAWS AND
DELAWARE LAW
Provisions in our Certificate of Incorporation, in our Bylaws and under
Delaware law could make it more difficult for other companies to acquire us,
even if doing so would benefit our stockholders. Our Certificate of
Incorporation and Bylaws contain the following provisions, among others, which
may inhibit an acquisition of our company by a third party:
- a staggered board of directors, where stockholders elect only a minority
of the board each year;
- advance notification procedures for matters to be brought before
stockholder meetings;
- a limitation on who may call stockholder meetings; and
- a prohibition on stockholder action by written consent.
We are also subject to provisions of Delaware law that prohibit us from
engaging in any business combination with any "interested stockholder", meaning
generally a stockholder who beneficially owns more than 15% of our stock, for a
period of three years from the date this person became an interested
stockholder, unless various conditions are met, such as approval of the
transaction by our Board. This could have the effect of delaying or preventing a
change in control. For a more complete discussion of these provisions of
Delaware law, please see "Description of Capital Stock -- Anti-Takeover
Provisions -- Delaware Law".
OUR STOCK PRICE MAY BE VOLATILE, WHICH COULD RESULT IN SUBSTANTIAL LOSSES FOR
STOCKHOLDERS
Before this offering, there has never been a public market for our common
stock. The market price for our common stock is likely to be 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, and
particularly so in recent periods.
16
<PAGE> 17
SUBSTANTIAL SALES OF OUR COMMON STOCK AFTER THE OFFERING COULD CAUSE OUR STOCK
PRICE TO FALL
Most of our outstanding shares are currently restricted from resale, but
some may be sold into the market in the near future. Sales of these shares into
the market could cause the market price of our common stock to drop
significantly, even if our business is doing well.
Immediately following this offering, we will have outstanding 33,954,958
shares of common stock. This includes the 3,600,000 shares we are selling in
this offering. Assuming that we sell all shares reserved under our directed
share program to the entities or persons for whom these shares have been
reserved, we expect that investors may resell 2,715,000 shares in the public
market immediately. The remaining 92.0%, or 31,239,958 shares, of our total
outstanding shares will become available for resale in the public market as
shown in the chart below:
<TABLE>
<CAPTION>
NUMBER OF SHARES/
% OF TOTAL OUTSTANDING DATE OF AVAILABILITY FOR RESALE INTO PUBLIC MARKET
- ---------------------- -----------------------------------------------------------
<C> <S>
2,629,386/7.7% Immediately.
302,991/0.9% 90 days after the date of this prospectus.
25,945,377/76.4% 180 days after the date of this prospectus due to an
agreement many of our stockholders have with the
underwriters. However, the underwriters can waive this
restriction and allow these stockholders to sell their
shares at any time.
2,362,204/7.0% After September 2, 2000.
</TABLE>
As restrictions on resale end, the market price of our stock could drop
significantly if the holders of these restricted shares sell them or the market
perceives that they intend to sell them. For a more detailed description, please
see "Shares Eligible for Future Sale".
YOU WILL SUFFER IMMEDIATE AND SUBSTANTIAL DILUTION IN THE BOOK VALUE OF YOUR
INVESTMENT
The initial public offering price per share will significantly exceed our
net tangible book value per share. If we were to liquidate immediately after the
offering, investors purchasing shares in this offering would receive a per share
amount of tangible assets net of liabilities that would be less than the initial
public offering price per share. Investors purchasing shares in this offering
will suffer dilution of $42.23 per share from their investment. For more
information, please see "Dilution".
17
<PAGE> 18
NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the statements under "Prospectus Summary", "Risk Factors",
"Management's Discussion and Analysis of Financial Condition and Results of
Operations", "Business", and elsewhere in this prospectus constitute statements.
These statements involve known and unknown risks, uncertainties, and other
factors that may cause our or our industry's actual results, levels of activity,
performance or achievements to be materially different than any expressed or
implied by these statements. In some cases, you can identify 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.
Although we believe that the expectations reflected in the statements are
reasonable, we cannot guarantee future results, levels of activity, performance
or achievements. We are under no duty to update any of the statements after the
date of this prospectus to conform these statements to actual results.
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<PAGE> 19
USE OF PROCEEDS
We estimate that the net proceeds to us from the sale of the shares being
offered will be $158.5 million, at an initial public offering price of $48.00
per share after deducting the underwriting discount and estimated offering
expenses payable by us. If the underwriters exercise their over-allotment option
in full, then we estimate that the net proceeds to us from the sale of the
shares being offered will be $182.6 million.
The principal purposes of this offering are to increase our working
capital, create a public market for our common stock, facilitate our future
access to the public capital markets and increase our visibility in the
marketplace. We have no specific plans for the net proceeds of this offering
other than general corporate purposes and working capital, and our use of these
proceeds will be in the discretion of our management. We may, for example, use a
portion of the net proceeds to acquire complementary technologies or businesses;
however, we currently have no commitments or agreements and are not involved in
any negotiations involving any of these transactions. Pending deployment of the
net proceeds of this offering, we intend to invest the net proceeds in
interest-bearing, investment grade securities.
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. We currently
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.
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<PAGE> 20
CAPITALIZATION
The following table sets forth our capitalization as of September 30, 1999
on an actual and as adjusted basis. The as adjusted column reflects our actual
capitalization plus:
- the filing of an amendment to our Certificate of Incorporation concurrent
with the closing of this offering to eliminate all existing classes of
preferred stock and to create 5,000,000 shares of undesignated preferred
stock;
- the automatic conversion of all shares of outstanding preferred stock
into 16,051,438 shares of common stock immediately prior to the closing
of this offering; and
- our sale of 3,600,000 shares of common stock at an initial public
offering price of $48.00 per share, after deducting the underwriting
discount and estimated offering expenses.
Neither of the columns reflects 15,450,000 shares of common stock reserved
for issuance under our stock incentive plan as of September 30, 1999, of which
11,201,230 shares were subject to outstanding options, or 195,600 shares of
common stock issuable upon the exercise of our Series A and Series B warrants.
You should read the table below along with our consolidated balance sheet
as of September 30, 1999 and the related notes.
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30, 1999
---------------------------
ACTUAL AS ADJUSTED
--------- ------------
(IN THOUSANDS, EXCEPT SHARE
AND PER SHARE DATA)
<S> <C> <C>
Cash and cash equivalents................................... $ 22,259 $ 180,795
======== =========
Long-term debt, excluding current portion................... 1,976 1,976
-------- ---------
Stockholders' equity:
Convertible preferred stock, 50,000,000 shares authorized,
actual; no shares authorized, issued or outstanding, as
adjusted:
Series A; $.01 par value; 9,036,600 shares issued and
outstanding, actual.................................... 90 --
Series B; $.01 par value; 2,347,200 shares issued and
outstanding, actual.................................... 24 --
Series C; $.01 par value; 2,305,434 shares issued and
outstanding, actual.................................... 23 --
Series D; $.01 par value; 2,362,204 shares issued and
outstanding, actual.................................... 24 --
Preferred stock; $.01 par value, no shares authorized,
issued or outstanding, actual; 5,000,000 shares
authorized, no shares issued or outstanding, as
adjusted................................................ -- --
Common stock; $.01 par value, 200,000,000 shares
authorized; 14,303,520 shares issued and outstanding,
actual; 33,954,958 shares issued and outstanding, as
adjusted................................................ 143 340
Additional capital.......................................... 55,838 214,338
Unearned stock-based compensation........................... (1,751) (1,751)
Stock purchase warrants..................................... 30 30
Accumulated deficit......................................... (16,660) (16,660)
-------- ---------
Total stockholders' equity.............................. 37,761 196,297
-------- ---------
Total capitalization............................... $ 39,737 $ 198,273
======== =========
</TABLE>
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<PAGE> 21
DILUTION
Our net tangible book value as of September 30, 1999 was $37.5 million, or
$1.23 per share. Net tangible book value per share represents the amount of our
total tangible assets, reduced by the amount of our total liabilities, and then
divided by the total number of shares of common stock outstanding after giving
effect to the automatic conversion of all shares of outstanding preferred stock.
Dilution in net tangible book value per share represents the difference between
the amount paid per share by purchasers of shares of common stock in this
offering and the net tangible book value per share of common stock immediately
after the completion of this offering. After giving effect to the sale of the
3,600,000 shares of common stock offered by us at an initial public offering
price of $48.00 per share, and after deducting the underwriting discount and
estimated offering expenses payable by us, our net tangible book value at
September 30, 1999 would have been $196.0 million or $5.77 per share of common
stock. This represents an immediate increase in net tangible book value of $4.54
per share to existing stockholders and an immediate dilution of $42.23 per share
to new investors purchasing shares at the initial offering price. The following
table illustrates this dilution on a per share basis:
<TABLE>
<S> <C> <C>
Initial public offering price per share..................... $48.00
Net tangible book value per share before the offering..... $ 1.23
Increase per share attributable to new investors.......... 4.54
------
Net tangible book value per share after the offering........ 5.77
------
Dilution per share to new investors......................... $42.23
======
</TABLE>
The following table summarizes, as of September 30, 1999, the differences
between the existing stockholders and new investors with respect to the number
of shares of common stock and preferred stock purchased from us, the total
consideration paid to us and the average price per share paid:
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE
-------------------- ---------------------- PRICE PER
NUMBER PERCENT AMOUNT PERCENT SHARE
---------- ------- ------------ ------- ---------
<S> <C> <C> <C> <C> <C>
Existing stockholders................. 30,354,958 89.4% $ 51,268,303 22.9% $ 1.69
New investors......................... 3,600,000 10.6 172,800,000 77.1 48.00
---------- ----- ------------ -----
Totals........................... 33,954,958 100.0% $224,068,303 100.0%
========== ===== ============ =====
</TABLE>
The preceding tables assume no issuance of shares of common stock under our
stock plans after September 30, 1999. As of September 30, 1999, 11,201,230
shares were subject to outstanding options at a weighted average exercise price
of $4.29 per share. This table also assumes no exercise of the 195,600 Series A
or Series B warrants outstanding as of September 30, 1999. If all of these
options and warrants were exercised, then the total dilution per share to new
investors would be $42.62.
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<PAGE> 22
SELECTED CONSOLIDATED FINANCIAL DATA
You should read the selected consolidated financial data set forth below
along with "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and our consolidated financial statements and the related
notes. We have derived the consolidated statement of operations data for 1996,
1997 and 1998 and the nine months ended September 30, 1999, and the consolidated
balance sheet data as of December 31, 1997 and 1998 and September 30, 1999 from
our consolidated financial statements that have been audited by
PricewaterhouseCoopers LLP. We have derived all other data in this table from
financial statements not included in this prospectus. We believe the unaudited
results shown in the table below include all adjustments, consisting only of
normal recurring adjustments, that we consider necessary for a fair presentation
of such information. Operating results for the nine months ended September 30,
1999 are not necessarily indicative of the results that may be expected for all
of 1999. Potentially dilutive common shares have been excluded from the shares
used to compute earnings per share in each loss year because their inclusion
would be antidilutive. Pro forma earnings per share data reflects the conversion
of all outstanding preferred stock into common stock, even if the effect of the
conversion is antidilutive.
<TABLE>
<CAPTION>
MARCH 13, 1995
(INCEPTION) NINE MONTHS ENDED
THROUGH YEAR ENDED DECEMBER 31, SEPTEMBER 30,
DECEMBER 31, --------------------------------------- -------------------------
1995 1996 1997 1998 1998 1999
-------------- ----------- ----------- ----------- ----------- -----------
(UNAUDITED) (UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Revenues........................ $ 17 $ 409 $ 1,783 $ 7,801 $ 4,802 $ 13,037
Cost of revenues................ 25 506 1,149 4,258 2,830 7,367
---------- ----------- ----------- ----------- ----------- -----------
Gross (loss) profit............. (8) (97) 634 3,543 1,972 5,670
Operating costs:
Research and development.... 333 394 292 842 563 2,960
Sales and marketing......... 59 321 586 656 387 5,625
General and
administrative............ 526 630 837 2,026 1,129 5,890
Stock-based expense......... -- -- -- -- -- 4,728
---------- ----------- ----------- ----------- ----------- -----------
Total operating costs........... 918 1,345 1,715 3,524 2,079 19,203
Operating (loss) income......... (926) (1,442) (1,081) 19 (107) (13,533)
Other income, net............... 4 11 20 215 196 54
---------- ----------- ----------- ----------- ----------- -----------
Net (loss) income............... $ (922) $ (1,431) $ (1,061) $ 234 $ 89 $ (13,479)
========== =========== =========== =========== =========== ===========
Earnings per share:
Basic....................... $ (.13) $ (.14) $ (.10) $ .02 $ .01 $ (1.00)
Diluted..................... (.13) (.14) (.10) .01 .00 (1.00)
Shares used to compute earnings
per share:
Basic....................... 7,262,352 10,316,599 10,618,481 11,191,670 10,990,053 13,451,407
Diluted..................... 7,262,352 10,316,599 10,618,481 26,776,611 25,224,247 13,451,407
Pro forma earnings per share:
Basic....................... $ .01 $ (.51)
Diluted..................... .01 (.51)
Shares used to compute pro forma
earnings per share:
Basic....................... 22,575,470 26,394,512
Diluted..................... 26,776,611 26,394,512
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31, AS OF
------------------------------------ SEPTEMBER 30,
1995 1996 1997 1998 1999
----------- ---- ------ ------ -------------
(UNAUDITED) (IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents................................... $106 $523 $1,999 $1,656 $22,259
Working capital............................................. (81) 505 2,783 3,814 33,717
Total assets................................................ 306 985 3,336 6,870 45,677
Long-term debt, excluding current portion................... -- 21 -- 413 1,976
Total stockholders' equity.................................. 104 792 3,052 4,592 37,761
</TABLE>
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<PAGE> 23
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 "Selected Consolidated
Financial Data" and our consolidated financial statements and related notes.
OVERVIEW
FreeMarkets creates customized business-to-business online auctions for
buyers of industrial parts, raw materials and commodities. We were founded in
March 1995 and began offering our auction services in that year. We currently
offer our auction services primarily in the United States, and to a lesser
extent in Europe. We created online auctions covering $1.0 billion worth of
purchase orders in 1998 and $1.4 billion worth of purchase orders in the nine
months ended September 30, 1999. We estimate that the achievable savings for our
clients resulting from completed auctions ranged from 2% to more than 25%.
DETERMINATION OF AUCTION VOLUME AND ACHIEVABLE SAVINGS
We believe that one indicator of our market acceptance is the estimated
dollar volume of direct materials, commodities and services that we auction for
our clients. We measure this auction volume by multiplying the lowest bid price
per unit in each auction by the estimated number of units that our client
expects to purchase. When our clients specify multi-year purchases in a request
for quotation, we calculate auction volume for the entire term. For example,
where our client specifies in its request for quotation that it expects to
purchase 10,000 units each year for a three-year term, we would calculate volume
for the related auction based on 30,000 units multiplied by the lowest bid price
submitted in the auction.
The actual dollar volume of direct materials, commodities or services that
our clients purchase may differ from our estimated auction volume. Because
non-price factors such as quality and service may be important to our client's
purchasing decision, our client may not select the lowest bid price that we use
in our calculation, or the parties may adjust prices in the future. In addition,
the actual number of units purchased by our client often varies from the
original estimate on which we base our calculation.
Auction volume does not necessarily correlate with either our revenues or
our operating results in any particular period or over time. Further, auction
volume has varied in the past and we expect it to vary in the future. The
following table sets forth our auction volume for the periods indicated:
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
---------------------------- --------------
1995 1996 1997 1998 1998 1999
---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
Auction volume (in millions)..................... $9 $124 $257 $979 $615 $1,363
</TABLE>
We believe that the percentage savings achievable by clients through our
auctions is an indicator of the effectiveness of our auction services. To
estimate these savings, we compare the last price paid by our client for the
auctioned items against the lowest bid price for those items in our auction.
Actual savings that our clients achieve may not equal these estimates because
our client may not select the lowest bid price, the parties may agree to change
price terms after our auction or our client may not actually buy all or any of
the auctioned items.
Each auction we conduct is a distinct event, with a different mix of
participants and different products being bid upon. Savings vary from auction to
auction, and many factors affecting savings are outside of our control. We
report savings in a range, reflecting our experience. The savings achieved in
any particular auction cannot be predicted, and may not be replicated. Factors
affecting savings include supply and demand conditions in the product category
from which our client is purchasing and past performance of our client's
purchasing organization. In addition, the percentage savings that can be
23
<PAGE> 24
achieved on commodities, such as chemicals and coal, is typically far less than
the savings that can be achieved on custom-made direct materials.
Some of our agreements with clients provide for incentive compensation
based on auction volumes and/or savings. These agreements may define auction
volumes or savings differently than the methods we use to calculate auction
volume and savings.
REVENUES
We generate revenues under service agreements with our clients. Our service
agreements typically provide us with revenues from fixed monthly fees, and may
also include performance incentive payments, based on volume, savings, or both,
and sales commissions. The revenue structure in a particular service agreement
may vary, depending upon the needs of our client and the conventional practices
in the supply market where our client obtains its direct materials or
commodities. The monthly fees that we receive are for the use of our technology,
information, market operations staff, market making staff and facilities.
Negotiated monthly fees vary by client, and reflect both the anticipated auction
volume and the staffing, expertise and technology we anticipate committing to
complete the services requested by our clients. For the nine months ended
September 30, 1999, fixed monthly fees constituted a majority of our revenues,
and we expect that these monthly fees will continue to constitute a majority of
our revenues for at least the next 12 months. Our agreements typically allow us
to limit the personnel resources that we must make available in performing these
services. 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
four years. At any given time, we have agreements of varying lengths with
staggered expirations. Our service agreements generally permit early termination
by our clients without penalty.
Some of our agreements include performance incentive payments that are
contingent upon our client achieving specific auction volume or savings
thresholds, or both, as set forth in the respective agreements. We recognize
these revenues as these thresholds are achieved. Most agreements entered into
since January 1999 include incentive payment provisions. We expect that as our
auction volume grows, a greater percentage of revenues will be attributable to
these incentive payments.
Our agreements may also provide for sales commissions to be paid to us upon
shipment of the auctioned items from the winning supplier to our client. We
recognize these commission revenues when the supplier ships to our client, which
in many cases occurs several months after our auction. Either the winning
supplier or our client pays these commissions, depending upon the terms of the
agreement. The service agreements that we have signed since January 1999 do not
include significant supplier-paid commissions, although we continue to receive
supplier-paid commissions under some agreements.
COST OF REVENUES
Cost of revenues consists primarily of the expenses related to staffing our
market making service organization and our Market Operations Center. These costs
also include an allocation of general overhead items such as building rent,
equipment leasing costs, telecommunications charges and depreciation expense.
Our gross margins vary from quarter to quarter. We must often add personnel to
our market making and market operations organizations based on our forecast of
anticipated clients' needs. If we over-estimate our clients' needs, our gross
margins may decrease because we cannot reduce our staffing levels in the short
term. Conversely, our gross margins may increase in periods when we earn
performance incentive payments resulting from our efforts in prior periods. As a
result, we have experienced volatility in our gross margins in the past and
expect this to continue.
24
<PAGE> 25
OPERATING COSTS
We classify our operating costs into four general categories: research and
development, sales and marketing, general and administrative and stock-based
expense, based on the nature of the expenditures.
We also allocate the total costs for overhead and facilities, based on
headcount, to each of the functional areas that use these services. These
allocated charges include general overhead items such as building rent,
equipment leasing costs, telecommunications charges and depreciation expense.
RESEARCH AND DEVELOPMENT
Research and development expenses consist primarily of expenses related to
the development and upgrade of our proprietary BidWare software and other market
making technologies. These expenses include employee compensation for software
developers and quality assurance personnel and third-party contract development
costs. We expect to increase our research and development expenses in absolute
dollars in future periods to invest in new technology for future product and
service offerings and to adapt and add features to our existing technology.
SALES AND MARKETING
Sales and marketing expenses consist primarily of employee compensation for
direct sales and marketing personnel, travel, public relations, sales and other
promotional materials, trade shows, advertising and other sales and marketing
programs. We expect to continue to increase our sales and marketing expenses 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.
GENERAL AND ADMINISTRATIVE
General and administrative expenses consist primarily of compensation for
personnel and fees for outside professional advisors. We expect that general and
administrative expenses will continue to increase in absolute dollars in future
periods as we continue to add staff and infrastructure to support our expected
domestic and international business growth and bear the increased costs
associated with being a public company.
STOCK-BASED EXPENSE
Stock-based expense consists of expenses related to employee stock option
grants and stock purchase warrants issued with exercise prices lower than the
deemed fair value of the underlying shares at the time of grant. Stock-based
compensation for employee stock options granted is amortized on an accelerated
method over the vesting period of each individual award.
Additionally, in October 1999, we issued to our Assistant Secretary, who is
neither an employee nor a director, options to purchase 30,000 shares of common
stock at an exercise price of $14.80 per share. As a result, and in accordance
with SFAS No. 123, we recorded stock-based expense of $246,000 in October 1999,
as determined using the Black-Scholes pricing method.
OTHER INCOME, NET
Other income consists primarily of interest income received from the
investment of proceeds from our financing activities, offset by interest expense
and other fees related to our bank borrowings. Other income also includes other
items not related to our operations. In the past, these items have included an
economic development grant and gains or losses on the disposal of fixed assets.
We expect interest income to increase in the short term as a result of our
investing the proceeds from our sale of Series D preferred stock and this
offering. We also expect interest expense to grow in future periods as we intend
to borrow additional funds under our bank credit facility.
25
<PAGE> 26
INCOME TAXES
We incurred a net taxable loss in each of 1996, 1997 and the nine months
ended September 30, 1998 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 September 30, 1999, we had $11.8 million of federal and $10.2 million
of 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 2019 and 2009,
respectively. However, in 1996 we sold a sufficient amount of our 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 $1.3 million, will
be subject to a limitation of $247,000 per year. We may generate additional net
operating loss carryforwards in the future.
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.
CUSTOMER CONCENTRATION
We depend on two clients, United Technologies and General Motors, for a
substantial portion of our revenues. These two clients represented 77% of our
revenues in 1998 and 58% of our revenues in the nine months ended September 30,
1999. We anticipate that we will continue to diversify our base of clients by
adding new clients and increasing sales to other existing clients and that the
percentage of total revenues we derive from United Technologies and General
Motors will decrease. We cannot be certain, however, that this will occur.
RESULTS OF OPERATIONS
The following table sets forth consolidated statement of operations data as
a percentage of revenues for the periods indicated:
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
------------------------ ---------------
1996 1997 1998 1998 1999
------ ----- ----- ----- ------
<S> <C> <C> <C> <C> <C>
Revenues............................................... 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of revenues....................................... 123.7 64.4 54.6 58.9 56.5
------ ----- ----- ----- ------
Gross (loss) profit.................................... (23.7) 35.6 45.4 41.1 43.5
Operating costs:
Research and development............................. 96.4 16.4 10.8 11.7 22.7
Sales and marketing.................................. 78.5 32.9 8.4 8.1 43.1
General and administrative........................... 154.0 46.9 26.0 23.5 45.2
Stock-based expense.................................. -- -- -- -- 36.3
------ ----- ----- ----- ------
Operating (loss) income................................ (352.6) (60.6) 0.2 (2.2) (103.8)
Other income (expense), net............................ 2.7 1.1 2.8 4.1 0.4
------ ----- ----- ----- ------
Net (loss) income...................................... (349.9)% (59.5)% 3.0% 1.9% (103.4)%
====== ===== ===== ===== ======
</TABLE>
26
<PAGE> 27
NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1999
REVENUES
Revenues increased 171% from $4.8 million in the nine months ended
September 30, 1998 to $13.0 million in the same period in 1999. The increase in
revenues is primarily attributable to an increased number of new clients for
which we conducted auctions, as well as increased use of our services by
existing clients. Revenues in both periods were substantially concentrated in
two clients, United Technologies and General Motors. In the nine months ended
September 30, 1998, these two clients together contributed revenues of $3.5
million, or 73% of our total revenues. Revenues in the nine months ended
September 30, 1998 included a $500,000 performance incentive from United
Technologies. In the same period in 1999, total revenues from these two clients
increased over 115% to $7.5 million, or 58% of our total revenues. Additionally,
a substantial portion of our revenue growth in the nine months ended September
30, 1999 occurred in the period from June 1999 through September 1999, as we
added 11 of the 21 clients we served in that nine-month period since mid-June.
Four of these new clients have entered into long-term agreements with us.
COST OF REVENUES
Cost of revenues increased from $2.8 million in the nine months ended
September 30, 1998 to $7.4 million in the same period in 1999. As a percentage
of revenues, however, cost of revenues declined from 59% to 57%. The increase in
absolute dollar amounts from the nine months ended September 30, 1998 to the
same period in 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 decrease in cost of revenues as a percentage of revenues is primarily
the result of spreading some relatively fixed costs over a higher base of
revenues. In addition, this improvement in our gross margin percentage was
favorably impacted by an increase in the proportion of revenues derived from
long-term agreements, including the $500,000 performance incentive we earned
from United Technologies. We have also increased staff productivity by becoming
more specialized in various market making activities. In the nine months ended
September 30, 1999, we had a lower incidence of deep price discounts which we
had used in earlier periods to attract clients. Finally, we attained some
operating efficiencies from our investments in information tools to automate
portions of our market making process, which positively impacted our gross
margins.
OPERATING COSTS
RESEARCH AND DEVELOPMENT. Research and development costs increased from
$563,000, or 12% of revenues, in the nine months ended September 30, 1998, to
$3.0 million, or 23% of revenues, in the same period 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.
SALES AND MARKETING. Sales and marketing expenses increased from $387,000,
or 8% of revenues, in the nine months ended September 30, 1998, to $5.6 million,
or 43% of revenues, in the same period 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 expenses in the
nine months ended September 30, 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. General and administrative expenses increased
from $1.1 million, or 24% of revenues, in the nine months ended September 30,
1998, to $5.9 million, or 45% of revenues, in the same period in 1999. The
increase both in absolute dollars and as a percentage of revenues is
27
<PAGE> 28
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 is also attributable to
start-up costs of $200,000 and other recurring costs of $776,000 associated with
our European subsidiary, which we established in late 1998.
STOCK-BASED EXPENSE
In September 1999, we issued warrants to a subsidiary of United
Technologies to purchase 304,431 shares of Series D preferred stock at an
exercise price of $.01 per share, in exchange for United Technologies' 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-based compensation
related to employee stock options granted in June and July 1999. In the nine
months ended September 30, 1999, $226,000 has been amortized related to these
grants.
OTHER INCOME, NET
Other income was $196,000 in the nine months ended September 30, 1998 as
compared to $54,000 in the same period in 1999. The change was primarily
attributable to an economic development grant from the Commonwealth of
Pennsylvania for $150,000 during the nine months ended September 30, 1998. The
change in 1999 was also the net result of a write-off of property and equipment
of $119,000 related to our move to our new headquarters, offset by increased net
interest income.
YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
REVENUES
Total revenues increased 336% from $409,000 in 1996 to $1.8 million in 1997
and 338% to $7.8 million in 1998. The increase in revenues from 1996 to 1998 is
primarily attributable to an increased number of new clients for which we
conducted auctions, as well as revenues from the increased use of our services
by existing clients. Revenues in 1997 and 1998 were substantially concentrated
in United Technologies and General Motors. In 1997, these two clients together
contributed revenues of $735,000, or 41% of our total revenues. In 1998, total
revenues from these two clients increased over 700% to $6.0 million, or 77% of
our total revenues. During 1998, $1.6 million of our revenues was attributable
to a performance incentive bonus we earned from United Technologies.
COST OF REVENUES
Cost of revenues increased in absolute dollars from $506,000 in 1996 to
$1.1 million in 1997 and to $4.3 million in 1998. The increase in absolute
dollar amounts from 1996 to 1998 was primarily attributable to the overall
growth in the size of our market making staff. Cost of revenues as a percentage
of revenues decreased from 124% in 1996 to 64% in 1997 and to 55% in 1998. The
decrease as a percentage of revenues over this period reflected operating
efficiencies as we spread certain relatively fixed costs over a larger base of
revenues and improved staff and operational productivity. The decrease in 1998
was affected specifically by the receipt of a $1.6 million performance incentive
bonus, which favorably impacted our gross margins. In addition, longer-term
agreements entered into with United Technologies and General Motors in 1997 and
1998 allowed us to forecast our workforce needs better and thereby hire and
deploy market making personnel more efficiently.
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<PAGE> 29
OPERATING COSTS
RESEARCH AND DEVELOPMENT. Research and development expenses decreased from
$394,000, or 96% of revenues, in 1996, to $292,000, or 16% of revenues, in 1997,
and increased to $842,000, or 11% of revenues, in 1998. The decrease in research
and development expenses in absolute dollars from 1996 to 1997 was primarily
attributable to the costs associated with the introduction of the first
generation of our BidWare software in 1996 and subsequent decrease in our use of
outside software development staff for this project in 1997. The increase in
absolute dollars from 1997 to 1998 was primarily attributable to an increase in
the number of software developers and quality assurance personnel hired by us to
further develop our BidWare software, as well as other market making technology.
The decrease in research and development expenses as a percentage of revenues
from 1996 to 1998 was due to the significant increase in revenues during this
period.
SALES AND MARKETING. Sales and marketing expenses increased from $321,000
in 1996 to $586,000 in 1997 and to $656,000 in 1998. Sales and marketing expense
as a percentage of revenues decreased from 79% in 1996 to 33% in 1997 and to 8%
in 1998. The increase in absolute dollar amounts from 1996 to 1998 resulted
primarily from continued investment in sales and marketing activities as our
business developed. The decrease in sales and marketing expenses as a percentage
of revenues from 1996 to 1998 was due to the significant increase in revenues
over this period. Further, a substantial portion of our overall revenue growth
in 1998 came from increased services provided to existing clients, which
required relatively less sales and marketing expense per dollar of revenues than
from new clients.
GENERAL AND ADMINISTRATIVE. General and administrative expenses increased
from $630,000 in 1996 to $837,000 in 1997 and to $2.0 million in 1998. As a
percentage of revenues, however, general and administrative expenses decreased
from 154% in 1996 to 47% in 1997 and to 26% in 1998. The increase in absolute
dollars from 1996 to 1998 resulted primarily from the addition of finance, human
resources and executive and administrative personnel to support the growth of
our business during this period. In 1998, we also incurred significant legal and
administrative costs related to establishing our European subsidiary. The
decrease in general and administrative expenses as a percentage of revenues from
1996 to 1998 was due to the significant increase in revenues over this period.
OTHER INCOME, NET
Other income increased from $11,000 in 1996 to $20,000 in 1997 and to
$215,000 in 1998. The increases in all periods were a result of interest earned
on increased cash balances. The increase in 1998 was also a result of the
receipt of a $150,000 economic development grant from the Commonwealth of
Pennsylvania.
LIQUIDITY AND CAPITAL RESOURCES
We have historically satisfied our cash requirements primarily through a
combination of revenues from operations and private equity financing
transactions. Through September 30, 1999, we raised cumulative net proceeds of
$49.7 million through private equity offerings. As of September 30, 1999, we had
cash and cash equivalents of $22.3 million, short-term investments of $10.3
million and working capital of $33.7 million.
Net cash used in operating activities totaled $1.6 million in 1996, $1.8
million in 1997, $1.2 million in 1998 and $8.6 million in the nine months ended
September 30, 1999. Our use of cash in 1996 and 1997 was primarily attributable
to operating losses, and in 1998 to an increase in working capital. The use of
cash in the nine months ended September 30, 1999 related primarily to the
operating loss generated by our investment in the growth of our business,
including an increase in personnel from 105 at the end of 1998 to 278 as of
September 30, 1999. It appeared in mid-May that if we were to continue with our
projected spending levels, we would have insufficient cash, unless we completed
another private placement. Accordingly, in September 1999, we completed our
Series D preferred stock private placement, which raised net proceeds of $30.3
million. In addition, in
29
<PAGE> 30
March 1999, we began leasing a significantly larger facility. The lease, which
runs through May 2004, currently requires an annual lease payment of $1.4
million. Our lease payments will grow as we take additional office space.
Net cash used in investing activities totaled $165,000 in 1996, $50,000 in
1997, $859,000 in 1998 and $14.9 million in the nine months ended September 30,
1999. Our use of cash in investing activities in 1996, 1997 and 1998 resulted
primarily from our continued additions to and upgrade of computing and
telecommunications equipment. At the end of 1998, we began purchasing equipment
using available funds under a previous credit facility and reduced our use of
leased equipment. During the nine months ended September 30, 1999, we spent
approximately $4.4 million to furnish our new facility and purchase computing
and telecommunications equipment to accommodate our increase in personnel. We
also used $10.3 million to purchase short-term investments.
Net cash provided by financing activities totaled $2.2 million in 1996,
$3.3 million in 1997, $1.7 million in 1998 and $44.1 million in the nine months
ended September 30, 1999. These positive financing cash flows primarily reflect
the net proceeds from private equity offerings and bank borrowings. During the
nine months ended September 30, 1999, we raised $40.6 million from the sale of
convertible preferred stock, received proceeds of $1.3 million from the exercise
of warrants, and had net borrowings of $2.2 million under our bank credit
facilities.
As of September 30, 1999, we had a $10.0 million bank credit facility,
consisting of a $5.0 million revolving line of credit, all of which was
available as of September 30, 1999, and two equipment loans totaling $5.0
million, of which $2.6 million was outstanding as of September 30, 1999. The
line of credit bears interest at a rate of prime plus 0.75% and expires in
September 2000. The equipment loans bear interest at a rate of prime plus 1.0%
and are payable over 36-month terms expiring in August 2002 and September 2003.
In June 1999, we initiated discussions with our lender to amend our
original bank credit facility to provide for additional liquidity to finance
future capital expenditures. The amendment, which became effective in September
1999, increased the total availability under our bank credit facility from $4.0
million to $10.0 million. The amendment also revised the minimum tangible net
worth covenant, under which we were in technical default from June through
August 1999, as a result of losses that we incurred through that date. We are
currently in compliance with all covenants under our amended bank credit
facility.
Our amended bank credit facility contains restrictive covenants, including
a limitation on incurring additional indebtedness and paying dividends. We are
also required to satisfy minimum tangible net worth and current and debt service
ratios each month. We have pledged substantially all of our tangible assets as
collateral for the bank credit facility.
Capital expenditures were $776,000 in 1998 and $4.4 million in the nine
months ended September 30, 1999. Capital expenditures over these periods were
primarily made to purchase computer and telecommunications equipment and for
furnishings in our new headquarters, as well as for expansion of our network and
server capacity. We funded these capital expenditures through a combination of
cash from operations, sales of our equity securities and bank borrowings. We
intend to fund future capital expenditures, which we estimate at $4.5 million
for the fourth quarter of 1999, through a combination of proceeds from our
recent sale of Series D preferred stock and bank borrowings. We anticipate an
increase in our capital expenditures over future periods consistent with growth
in our operations, infrastructure and personnel.
We expect to experience significant 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 clients. 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; however,
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<PAGE> 31
we currently have no commitments or agreements and are not involved in any
negotiations regarding any of these transactions. We believe that the net
proceeds from this offering, combined with current cash resources, will be
sufficient to meet our working capital and capital expenditures for at least the
next 18 months. Thereafter, we may find it necessary to obtain additional equity
or debt 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.
QUARTERLY OPERATING RESULTS
The following table sets forth our unaudited quarterly results of
operations data for our 11 most recent quarters, as well as the percentage of
revenues represented by each item. You should read this table along with our
consolidated financial statements and related notes. We have prepared this
unaudited information on the same basis as our audited financial statements, and
it includes all adjustments, consisting only of normal recurring adjustments,
that we consider necessary for a fair presentation of our financial position and
operating results for the quarters presented.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
--------------------------------------------------------------------------
MAR. 31, JUNE 30, SEP. 30, DEC. 31, MAR. 31, JUNE 30, SEP. 30,
1997 1997 1997 1997 1998 1998 1998
-------- -------- -------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PERCENTAGES)
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues................... $ 124 $ 248 $ 531 $ 880 $ 1,109 $ 1,287 $ 2,406
Cost of revenues........... 186 232 264 467 608 971 1,251
------- ------- ------- ------- ------- ------- -------
Gross (loss) profit........ (62) 16 267 413 501 316 1,155
Operating costs:
Research and development.. 95 53 69 75 144 180 239
Sales and marketing....... 114 115 121 236 114 117 156
General and
administrative.......... 177 183 207 270 353 351 425
Stock-based expense....... -- -- -- -- -- -- --
------- ------- ------- ------- ------- ------- -------
Total operating costs...... 386 351 397 581 611 648 820
------- ------- ------- ------- ------- ------- -------
Operating (loss) income.... (448) (335) (130) (168) (110) (332) 335
Other income (expense),
net....................... 5 5 5 5 23 163 10
------- ------- ------- ------- ------- ------- -------
Net (loss) income.......... $ (443) $ (330) $ (125) $ (163) $ (87) $ (169) $ 345
======= ======= ======= ======= ======= ======= =======
AS A PERCENTAGE OF
REVENUES:
Revenues................... 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of revenues........... 150.0 93.5 49.7 53.1 54.8 75.4 52.0
------- ------- ------- ------- ------- ------- -------
Gross (loss) profit........ (50.0) 6.5 50.3 46.9 45.2 24.6 48.0
Operating costs:
Research and development.. 76.6 21.4 13.0 8.5 13.0 14.0 9.9
Sales and marketing....... 91.9 46.4 22.8 26.8 10.3 9.1 6.5
General and
administrative.......... 142.8 73.8 39.0 30.7 31.8 27.3 17.7
Stock-based expense....... -- -- -- -- -- -- --
------- ------- ------- ------- ------- ------- -------
Total operating costs...... 311.3 141.6 74.8 66.0 55.1 50.4 34.1
------- ------- ------- ------- ------- ------- -------
Operating (loss) income.... (361.3) (135.1) (24.5) (19.1) (9.9) (25.8) 13.9
Other income (expense),
net....................... 4.0 2.0 1.0 0.6 2.1 12.7 0.4
------- ------- ------- ------- ------- ------- -------
Net (loss) income.......... (357.3)% (133.1)% (23.5)% (18.5)% (7.8)% (13.1)% 14.3%
======= ======= ======= ======= ======= ======= =======
<CAPTION>
THREE MONTHS ENDED
-----------------------------------------
DEC. 31, MAR. 31, JUNE 30, SEP. 30,
1998 1999 1999 1999
-------- -------- -------- --------
(IN THOUSANDS, EXCEPT PERCENTAGES)
<S> <C> <C> <C> <C>
Revenues................... $ 2,999 $ 3,499 $ 4,183 $ 5,355
Cost of revenues........... 1,428 1,566 2,583 3,218
------- ------- ------- -------
Gross (loss) profit........ 1,571 1,933 1,600 2,137
Operating costs:
Research and development.. 279 555 806 1,599
Sales and marketing....... 269 593 1,869 3,163
General and
administrative.......... 897 1,243 2,158 2,489
Stock-based expense....... -- -- -- 4,728
------- ------- ------- -------
Total operating costs...... 1,445 2,391 4,833 11,979
------- ------- ------- -------
Operating (loss) income.... 126 (458) (3,233) (9,842)
Other income (expense),
net....................... 19 (34) (32) 120
------- ------- ------- -------
Net (loss) income.......... $ 145 $ (492) $(3,265) $(9,722)
======= ======= ======= =======
AS A PERCENTAGE OF
REVENUES:
Revenues................... 100.0% 100.0% 100.0% 100.0%
Cost of revenues........... 47.6 44.8 61.7 60.1
------- ------- ------- -------
Gross (loss) profit........ 52.4 55.2 38.3 39.9
Operating costs:
Research and development.. 9.3 15.9 19.3 29.8
Sales and marketing....... 8.9 16.9 44.7 59.1
General and
administrative.......... 30.0 35.5 51.6 46.5
Stock-based expense....... -- -- -- 88.2
------- ------- ------- -------
Total operating costs...... 48.2 68.3 115.6 223.6
------- ------- ------- -------
Operating (loss) income.... 4.2 (13.1) (77.3) (183.7)
Other income (expense),
net....................... 0.6 (1.0) (0.8) 2.2
------- ------- ------- -------
Net (loss) income.......... 4.8% (14.1)% (78.1)% (181.5)%
======= ======= ======= =======
</TABLE>
YEAR 2000 ISSUES
Many computer systems are coded to accept only two-digit entries in date
code fields. These systems may be unable to distinguish whether "00" means 1900
or 2000, which may result in failures or the creation of erroneous results by,
at or beyond the year 2000. Many companies' computer and/or software systems may
need to be upgraded or replaced in order to process dates correctly beginning on
January 1, 2000 and to comply with the so-called "Year 2000" requirements.
We rely on our internally developed software as well as software, hardware
and other computer technology developed by third parties. The failure of any of
this software, hardware or computer technology could result in the interruption
of our auction services, delay or loss of revenues, diversion of development
resources, damage to our reputation or liability to our clients, or both, any of
which could seriously harm our business.
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We believe, based on internal assessments to date, that our internally
developed proprietary software, including our BidWare software, is Year 2000
compliant. We are not certain that this is the case, however, and it is possible
that our BidWare software will not function properly when used by auction
participants on systems that are not Year 2000 compliant. We generally do not
represent to our clients that our software and systems are Year 2000 compliant,
although we have been compelled to make this representation to some significant
clients. For these clients, our liability is limited to the actual damages
sustained by the client, subject to specific dollar limitations in each
agreement. We are not liable, however, for Year 2000 noncompliance resulting
from the incompatibility of our clients' technology with ours, or from problems
with public or private networks over which we run our auctions.
We also believe, based on internal assessments to date and representations
made to us by third-party vendors, that the third-party software and hardware
that we operate in our business, including our basic operating systems, office
software, servers and databases, either is Year 2000 compliant or can be made
Year 2000 compliant without significant cost or effort. Our servers and some of
our personal computers are not currently Year 2000 compliant. However, we are in
the process of performing vendor-recommended upgrades necessary to make these
servers and personal computers Year 2000 compliant. We intend to complete these
upgrades prior to December 31, 1999 at a cost that we estimate to be no greater
than $170,000.
It is difficult for us to assess the Year 2000 compliance of the general
communications infrastructure on which we rely to conduct our online auctions.
Our online auctions depend on the successful technical operation of an entire
chain of software, hardware and telecommunications equipment. The failure of any
element in this chain to be Year 2000 compliant could result in a disruption of
our auction services. Many of the elements in this chain, such as
telecommunications equipment and Internet connectivity, are not within our
control. For example, most suppliers who participate in our online auctions use
our BidWare software by dialing into a network provided by a third party, from
whom we lease private network services. While we have contacted this vendor and
requested confirmation concerning Year 2000 compliance, the vendor has not
provided the confirmation we requested.
We have limited information concerning the Year 2000 compliance of our
clients and of suppliers who participate in our online auctions. In addition,
many suppliers are located in foreign countries with inferior telecommunications
infrastructure. We expect that many auction participants will have to perform
vendor-recommended upgrades to their systems to become Year 2000 compliant. We
believe that we have the ability to bypass isolated failures of our clients'
systems through other means. However, a generalized failure of any of our
clients' systems or the failure of the systems of a significant number of
suppliers could prevent us from successfully conducting online auctions for
those clients or with those suppliers and could adversely affect our business.
We may incur extra costs from time to time in supporting clients and suppliers
who are not Year 2000 compliant.
We think that the most reasonably likely worst case Year 2000 scenario for
our business would be if there were a generalized failure of the
telecommunications equipment and Internet connectivity on which we rely to
conduct our online auctions. Such a failure would prevent us from conducting
online auctions until the providers of this equipment and connectivity restored
service. We do not have a formal contingency plan to address such a failure or
any other generalized failure of computer systems due to the Year 2000 issue.
MARKET RISK
Nearly all of our revenues recognized to date have been denominated in
United States dollars and are primarily from clients in the United States. We
have a European subsidiary located in Belgium and intend to establish other
foreign subsidiaries in the future. Revenues from international clients to date
have not been substantial, and nearly all of these revenues have been
denominated in United States dollars. In the future, a portion of the revenues
we derive from international operations may be
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<PAGE> 33
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. Although
currency fluctuations are currently not a material risk to our operating
results, we will continue to monitor our exposure to currency fluctuations and
when appropriate, 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. We do not currently
utilize any derivative financial instruments or derivative commodity
instruments.
Our interest income is sensitive to changes in the general level of United
States interest rates, particularly since the majority of our investments are in
short-term instruments. Borrowings under our existing credit lines are also
interest rate sensitive, since the interest rate charged by our bank varies with
changes in the prime rate of lending. We believe, however, that we are currently
not subject to material interest rate risk.
RECENT ACCOUNTING PRONOUNCEMENT
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities". SFAS No. 133,
which is effective, as amended, for all quarters in fiscal years beginning after
June 15, 2000, establishes accounting and reporting standards for derivative
financial instruments and hedging activities related to those instruments, as
well as other hedging activities. As we do not currently engage in derivative or
hedging activities, we do not expect the adoption of this standard to have a
significant impact on our consolidated financial statements.
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<PAGE> 34
BUSINESS
THE COMPANY
FreeMarkets creates customized business-to-business online auctions for
buyers of industrial parts, raw materials and commodities. We combine our
proprietary BidWare Internet technology with our in-depth knowledge of supply
markets to help our clients obtain lower prices, make better purchasing
decisions and achieve significant savings. We created online auctions covering
$1.0 billion worth of purchase orders in 1998 and $1.4 billion worth of purchase
orders in the nine months ended September 30, 1999. We estimate that the
resulting savings for our clients ranged from 2% to more than 25%. Since 1995,
we have created online auctions for more than 30 clients in over 50 product
categories, including injection molded plastic parts, commercial machinings,
metal fabrications, chemicals, printed circuit boards, corrugated packaging and
coal. More than 2,000 suppliers from over 30 countries have participated in our
auctions. Our clients are purchasing organizations, including United
Technologies Corporation, General Motors Corporation, The Quaker Oats Company,
Emerson Electric Company, Honeywell International Inc. and the Commonwealth of
Pennsylvania.
INDUSTRY BACKGROUND
GROWTH OF BUSINESS-TO-BUSINESS ELECTRONIC COMMERCE
The Internet is one of the fastest-growing means of communication, reaching
consumers and businesses globally. 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
expects business-to-business electronic commerce to grow more rapidly than
business-to-consumer electronic commerce over the next several years. Forrester
Research estimates that business-to-business electronic commerce will grow from
$109 billion in 1999 to $1.3 trillion in 2003, accounting for 90% of the dollar
value of electronic commerce in the United States by 2003, and that total
electronic commerce worldwide may reach as high as $3.2 trillion by 2003.
Auctions targeted at consumers are a popular application of Internet
technology. Forrester Research projects that the value of goods sold through
Internet auctions will increase from $8.7 billion in 1998 to $52.6 billion in
2002. The popularity of consumer-oriented auction sites and the opportunity
presented by business-to-business electronic commerce have spurred the creation
of business-to-business Internet auction sites. However, we believe that these
auction sites have not adequately addressed the problems faced by manufacturers
who purchase "direct materials" -- the industrial parts and raw materials 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 at times pay prices that are too high. 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 the buyer's specifications. Unlike maintenance,
repair and operating supplies, direct materials are often not
standardized and therefore 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 often 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
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<PAGE> 35
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 business. Because competition among suppliers is limited by these factors,
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.
LIMITATIONS OF CURRENT BUSINESS-TO-BUSINESS ELECTRONIC COMMERCE APPLICATIONS
The Internet offers an opportunity to make business-to-business commerce
more efficient by facilitating the communication and use of information.
Although several electronic commerce applications for business purchasing have
emerged, we believe that none has adequately addressed the problems presented by
direct materials purchasing. Several of these applications, and the primary
reasons why we believe that they fail to meet the needs of direct materials
buyers, are summarized below:
- SOFTWARE THAT FACILITATES THE PROCUREMENT OF STANDARDIZED PRODUCTS. These
software applications can reduce the paperwork needed to requisition
office supplies and other standardized products, but are not suitable for
the purchase of direct materials for which no catalogs or price lists
exist.
- WEBSITES DEDICATED TO PARTICULAR PRODUCT CATEGORIES. These so-called
"vertical market" sites are generally supported by supplier-paid
advertisements, and as a result, may contain biased information.
Moreover, buyers of custom-made or tailored products often need to
exchange detailed, confidential information with suppliers and to follow
specific procedures when making purchases. These vertical market sites
generally do not support buyer-specific purchasing processes. Thus, they
are of limited benefit to many industrial buyers.
- SELLER-ORIENTED BUSINESS-TO-BUSINESS AUCTION SITES. These sites enable
sellers to offer goods to multiple potential buyers. They are designed to
sell standard or excess items, such as used machinery, to the highest
bidder. As with websites dedicated to particular product categories,
these auction sites are not suitable for the purchase of items such as
direct materials that are custom-made to the buyer's specifications.
We believe that neither software nor Internet technology 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 buyer-oriented Internet technology with services that are customized to
buyers' needs.
THE FREEMARKETS SOLUTION
We combine our proprietary BidWare Internet technology with our in-depth
knowledge of supply markets to help industrial buyers obtain lower prices and
make better purchasing decisions. In a FreeMarkets online auction, multiple
suppliers from around the world can submit bids for a buyer's purchase order in
a real-time, interactive competition. Our auctions, in contrast to those
designed for sellers, are "downward price" auctions in which suppliers continue
to lower their prices until the auction is closed. For each auction, we work
with our client 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. Our service, which we call "market
making", creates a custom market for the goods or services being purchased by
our client in a particular auction. Our solution provides:
- SUBSTANTIAL SAVINGS. Our online auctions can deliver substantial savings
to our clients. 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
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<PAGE> 36
custom industrial components, with even greater savings at times. Clients
often begin to save with the first auction we conduct.
- 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 technology is also flexible. We can easily configure our
BidWare software in many different formats to address the characteristics
of a particular supply market and to achieve the particular objectives of
each of our clients. In addition, we engage in a continuous process of
improving our technology by adding new functions and features that we
develop through our auction experience.
- TAILORED APPROACH TO CLIENTS' NEEDS. We tailor our services to meet the
needs of each client. Our clients are typically large corporations that
purchase a wide variety of industrial parts, raw materials and
commodities. Each client has its own unique organizational structure,
approach to purchasing and specific purchasing objectives. We work with
each client to identify the portions of their purchases that are best
suited for our market making approach and we design a program of services
that meets their needs.
- IN-DEPTH KNOWLEDGE OF SUPPLY MARKETS. We develop and manage specialized
information about many different product categories. Each time we conduct
an auction for a client, we add to the knowledge we can apply to our
business. We maintain a database of thousands of potential suppliers,
with information about their manufacturing processes, quality assurance
practices, market focus and facilities. This in-depth knowledge enables
us to provide our clients with market information that they cannot easily
generate themselves or obtain from other sources.
- MARKET INTEGRITY. We have designed our market making service to enable
our clients 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 sent to
potential suppliers provides detailed and clear specifications, so that
all suppliers who participate in a FreeMarkets online auction have
consistent information to use as a basis for their bids. Buyers and
suppliers who participate in our auctions agree in advance to a set of
auction 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
auctions. The key elements of our strategy are:
- EXTEND OUR CLIENT BASE. We intend to extend our client base in our target
market of Global 1000 corporations and other large enterprises,
particularly those whose purchasing needs include custom-engineered
industrial parts or other customized goods or services obtained from
fragmented supply markets. We also successfully serve the Commonwealth of
Pennsylvania, and believe that our service can attract other governmental
entities. In order to become better known in our target markets, we plan
to hire additional sales and marketing personnel and increase our
marketing and advertising expenditures on brand development.
- EXPAND INTO ADDITIONAL PRODUCT CATEGORIES. We intend to expand into
additional product categories where our online auctions can continue to
generate savings for buyers. We plan to identify these markets by working
with our existing and prospective clients to determine additional direct
materials, services and commodities that would be appropriate for our
solution and by hiring personnel with expertise in a variety of product
categories. We believe that knowledge of additional product categories
will enable us to expand our relationships with our existing clients, as
well as to serve new clients.
- GROW INTERNATIONAL PRESENCE. We intend to expand our presence in Europe
and to create a presence in both Asia and Latin America to better serve
multinational enterprises. We have
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<PAGE> 37
served buyers in the United States and Europe, with over 2,000 suppliers
from more than 30 countries participating in our online auctions. We
believe that we can assist buyers in identifying potential suppliers
worldwide and that our service will be attractive to buyers based outside
the United States.
- FOSTER A CULTURE OF EXCELLENCE AND CLIENT 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 clients. Since our inception, we have
emphasized the creation of an environment of excellence and client
service. We believe that our commitment to excellent service has led and
will continue to lead to new client referrals from satisfied buyers who
have used our auctions.
- ADD BIDDING FEATURES AND AUTOMATION TOOLS. We intend to continue to add
functions and features to our BidWare technology. These functions and
features will facilitate our ability to provide to new and existing
clients additional services, such as upward-price auctions and trading
exchanges for used equipment and excess inventory. We also intend to
develop new tools that will automate portions of our market making
process, enhancing the value we can provide to clients and improving the
scalability of our business.
- INTRODUCE BUYER HUB WEBSITES. We intend to introduce websites, which we
call "buyer hubs", that will incorporate buyers' proprietary information
and tools that they may use to manage their direct materials purchasing.
We believe that these buyer hubs will position us to provide additional
services to our current clients, allowing us to participate in a greater
proportion of their purchasing decisions, and help us to attract new
clients. We currently operate prototype buyer hubs on behalf of two
clients. We intend to build additional buyer hubs that our clients can
use more widely throughout their own organizations to purchase from a
broader range of product categories.
THE FREEMARKETS MARKET MAKING PROCESS
We help our clients obtain lower prices and make better purchasing
decisions. Our process combines auction services and our proprietary BidWare
Internet technology. We call this process "market making" because we create a
custom market for the direct materials, commodities or services being purchased
in each FreeMarkets online auction. To make a custom market, we work with a
client, typically over a period that ranges from four to eight weeks, to
accomplish the following:
[Graphic depiction of five arrows, with the following text in each arrow:
in the first arrow, "Identify Potential Savings", in the second arrow, "Prepare
Request for Quotation"; in the third arrow, "Select Suppliers and Distribute
Request for Quotation"; in the fourth arrow, "Conduct Online Auction", and in
the fifth arrow, "Implement Results".]
IDENTIFY POTENTIAL SAVINGS. We work with our client to identify which of
its purchases seem best suited to our market making process. Although our online
auctions generate 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 client to prepare a request for quotation. The
request for quotation is our client's specification of the materials to be
auctioned. This specification is sent to selected suppliers to help them prepare
their bids. Because many direct materials must be custom-made to a buyer's
specifications, it is essential for
37
<PAGE> 38
the request for quotation to specify precisely all of our client's requirements,
including the applicable technical characteristics, quality and logistics
requirements and commercial terms. An auction typically includes components with
different characteristics or delivery locations, so we group components into
auction 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 client
and others we identify from our supplier database or additional market research.
After a detailed screening process, our client selects a list of potential
suppliers. Because most industrial purchases are made from a select group of
potential suppliers, our online auctions are private, and only those suppliers
which our client ultimately invites may participate. Privacy is important
because the information contained in the request for quotation is highly
confidential and our client will award a purchase order only to a qualified
supplier. Once our client has selected potential suppliers, we provide these
suppliers with the request for quotation to enable them to prepare for the
auction. Before auction day, we train suppliers in the use of our BidWare
software.
CONDUCT ONLINE AUCTION. After potential suppliers have been selected and
trained, we conduct an online auction. During the auction, suppliers remain
anonymous to one another but can see competing price bids in real time, while
our client can see both the identity and current bid of each supplier. An
auction typically lasts from 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 Center
in Pittsburgh provides continuous support to our clients and the suppliers
involved in our auctions throughout the process. We monitor auction performance,
send real-time messages to participants, and strive to ensure that all bidders
can participate effectively. We believe that our active involvement during
auctions makes our process more reliable. We can support auction participants in
more than 20 different languages. We consider this to be a critical skill in
helping clients to buy from suppliers around the world.
IMPLEMENT RESULTS. After the online auction has been completed, we assist
our client in analyzing and implementing auction results so that our client can
award a purchase order to the supplier or suppliers providing the best overall
value. In some situations, our client can make an award decision and issue a
purchase order soon after an auction. In other situations, our client may
perform additional analysis and due diligence before making an award. Since
awards may be based not only on price, but also on non-price factors such as
quality and delivery capabilities, the low bidder does not always win a
FreeMarkets online auction. Our client ultimately makes the final award
decision.
CASE STUDIES
The examples that follow illustrate how the FreeMarkets market making
process helps clients achieve savings on their direct materials purchases. Each
auction we conduct is a distinct event, with a different mix of participants and
products. The results of any auction cannot be predicted, and may not be
replicated.
UNITED TECHNOLOGIES CORPORATION
We have conducted over 50 auctions for United Technologies since 1996. The
case study presented below describes a single auction we conducted in 1997 for a
three-year contract to purchase injection molded plastic parts used in heating,
ventilating and air conditioning equipment. The auction resulted in projected
savings, estimated after final supplier selection, of $1.2 million per year, or
$3.6 million over the life of the contract. This represented a 12% savings when
compared to the previous prices paid by United Technologies for these parts.
IDENTIFY POTENTIAL SAVINGS. We worked with United Technologies to identify
injection molded plastic parts purchased by four different plants as suitable
for an online auction. The package to be auctioned included 159 different parts,
all to be produced to United Technologies' specifications. These
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<PAGE> 39
parts represented a total of $29.1 million of purchases over the three-year life
of the contract to be bid, or $9.7 million annually, based on the previous
prices paid by United Technologies.
PREPARE REQUEST FOR QUOTATION. We worked with our client to write a request
for quotation describing the parts to be auctioned. The request for quotation
included blueprints and material specifications, as well as other technical
details needed by suppliers to prepare their bids. We grouped the 159 parts into
10 different lots, reflecting differences in part size, materials and special
treatments required for the finished parts.
SELECT POTENTIAL SUPPLIERS AND DISTRIBUTE REQUEST FOR QUOTATION. We helped
our client to select appropriate suppliers for each of the 10 lots. We
identified potential suppliers from among those used by United Technologies in
the past, from our database and from research that we performed during this
project. All suppliers completed surveys designed to profile their capabilities
as plastic molders and assess their quality assurance practices. Because the
parts varied from small, decorative items to large, functional items, it was
necessary to select and to distribute the request for quotation to a diverse
group of suppliers to ensure that we had a sufficiently competitive market for
each of the 10 lots. Ultimately, United Technologies selected 36 different
suppliers to participate in the auction and shipped a request for quotation to
each.
CONDUCT ONLINE AUCTION. The auction began at 11:00 a.m. Eastern Time and
open bidding ensued on all 10 lots. Within eight minutes of the auction's
opening, 40 bids had been received, and the aggregate low bid for all 10 lots
stood at an amount that represented $27.5 million over the three-year life of
the contract. At this point, the projected savings equaled $1.6 million, or 5%,
below the amount that United Technologies would have paid over three years based
on the previous prices they had paid for these parts. The first lot closed at
12:07 p.m., with a total of 132 bids having been placed, 12 of which had been
received in the final 10 minutes of bidding. The remaining lots closed
sequentially over the next three hours, allowing bidders to concentrate on each
lot individually in the intense final minutes of bidding.
IMPLEMENT RESULTS. We worked with United Technologies to assess bidding
results. Because non-price factors were also important, we had informed
suppliers in advance that low bidders would not automatically win, just as low
bidders would not automatically win in more traditional bidding processes.
Ultimately, United Technologies received 382 bids on the 10 lots from 28
suppliers, and selected six suppliers. If United Technologies purchases the full
auctioned volume over the contract life, then it will pay an aggregate purchase
price of $25.5 million over the three-year period, saving $3.6 million, or 12%,
over the life of the contract.
OTHER EXAMPLES
Since 1995, we have created similar online auctions for more than 30
clients. The examples below illustrate the savings that we have helped our
clients achieve on purchases in a variety of product categories.
PRINTED CIRCUIT BOARDS. In January 1998, we conducted two online auctions
for multi-layered printed circuit boards on behalf of a Fortune 100 corporation,
which resulted in aggregate savings of $10.6 million per year, or $31.7 million
over the life of the three-year contract bid. This represented savings of 43%
below the prices previously paid for these components by our client. The
package, on which 29 suppliers from Europe, Asia and North America bid, included
383 different printed circuit board designs. Based on the low bid price achieved
in these auctions, these components would represent $41.8 million of purchases
over a three-year period, or $13.9 million annually.
COMMERCIAL MACHININGS. In April 1999, we conducted an online auction for
commercial machinings on behalf of an electrical products company, which
resulted in savings of $2.1 million per year, or $6.3 million over the life of
the three-year contract bid. This represented savings of 24% below the prices
previously paid for these components by our client. The package included 813
different precision machined metal components, which previously were produced by
as many as 56 different
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suppliers. One of our client's objectives for this auction was to reduce the
number of suppliers. We expect that, as a result of our auction, our client will
ultimately purchase the components in this package from approximately 15
suppliers. The bidders during this auction participated simultaneously from
Taiwan, India, Hong Kong, Malaysia, Mexico and the United States. Based on the
low bid price achieved in our auction, these components would represent $19.8
million of purchases over a three-year period, or $6.6 million annually.
LABELS. In June 1999, we conducted an online auction for packaging labels
on behalf of a major consumer packaged goods company, which resulted in annual
savings of $1.5 million. This represented savings of 41% below the prices
previously paid for these labels by our client. The package, on which three
suppliers bid, included 76 different labels. Based on the low bid price achieved
in our auction, these labels would represent $2.1 million of purchases over the
one-year term of the contract bid.
ROCK SALT. In July 1999, we conducted an online auction for rock salt on
behalf of a government purchasing organization, which resulted in annual savings
of $2.5 million. This represented savings of 7% below the prices previously paid
for this material by our client. The package, on which nine suppliers bid,
included solar and mined rock salt used to melt ice on winter roads. Based on
the low bid price achieved in our auction, this material would represent a total
of $31.1 million of purchases over the one-year term of the contract bid.
PRODUCT CATEGORIES
We create online auctions for our clients in a wide variety of product
categories, ranging from commodities to custom-engineered components. The number
of product categories in which we have experience had grown to more than 50 as
of September 30, 1999. The following list includes some of the product
categories in which we have had the most experience:
<TABLE>
<S> <C> <C>
Chemicals Fasteners Motor freight
Coal Injection molded plastics Printed circuit boards
Commercial machinings Metal fabrications Service center metals
Corrugated packaging Metal stampings Transformers
Die castings Molded rubber
</TABLE>
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 auctions in a product category for multiple clients, so we gain
knowledge and improve productivity over time through repeated auctions.
CLIENTS
Our clients are among the world's largest buyers of industrial parts, raw
materials and commodities. To date, we have created online auctions for more
than 30 clients. We have served the following clients in the nine months ended
September 30, 1999:
<TABLE>
<S> <C> <C>
Allegheny Ludlum Corporation Emerson Electric Company Navistar International
BP Amoco Corporation FirstEnergy Corp. Owens Corning
Commonwealth of Pennsylvania General Electric Company Pepsico, Inc.
Conopco, Inc. (acting through its The Quaker Oats Company
(which does business as GE Industrial Systems Reliant Energy, Incorporated
Unilever Home & Personal business component) (formerly known as Houston
Care USA) General Motors Corporation Lighting & Power)
Delphi Automotive Systems Hillenbrand Industries, SmithKline Beecham plc
Corporation Inc. United Technologies Corporation
Eaton Corporation Honeywell International Welch Foods Inc.
Inc.
(formerly AlliedSignal
Inc.)
</TABLE>
We provide services to our clients under service agreements that range from
a few months to four years. These agreements are typically cancelable by our
clients on minimal notice and without substantial penalties. Our agreements
typically provide us with revenues from fixed monthly fees. Some
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<PAGE> 41
of our agreements also include performance incentive payments that are
contingent upon our client achieving specific auction volume or savings
thresholds, or both. Our agreements may also provide for sales commissions to be
paid to us upon shipment of the auctioned items from the winning supplier to our
client. We never take title to or possession of any of the products purchased
through our auctions. We also do not oversee delivery of or payment for these
products.
SALES AND MARKETING
We sell our services through our direct sales organization. As of September
30, 1999, our direct sales force consisted of 14 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 and
other senior executives within a buying organization. When a prospective client
is interested in working with us, we will analyze which portions of its direct
material purchases are best suited to our market making process. Throughout this
analysis, we work with the prospective client to negotiate terms of a service
agreement.
New clients often enter into short-term agreements with us in order to try
our service before making a longer-term commitment. Because our technology need
not be integrated with the client's existing information technology
infrastructure, short-term agreements can quickly result in savings for our
client. Our short-term agreements typically last four to six months, during
which time we prepare and conduct a range of auctions. Our goal through this
process is to demonstrate our capability to provide savings, and to obtain a
longer-term service agreement with the client.
Our marketing efforts focus on general communications and on obtaining
referrals from our existing clients. We participate in trade conferences and
purchasing industry forums, and advertise in major airports and business
publications. We intend to increase our advertising and marketing expenditures
in an effort to become better known in our target markets. These expenditures
will cover the addition of sales, marketing and business development personnel,
increased advertising in professional journals and general business and trade
media, increased media relations, increased presence at purchasing and
technology trade conferences, and continuing improvements to our website.
TECHNOLOGY AND OPERATIONS
We have built our proprietary auction technology called BidWare to create
highly-interactive auctions tailored to the needs of industrial purchasers. Our
Internet-based BidWare software provides an easy-to-use graphical interface that
our clients use to watch their auctions progress and that suppliers use to
submit bids. Suppliers participate from their own offices, where key decision
makers submit bids. Our BidWare software provides nearly instantaneous response,
displaying these bids to all users within seconds of submission. A truly dynamic
auction results, as buyers watch prices decrease before their eyes.
We operate a Market Operations Center in our Pittsburgh headquarters to
ensure that each auction is actively managed and runs smoothly. We strive to
make our auctions extremely reliable, both through our operations methodology
and the quality of our BidWare software. The BidWare architecture contains many
features to monitor and control auctions so that our Market Operations Center
can quickly respond in the event of technical or other difficulties. In
addition, our Market Operations Center staff actively supports bidders before
and during auctions, helping to further ensure the reliability of our service.
Although we have taken extensive measures to ensure the reliability of our
auctions, we cannot guarantee that we will not have technical interruptions or
failures in the future.
Our BidWare software incorporates a wide range of bidding features and
auction formats that we have developed to address specific needs of industrial
purchasers. Examples of the types of auctions we can run with our BidWare
software include:
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<PAGE> 42
- multi-parameter auctions, where submitted bids incorporate quality and
technical factors as well as prices;
- differential index auctions, where suppliers compete on price
differentials from a pre-specified index or reference price that may
fluctuate during the life of the contract;
- multi-currency auctions, where our client and suppliers can choose to
monitor the auction in the currency of their choice; and
- multi-period auctions, where suppliers can submit a series of price
quotes covering multiple future periods.
Because we can operate our BidWare software in many different formats and
set many different control parameters, we can create tailored auctions that
address particular industrial purchasing situations.
Our BidWare software is designed so that users can connect to our BidServer
technology, the server-side application that manages our auctions, through
either their own Internet connections or an Internet service provider from which
we lease private network services. We encourage bidders to use our leased
network service provider so that we can obtain a more reliable and uniform level
of performance that we believe is important for real-time interactive bidding.
We operate our BidServer technology from our Market Operations Center in
Pittsburgh, where we have redundant links to our Internet service provider and a
redundant router configuration that automatically reroutes traffic if a
connection fails.
We expended $842,000 on research and development in 1998 and $3.0 million
in the nine months ended September 30, 1999. We plan to increase our research
and development expenditures to continue adding features to our technology and
to develop new Internet-based purchasing automation tools. We plan to continue
to develop tools to manage purchasing information customized for specific
clients. We believe that these tools may enable us to increase our employees'
productivity and allow us to serve more clients as we further automate our
services. We may also be able to derive additional revenues from operating these
tools for clients.
COMPETITION
A number of companies provide services or products to the market for
business-to-business electronic commerce, and existing and potential clients can
choose from a variety of current and potential competitors' services.
Competition in this market is rapidly evolving and intense, and we expect
competition to further intensify in the future. We currently or potentially will
compete with a number of other companies, including:
- well-financed entrepreneurial start-ups that offer similar services or
services perceived by a client to be similar;
- providers of electronic commerce technology extending their offerings to
include services or technology similar to ours;
- 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 auctions.
Our online auction service is one of many alternative approaches to
purchasing that buyers are considering. 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,
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<PAGE> 43
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
buyers will confuse our services with those of our competitors or choose the
services of a competitor with greater resources. We also face the risk that
buyers may attain poor results with other products or services and lose interest
in trying our services. We may not be able to keep our current clients or secure
new ones in light of these issues.
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 clients and with
suppliers who participate in our online auctions. We do not sell our BidWare
software to our clients or to suppliers, but rather license it for the limited
purpose of enabling buyers to view our online auctions and suppliers to submit
bids. 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
the European Community. We have also applied for United States trademark
registration on SmartRFI, SmartRFQ and CBE. We have cleared the opposition
period in the European Community for our trademark application for FreeMarkets
and we have applied for trademarks in other jurisdictions.
We have filed patent applications in the United States with respect to
proprietary features of our technology, which include features relating to how
we conduct auctions and the business processes for making markets, which we
currently use or intend to use in the future. We cannot assure you that these
patents will be issued, or that even if issued, these patents 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 online auction
services. We may, at times, 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 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,
copyrights 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 generally. 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 clients
worldwide, foreign jurisdictions may claim that
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<PAGE> 44
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.
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 auction services. However, one or more jurisdictions may attempt to
impose these laws and regulations on our operations in the future.
EMPLOYEES
As of September 30, 1999, we had 278 employees, 249 of whom were located at
our Pittsburgh headquarters and 29 at our office in Brussels, Belgium. Of our
employees, 141 are engaged in market making, 37 in research and development, 27
in sales and marketing, 25 in technical operations and 48 in 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.
FACILITIES
Our headquarters in Pittsburgh, Pennsylvania currently occupies 72,000
square feet of office space under a lease that expires in May 2004. 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 two
years. We also lease an office of 11,000 square feet in Brussels, Belgium and an
office of 4,700 square feet in San Jose, California. We may add additional
offices in the United States and in other countries.
LEGAL PROCEEDINGS
We are not currently involved in any material legal proceedings.
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."
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MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The following table sets forth specific information regarding our executive
officers and directors as of December 1, 1999:
<TABLE>
<CAPTION>
NAME AGE POSITION(S)
- --------------------------------------------------- --- -----------------------------------------------------
<S> <C> <C>
Glen T. Meakem..................................... 35 President, Chief Executive Officer, Chairman of the
Board and Director
Sam E. Kinney, Jr.................................. 35 Executive Vice President, Secretary and Director
David J. Becker.................................... 36 Executive Vice President and Chief Operating Officer
Thomas L. Dammer................................... 35 Vice President of Sales
Joan S. Hooper..................................... 42 Vice President, Chief Financial Officer and Treasurer
Jane M. Kirkland................................... 40 Vice President and Chief Information Officer
John P. Levis, III................................. 38 Vice President of People Development
Thomas L. McLeod................................... 41 Vice President of Market Making
Dr. Eric C. Cooper................................. 40 Director
L. John Doerr...................................... 48 Director
Thomas J. Meredith................................. 49 Director
David A. Noble..................................... 40 Director
</TABLE>
GLEN T. MEAKEM co-founded FreeMarkets in 1995 and has served as our
President, Chief Executive Officer, Chairman of the Board and a director since
our inception. Prior to co-founding FreeMarkets, from May 1994 to February 1995,
Mr. Meakem was employed as a manager in the Corporate Business Development Group
of General Electric Co. From January 1992 to April 1994, Mr. Meakem was an
associate with McKinsey & Company, Inc., a management consulting firm, where he
focused on industrial sourcing and commodities trading for clients in the United
States and Mexico. From June 1986 to December 1991, Mr. Meakem was an officer in
the United States Army Reserve. During this period, Mr. Meakem served two
separate active duty tours in the Army, the first from July 1986 to December
1986, and the second from December 1990 to June 1991. During his second active
duty tour, Mr. Meakem volunteered for and served as a combat engineer platoon
leader in Operation Desert Storm. From January 1987 to July 1989, Mr. Meakem
held product marketing positions of increasing responsibility with Kraft-General
Foods Corporation. Mr. Meakem earned an A.B. in government from Harvard
University and an M.B.A. from Harvard Business School.
SAM E. KINNEY, JR. co-founded FreeMarkets in 1995 and has served as our
Secretary and a director since our inception. From April 1995 to May 1998, he
was a Vice President of FreeMarkets, and since May 1998 he has been an Executive
Vice President. He also served as Acting Chief Financial Officer from June 1998
to September 1999, and as our Treasurer from our inception until September 1999.
Prior to co-founding FreeMarkets, from March 1992 to April 1995, Mr. Kinney was
employed as a consultant and engagement manager at McKinsey & Company, Inc. From
July 1990 to March 1992, Mr. Kinney worked as a special projects and budget
manager for Lucas Aerospace Power Equipment Corporation. From July 1986 to June
1988, Mr. Kinney was employed as a consultant with Booz-Allen & Hamilton, Inc.,
a management consulting firm. During his tenure as a consultant with McKinsey &
Company and Booz-Allen & Hamilton, Mr. Kinney worked on issues of sourcing,
industrial distribution and operations effectiveness for industrial, healthcare
and financial institution clients. Mr. Kinney earned an A.B. in economics from
Dartmouth College and an M.B.A. from the Amos Tuck School of Business
Administration at Dartmouth College.
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DAVID J. BECKER has served as an Executive Vice President and our Chief
Operating Officer 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 as Manager,
Worldwide Logistics Information Network. Mr. Becker earned a B.S. in chemical
and petroleum refining engineering from Colorado School of Mines, an M.S. in
chemical engineering from the West Virginia College of Graduate Studies and an
M.B.A. from Harvard Business School.
THOMAS L. DAMMER has served as our Vice President of Sales since September
1998. Prior to joining FreeMarkets, from January 1994 to September 1998, Mr.
Dammer was employed by SmithKline Beecham Consumer Healthcare, where he served
in several positions, including Associate Director, Worldwide Business
Development and National Account Manager, Managed Care. From September 1987 to
January 1994, Mr. Dammer held several sales, sales management and marketing
product management positions with The Upjohn Company. Mr. Dammer earned a B.S.
in chemistry from Hope College (Michigan) and an M.B.A. from Duquesne
University.
JOAN S. HOOPER has served as a Vice President and our Chief Financial
Officer and Treasurer since 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 as
Financial Vice President of AT&T Business Services. Ms. Hooper holds a B.S.B.A.
in finance from Creighton University and an M.B.A. from Northwestern University,
and is a Certified Public Accountant and Certified Management Accountant.
JANE M. KIRKLAND has served as a Vice President and our Chief Information
Officer since July 1999. Prior to joining FreeMarkets, from June 1988 to July
1999, Ms. Kirkland was employed with McKinsey & Company, Inc., where she worked
in several positions, including Associate, Principal and Director of Knowledge
Management. During her tenure at McKinsey & Company, Ms. Kirkland focused on
serving clients in the financial services and electronics industries. Ms.
Kirkland holds a B.A. in English from Smith College, an M.A.T. in English from
Brown University, an M.S. in computer science from the University of
Massachusetts, Lowell and an M.B.A. from the Amos Tuck School of Business
Administration at Dartmouth College.
JOHN P. LEVIS, III has served as our 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 healthcare, financial services, energy, food
service and media clients on issues of marketing, channel strategy and cost
management. Mr. Levis earned a B.A. in history from Yale College and an M.B.A.
from the Amos Tuck School of Business Administration at Dartmouth College.
THOMAS L. MCLEOD has served as our Vice President of Market Making since
May 1998. Prior to joining FreeMarkets, from June 1996 to May 1998, Mr. McLeod
was a Principal with A.T. Kearney, a management consulting firm. From 1988 to
1996, Mr. McLeod was employed by Gemini Consulting, most recently in the
position of Vice President in the Federal Republic of Germany, where he led the
Analysis and Design practice. Mr. McLeod earned a B.A. in economics from the
University of Virginia and an M.B.A. from the College of William and Mary.
DR. ERIC C. COOPER has served as a director of FreeMarkets since June 1999.
Dr. Cooper was a co-founder of FORE Systems, Inc., a pioneer in the development
of ATM high speed networking equipment, which was acquired by GEC, p.l.c. in
June 1999. From FORE Systems' inception in April 1990 to June 1999, Dr. Cooper
served as Chairman of the Board, and he also served as Chief Executive Officer
from inception through January 1998. Prior to co-founding FORE Systems in 1990,
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<PAGE> 47
Dr. Cooper was on the faculty of Carnegie Mellon University. Dr. Cooper earned a
Ph.D. in computer science from the University of California at Berkeley, and an
A.B. in mathematics from Harvard University.
L. JOHN DOERR has served as a director of FreeMarkets since October 1999.
Mr. Doerr has been a general partner of Kleiner Perkins Caufield & Byers, a
private venture capital firm, since September 1980. In 1974, he joined Intel
Corporation and held various engineering, marketing and management assignments.
Mr. Doerr is also a director of Martha Stewart Living Omnimedia, Inc.,
Amazon.com, Inc., excite@Home Corporation, drugstore.com, inc., Healtheon
Corporation, Intuit Inc., Epicor Software Corporation and Sun Microsystems,
Inc., as well as several private companies. Mr. Doerr earned a B.S. and an M.S.
in electrical engineering from Rice University and an M.B.A. from Harvard
Business School.
THOMAS J. MEREDITH has served as a director of FreeMarkets since November
1999. Mr. Meredith has been Senior Vice President and Chief Financial Officer of
Dell Computer Corporation since November 1992. Prior to joining Dell, Mr.
Meredith was Vice President and Treasurer of Sun Microsystems, Inc. Mr. Meredith
is also a director of i2 Technologies Inc. and International Integration Inc.
(i-Cube). Mr. Meredith earned a B.A. in political science from St. Francis
College, a J.D. from Duquesne University and a Masters of Law in taxation from
Georgetown University.
DAVID A. NOBLE has served as a director of FreeMarkets since April 1999.
Mr. Noble is currently a general partner of Stolberg, Meehan & Scano, a private
equity investment fund focusing on business-to-business services in the
communications, utilities, information technology and electronic commerce
industries. From July 1985 to September 1997, Mr. Noble was employed with
McKinsey & Company, Inc., most recently as a Principal and head of the firm's
commodity risk management practice. Mr. Noble earned a B.S. in electrical
engineering from the Massachusetts Institute of Technology and an M.B.A. from
Harvard Business School.
BOARD COMPOSITION
Our Board of Directors currently consists of six members. Currently, each
director is elected for a period of one year at our annual meeting of
stockholders and serves until the next annual meeting or until his successor is
duly elected and qualified. Effective upon this offering, the Board will be
divided into three classes, with each class serving a staggered three-year term.
Messrs. Meredith and Noble will serve as directors in the class having a term
first ending in 2000, Dr. Cooper and Mr. Doerr will serve as directors in the
class having a term first ending in 2001 and Messrs. Kinney and Meakem will
serve as directors in the class having a term first ending in 2002. See
"Description of Capital Stock -- Anti-Takeover Provisions".
BOARD COMMITTEES
Our Board of Directors established a compensation committee and an audit
committee in 1998. The compensation committee currently consists of Mr. Noble as
Chairman and Dr. Cooper. The compensation committee reviews and recommends to
the Board of Directors the compensation and benefits of our executive officers,
administers our stock option plans and establishes and reviews general policies
relating to compensation and benefits of our employees. The audit committee
currently consists of Dr. Cooper as Chairman and Mr. Noble. The audit committee
reviews our internal accounting procedures and consults with, and reviews the
services provided by, our independent accountants.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Neither of the members of our compensation committee has ever been an
officer or employee of FreeMarkets. None of our executive officers serves as a
member of the board of directors or compensation committee of any entity that
has one or more executive officers serving on our Board of Directors or
compensation committee.
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<PAGE> 48
DIRECTOR COMPENSATION
We reimburse our directors for travel and lodging expenses in connection
with attendance at Board and committee meetings. All of our directors, including
non-employee directors, are eligible to receive options under our Amended and
Restated Stock Incentive Plan. We recently granted options to all of our
non-employee directors. See "-- Option Grants -- Recent Option Grants".
EMPLOYMENT AND CHANGE IN CONTROL ARRANGEMENTS
All of our executive officers serve at the discretion of the Board of
Directors.
If we experience a change in control, some of the outstanding options held
by some of our executive officers, including Messrs. Meakem, Kinney, Becker,
Levis and McLeod, that were not previously vested will immediately vest. As of
September 30, 1999, the minimum number of options held by Messrs. Meakem,
Kinney, Becker, Levis and McLeod that could vest under this provision is as
follows: Mr. Meakem -- 1,120,000; Mr. Kinney -- 680,000; Mr. Becker -- 457,000;
Mr. Levis -- 52,500; and Mr. McLeod -- 240,000. In addition, if the acquiror in
any change of control fails to provide substitute options to replace outstanding
options held by these executive officers, then all outstanding options not
previously vested would vest upon the change of control.
Generally, a change in control would include:
- an acquisition of more than 50% of the combined voting power of all our
outstanding securities; or
- a merger where, following the transaction, our stockholders own 50% or
less of the voting securities of the surviving or resulting entity; or
- our liquidation or the sale of substantially all of our assets; or
- individuals who currently form a majority of our Board of Directors
ceasing to be a majority, unless the new directors are nominated for
election by our current Board of Directors or their nominated successors.
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EXECUTIVE COMPENSATION
The following table sets forth the compensation received for services
rendered to FreeMarkets by our Chief Executive Officer and our four other most
highly compensated executive officers who earned more than $100,000 during 1998.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION AWARDS
ANNUAL COMPENSATION (OPTION AWARDS)
---------------------------------- --------------------
OTHER ANNUAL NUMBER OF SECURITIES
NAME AND PRINCIPAL POSITION SALARY BONUS COMPENSATION UNDERLYING OPTIONS
- --------------------------- -------- ------- ------------- --------------------
<S> <C> <C> <C> <C>
Glen T. Meakem.......................... $177,083 $50,000 -- 1,440,000
President, Chief Executive Officer and
Chairman of the Board
Sam E. Kinney, Jr....................... 140,000 30,000 -- 960,000
Executive Vice President and Acting
Chief Financial Officer
David J. Becker......................... 140,000 30,000 -- 480,000
Executive Vice President and Chief
Operating Officer
Thomas L. McLeod (1).................... 123,590 60,250 $50,000 480,000
Vice President of Market Making
John P. Levis, III...................... 115,000 15,000 -- 30,000
Vice President of People Development
</TABLE>
- ---------------
(1) Mr. McLeod became Vice President of Market Making in May 1998. His other
annual compensation for 1998 reflects a relocation allowance.
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OPTION GRANTS
The following table provides summary information regarding stock options
granted to our Chief Executive Officer and our four other most highly
compensated executive officers during 1998. We granted these options at an
exercise price equal to the fair market value of the common stock on the date of
grant as determined by the Board of Directors. Thirty percent of the options
shown for each executive officer will become exercisable immediately upon the
closing of this offering. The remaining options will become exercisable at the
rate of 25% per year beginning May 2001, unless we experience a change in
control. In that event, 50% of the options set forth in the table below which
are not yet vested would immediately vest, and the remaining options would vest
over the periods set forth above.
We calculated the potential realizable value of options in the table
assuming the exercise price on the date of grant appreciates at the indicated
rate for the entire term of the option and that the option holder exercises his
option on the last day of its term at the appreciated price. All options listed
have a term of 10 years. We assumed stock price appreciation of 5% and 10%
pursuant to the rules of the Securities and Exchange Commission. We cannot
assure you that the actual stock price will appreciate over the 10-year option
term at the assumed 5% and 10% levels or at any other rate.
OPTION GRANTS DURING 1998
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
--------------------------------------------------- POTENTIAL REALIZABLE
PERCENTAGE VALUE AT ASSUMED
NUMBER OF OF TOTAL ANNUAL RATES OF
SECURITIES OPTIONS STOCK PRICE APPRECIATION
UNDERLYING GRANTED IN EXERCISE FOR OPTION TERM
OPTIONS 1998 TO PRICE PER EXPIRATION -------------------------
NAME GRANTED EMPLOYEES SHARE DATE 5% 10%
- ---- ---------- ------------- --------- ---------- ---------- ------------
<S> <C> <C> <C> <C> <C> <C>
Glen T. Meakem............. 1,440,000 23.4% $1.08 5/28/08 $981,076 $2,486,238
Sam E. Kinney, Jr.......... 960,000 15.6 1.08 5/28/08 654,050 1,657,492
David J. Becker............ 480,000 7.8 1.08 5/28/08 327,025 828,746
Thomas L. McLeod........... 480,000 7.8 1.08 5/28/08 327,025 828,746
John P. Levis, III......... 30,000 0.5 1.08 5/28/08 20,439 51,797
</TABLE>
RECENT OPTION GRANTS
In July 1999, we granted options to purchase 225,000 shares of common stock
to Jane M. Kirkland when she joined our company. These options are exercisable
at a price of $4.77 per share and vest over a five-year term.
We made the following option grants to purchase shares of our common stock
to our executive officers in August and September 1999:
<TABLE>
<S> <C>
Glen T. Meakem............................................ 800,000
Sam E. Kinney, Jr......................................... 400,000
David J. Becker........................................... 200,000
Thomas L. Dammer.......................................... 20,000
John P. Levis, III........................................ 75,000
</TABLE>
These options are exercisable at a price of $14.80 per share and vest over a
five-year term.
In September 1999, we granted options to purchase 225,000 shares of common
stock to Joan S. Hooper when she joined our company. These options are
exercisable at a price of $14.80 per share and vest over a five-year term.
In October 1999, we granted options to purchase 30,000 shares of common
stock to each of Dr. Eric C. Cooper and David A. Noble, two of our non-employee
directors, in connection with their service on our Board. These options are
exercisable at a price of $14.80 per share and vested
50
<PAGE> 51
immediately upon grant. By letter agreement, each of Dr. Cooper and Mr. Noble,
subject to limited exceptions, may not sell or otherwise transfer any of the
shares acquired upon exercise of these options until October 27, 2000, after
which each may only sell 10,000 of such shares. After October 27, 2001, each may
sell an additional 10,000 shares, and after October 27, 2002, each may sell the
remaining 10,000 shares. In November 1999, Dr. Cooper exercised the 30,000
options granted to him.
Also in October 1999, we granted options to purchase 350,000 shares of
common stock to L. John Doerr, also a non-employee director, in connection with
his service on our Board. These options were exercisable at a price of $14.80
per share and vested immediately upon grant. By letter agreement, Mr. Doerr,
subject to limited exceptions, may not sell or otherwise transfer any of the
shares acquired upon exercise of these options until October 27, 2000, after
which he may only sell 116,667 of such shares. After October 27, 2001, he may
sell an additional 116,666 shares, and after October 27, 2002, he may sell the
remaining 116,667 shares. In November 1999, Mr. Doerr exercised the 350,000
options granted to him.
In November 1999, we granted options to purchase 50,000 shares of common
stock to Thomas J. Meredith, a non-employee director, in connection with his
service on our Board. These options were exercisable at a price of $14.80 per
share and were to vest over a three-year term. In November 1999, our
Compensation Committee permitted Mr. Meredith to exercise all of the 50,000
options granted to him, at which time Mr. Meredith executed a Restricted Stock
Purchase Agreement under which the shares he acquired may be repurchased by us
for the exercise price in the event that Mr. Meredith ceases to serve as a
member of our Board for any reason other than his death or permanent disability.
Our repurchase rights lapse over a three-year period equivalent to the
three-year vesting period that was applicable to Mr. Meredith's options. The
shares owned by Mr. Meredith cannot be sold or otherwise transferred during the
period in which we have repurchase rights.
FISCAL YEAR END OPTION VALUES
The following table provides summary information concerning the shares of
common stock represented by outstanding stock options held by our Chief
Executive Officer and our four other most highly compensated executive officers
as of December 31, 1998. None of these executive officers exercised options
during 1998. We have calculated the value of in-the-money options based on the
estimated fair market value for our common stock of $1.67 per share on December
31, 1998.
FISCAL YEAR END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
OPTIONS AT DECEMBER 31, IN-THE-MONEY OPTIONS AT
1998 DECEMBER 31, 1998
--------------------------- ---------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Glen T. Meakem................................. -- 1,440,000 -- $840,000
Sam E. Kinney, Jr.............................. -- 960,000 -- 560,000
David J. Becker................................ 78,000 597,000 $96,850 425,275
Thomas L. McLeod............................... -- 480,000 -- 280,000
John P. Levis, III............................. 39,000 186,000 43,875 193,000
</TABLE>
STOCK PLANS
STOCK INCENTIVE PLAN
The Board of Directors adopted and our stockholders approved our Amended
and Restated Stock Incentive Plan in June 1999. The Amended and Restated Stock
Incentive Plan amended and restated our 1998 Stock Option Plan. The Amended and
Restated Stock Incentive Plan became effective on June 30,
51
<PAGE> 52
1999, and it will terminate on March 1, 2008, unless the Board of Directors
terminates it earlier. We may grant the following types of awards under the
Amended and Restated Stock Incentive Plan:
- incentive stock options;
- nonqualified stock options; and
- restricted stock.
As of September 30, 1999, we had granted options to purchase 10,482,500
shares of common stock under the Amended and Restated Stock Incentive Plan, of
which 59,520 had been exercised and 156,550 had been forfeited. We had not
granted any shares of restricted stock under the Amended and Restated Stock
Incentive Plan.
We may currently award a maximum of 15,450,000 shares of common stock under
the Amended and Restated Stock Incentive Plan, plus any shares of stock covered
by the unexercised portion of any terminated options granted under the 1996
Stock Incentive Plan, discussed below. In addition, the number of awardable
shares automatically increases on the first day of each year beginning in 2001
by an amount equal to the lesser of 1,500,000 shares or 3% of our total shares
outstanding on the last day of the immediately preceding year, unless the Board
of Directors determines to increase the amount by a lesser number of shares. Our
compensation committee administers the Amended and Restated Stock Incentive
Plan.
If control of our company changes through, for example, an acquisition of
more than 50% of our stock by another person or company, or through a merger
with another company, and the acquiror fails to assume or replace with
equivalent awards all outstanding awards under the Amended and Restated Stock
Incentive Plan, then all outstanding options that have not vested prior to the
change of control will immediately vest and the restrictions on any restricted
stock that have not lapsed before the change of control will immediately lapse.
If, upon a change of control, an acquiror agrees to assume or substitute for the
outstanding awards, then 50% of any unvested options that we have granted since
June 30, 1999, will immediately vest and the restrictions on 50% of any
restricted stock will immediately lapse.
1996 STOCK INCENTIVE PLAN
The Board of Directors adopted and our stockholders approved our 1996 Stock
Incentive Plan in January 1996. The 1996 Stock Incentive Plan will terminate in
January 2006, unless the Board of Directors terminates it earlier. If control of
our company changes, all unvested options held by grantees whom we have employed
for at least three years will immediately vest. We may not grant any further
options under the 1996 Stock Incentive Plan. Our compensation committee
administers the 1996 Stock Incentive Plan.
EMPLOYEE STOCK PURCHASE PLAN
The Board of Directors adopted and our stockholders approved our Employee
Stock Purchase Plan in 1999. The Employee Stock Purchase Plan permits eligible
employees to purchase common stock, through payroll deductions, at a discount
from its fair market value. We have reserved a total of 500,000 shares of common
stock for issuance under the Employee Stock Purchase Plan, plus an automatic
annual increase on the first day of each year beginning in 2000 equal to the
total number of shares purchased under the Employee Stock Purchase Plan during
the immediately preceding fiscal year, up to a maximum of 2,000,000 shares that
can be reserved for issuance under the plan. The Employee Stock Purchase Plan
becomes effective upon the effective date of the registration statement filed in
connection with this offering and, unless the Board of Directors terminates it
earlier, will continue in effect for a term of 20 years.
52
<PAGE> 53
The Employee Stock Purchase Plan is intended to qualify under Section 423
of the Internal Revenue Code. The Employee Stock Purchase Plan consists of a
series of overlapping 24-month offering periods. Each offering period consists
of four six-month purchase periods. Participating employees will automatically
make stock purchases at the end of each purchase period. The initial offering
period and the initial purchase period will begin on the date of this
prospectus. The Board of Directors has the authority under the plan to set new
offering or purchase periods.
The Board of Directors or a committee appointed by the Board of Directors
will administer the Employee Stock Purchase Plan. The Employee Stock Purchase
Plan permits eligible employees to purchase common stock through payroll
deductions, which may not exceed 20% of an employee's compensation, unless the
Board decides to increase such amount. The purchase price is equal to the lower
of 85% of the fair market value of the common stock at the beginning of the
applicable offering period or 85% of the fair market value of the common stock
at the end of each corresponding purchase period. In circumstances specified in
the Employee Stock Purchase Plan, we may adjust the purchase price during an
offering period to avoid our incurring adverse accounting charges. Our
employees, including officers and employee directors, are eligible to
participate in the Employee Stock Purchase Plan if they are employed by us for
at least 20 hours per week and more than five months in the year. Employees may
withdraw from participation in the Employee Stock Purchase Plan at any time and
receive a refund of their payroll deductions made since the last purchase date,
in which case they cannot resume participation until the beginning of the next
offering period. Participation ends automatically upon termination of
employment.
Each employee's purchase of common stock during any one purchase period is
subject to limitations. In the event that another company acquires us, the
Employee Stock Purchase Plan generally provides that the acquiror shall assume
each right to purchase stock or shall substitute equivalent rights; otherwise,
each right to purchase common stock will accelerate and become exercisable
immediately before the acquisition. The Board of Directors has the power to
amend or terminate the Employee Stock Purchase Plan.
LIMITATION OF LIABILITY OF DIRECTORS AND INDEMNIFICATION MATTERS
Our Certificate of Incorporation limits the liability of directors to the
maximum extent permitted by Delaware law. Delaware law provides that directors
of a corporation will not be personally liable for monetary damages for breach
of their fiduciary duties as directors, except liability for:
- any breach of their duty of loyalty to the corporation or its
stockholders;
- acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law;
- unlawful payments of dividends or unlawful stock repurchases or
redemptions; or
- any transaction from which a director derives an improper personal
benefit.
This limitation of liability does not apply to liabilities arising under
the federal securities laws and does not affect the availability of equitable
remedies such as injunctive relief or rescission.
Our Certificate of Incorporation and Bylaws provide that we shall indemnify
our directors and executive officers, and may indemnify our other officers and
employees and other agents, to the fullest extent permitted by law. We believe
that indemnification under our Bylaws covers at least negligence and gross
negligence on the part of indemnified parties. Our Bylaws also permit us to
secure insurance on behalf of any officer, director, employee or other agent for
any liability arising out of his or her actions in such capacity and certain
other capacities, such as serving as a director of another corporation at the
request of the Board, regardless of whether the Bylaws would permit
indemnification.
We have entered into agreements to indemnify our directors and officers in
addition to indemnification provided for in our Certificate of Incorporation and
our Bylaws. These agreements,
53
<PAGE> 54
among other things, provide for indemnification of our directors and officers
for expenses specified in the agreements, including attorneys' fees, judgments,
fines and settlement amounts incurred by any of these persons in any action or
proceeding arising out of these persons' services as a director or officer for
us, any of our subsidiaries or any other entity to which the person provides
services at our request. We believe that these provisions and agreements are
necessary to attract and retain qualified persons as directors and officers.
At present, we are not aware of any pending or threatened litigation or
proceeding involving a director, officer, employee or agent in which
indemnification would be required or permitted.
54
<PAGE> 55
CERTAIN TRANSACTIONS
In May 1996, we sold 4,019,400 shares of Series A-1 preferred stock at a
price of $.43 per share. In this private placement, we sold 1,176,000 shares to
CSM Partners, 18,000 shares to Saturn Capital and 58,800 shares to Jane M.
Kirkland. As consideration for acting as placement agent, we also issued to
Saturn Capital warrants to purchase 810,000 shares of Series A-1 preferred stock
with an exercise price of $.54 per share.
In September 1996, we sold 219,600 shares of common stock at a price of
$.43 per share. In this private placement, we sold 58,800 shares to David J.
Becker.
From December 1996 through July 1997, we sold 2,347,200 shares of Series B
preferred stock at a price of $.54 per share. In this private placement, we sold
22,200 shares to Jane M. Kirkland, 21,000 shares to John P. Levis, III and
46,200 shares to David A. Noble. As consideration for acting as placement agent,
we issued to Saturn Capital warrants to purchase 571,800 shares of Series B
preferred stock with an exercise price of $.54 per share.
In October 1997, we sold 5,017,200 shares of Series A-2 preferred stock at
a price of $.54 per share. In this private placement, we sold 922,800 shares to
CSM Partners, 66,000 shares to David J. Becker, 76,200 shares to Jane M.
Kirkland, 115,800 shares to John P. Levis, III and 138,000 shares to David A.
Noble. As consideration for acting as placement agent, we issued to Saturn
Capital warrants to purchase 1,222,800 shares of Series A-2 stock with an
exercise price of $.54 per share.
In October 1997, we sold 531,000 shares of common stock at a price of $.54
per share. In this private placement, we sold 39,000 shares to John P. Levis,
III.
In October 1998, we sold 780,000 shares of common stock at a price of $1.67
per share. In this private placement, we sold 873 shares to Glen T. Meakem,
15,000 shares to Thomas L. Dammer, 18,000 shares to David J. Becker, 8,502
shares to John P. Levis, III and 60,000 shares to Thomas L. McLeod.
In February 1999, Goldman, Sachs & Co. committed to invest at least
$6,596,700 in an offering of FreeMarkets' equity securities. That private
placement was completed in April 1999, when we sold 1,382,955 shares of Series C
preferred stock to Goldman, Sachs & Co. and two of its affiliated entities at a
price of $4.77 per share. Goldman, Sachs & Co. is an underwriter in this
offering. In this private placement, we also sold 156,705 shares to CSM
Partners, 1,269 shares to Saturn Capital, 4,152 shares to David J. Becker,
11,700 shares to Jane M. Kirkland and 1,383 shares to John P. Levis, III.
We paid $600,000 to Saturn Capital in April 1999 to act as placement agent
in order to complete the Series C offering. Saturn Capital also agreed at that
time to relinquish its contractual rights to receive any warrants to purchase
shares of Series C preferred stock or any other compensation, and to act as
placement agent in any future financings by the Company.
In September 1999, we sold 2,057,773 shares of Series D preferred stock at
a price of $14.80 per share. In this private placement, we sold 3,292 shares to
David J. Becker, 8,643 shares to Jane M. Kirkland and 1,414,552 shares to a
subsidiary of United Technologies. We also issued to a subsidiary of United
Technologies warrants to purchase 304,431 shares of Series D preferred stock in
exchange for United Technologies' agreement to delete from its contract with us
provisions that limited our ability to render services to its competitors. These
warrants were exercised at a price of $.01 per share in September 1999. United
Technologies is our largest customer. In 1997, we earned $585,000 in revenues
from United Technologies, in 1998, we earned $4.5 million in revenues from
United Technologies and in the nine months ended September 30, 1999 we earned
$5.3 million in revenues from United Technologies.
In each transaction set forth above where executive officers, directors,
five percent or greater stockholders or family members of any of these persons
purchased shares, these shares were purchased at the same price, and on the same
terms, as shares purchased by other investors at those times. Each share of our
preferred stock is convertible into one share of common stock. To date, warrants
to purchase 2,409,000 shares of our common stock have been exercised, at an
exercise price of $.54 per share.
55
<PAGE> 56
PRINCIPAL STOCKHOLDERS
The following table sets forth information known to us with respect to the
beneficial ownership by the following persons of our common stock as of
September 30, 1999, as adjusted to reflect the sale of common stock by us:
- our Chief Executive Officer and each of our four other most highly
compensated executive officers;
- each director;
- each stockholder known by us to own beneficially more than 5% of our
common stock; and
- all executive officers and directors as a group.
Percentage ownership in the following table is based on 30,354,958 shares
of common stock outstanding as of September 30, 1999. Percentage ownership
assumes conversion of all shares of preferred stock outstanding as of September
30, 1999 into shares of common stock, which will occur upon the closing of this
offering.
The table does not include the beneficial ownership of our common stock by
L. John Doerr, who became a director on October 28, 1999. On that date, Mr.
Doerr was granted immediately exercisable options to purchase 350,000 shares of
our common stock, which he exercised in November 1999. Subject to limited
exceptions, Mr. Doerr is restricted from transferring the shares he acquired
upon exercise of these options; this restriction lapses over a three-year
period. If Mr. Doerr's beneficial ownership were included in the table, his
percentage ownership before the offering would be 1.1% and after the offering
would be 1.0%.
The table also does not include the beneficial ownership of our common
stock by Thomas J. Meredith, who became a director on November 17, 1999. On that
date, Mr. Meredith was granted options to purchase 50,000 shares of our common
stock at a price of $14.80 per share, which he exercised in November 1999. If
Mr. Meredith's beneficial ownership were included in the table, his percentage
ownership before and after the offering would be less than 1.0%.
We have determined beneficial ownership in the table in accordance with the
rules of the Securities and Exchange Commission. In computing the number of
shares beneficially owned by a person and the percentage ownership of that
person, we have deemed shares of common stock subject to options or warrants
held by that person that are currently exercisable or will become exercisable
within 60 days of September 30, 1999, and all options that will be exercisable
upon completion of the offering to be outstanding. We have not deemed these
shares to be outstanding for computing the percentage ownership of any other
person. To our knowledge, except as set forth in the footnotes below, each
stockholder identified in the table possesses sole voting and investment power
with respect to all shares of common stock shown as beneficially owned by such
stockholder.
The address of CSM Partners is Two Gateway Center, Suite 1800, Pittsburgh,
PA 15222. The address of Jeffrey S. McCormick, c/o Saturn Capital, Inc. is 75
Federal Street, Boston, MA 02110. The address of United Technologies Corporation
is One Financial Plaza, Hartford, CT 06101. The address of each other 5%
stockholder listed in the following table is c/o FreeMarkets, Inc., 22nd Floor,
One Oliver Plaza, 210 Sixth Avenue, Pittsburgh, PA 15222.
56
<PAGE> 57
<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP
--------------------------------------------------------------------------------
NUMBER OF OPTIONS
AND WARRANTS PERCENT
NUMBER OF EXERCISABLE BY --------------------------------
SHARES NOVEMBER 29, 1999 TOTAL BEFORE OFFERING AFTER OFFERING
--------- ----------------- ------------- --------------- --------------
<S> <C> <C> <C> <C> <C>
Glen T. Meakem (1).......... 3,152,000 432,000 3,584,000 11.6% 10.4%
Sam E. Kinney, Jr. (2)...... 1,857,600 288,000 2,145,600 7.0 6.3
David J. Becker (3)......... 283,444 261,000 544,444 1.8 1.6
Thomas L. McLeod (4)........ 60,000 144,000 204,000 * *
John P. Levis, III (5)...... 710,685 57,000 767,685 2.5 2.3
Dr. Eric Cooper (6)......... 31,892 -- 31,892 * *
David A. Noble (7).......... 184,200 -- 184,200 * *
CSM Partners (8)............ 2,319,912 -- 2,319,912 7.6 6.8
Jeffrey S. McCormick,
c/o Saturn Capital, Inc.
(9)....................... 2,428,269 -- 2,428,269 8.0 7.2
United Technologies
Corporation (10).......... 1,718,983 -- 1,718,983 5.7 5.1
All executive officers and
directors as a group (10
persons) (11)(12)......... 6,625,964 1,200,000 7,825,964 24.8 22.3
</TABLE>
- ---------------
* Less than 1% of the outstanding shares of common stock.
(1) Includes 2,542,200 shares held by a limited partnership controlled by Mr.
Meakem.
(2) Includes 1,577,400 shares held by various trusts for the benefit of Mr.
Kinney's family and by a limited partnership controlled by Mr. Kinney.
(3) Includes 270,000 shares held by a limited partnership controlled by Mr.
Becker.
(4) Includes 30,000 shares owned by Mr. McLeod's wife. Mr. McLeod disclaims
beneficial ownership of these shares.
(5) Includes 120,000 shares held by various trusts. Mr. Levis disclaims
beneficial ownership of these shares.
(6) Does not include 30,000 shares purchased by Dr. Cooper in November 1999
pursuant to immediately exercisable options granted to him on October 28,
1999. See Note (7).
(7) Does not include immediately exercisable options to purchase 30,000 shares
granted to Mr. Noble on October 28, 1999. If these options and the shares
referred to in Note (6) were included in the table, the percentage
ownership of all executive officers and directors as a group before the
offering would be 24.9% and after the offering would be 22.4%.
(8) CSM Partners is a general partnership with three general partners and is
governed by majority rule of these partners. Accordingly, the voting
majority of the general partners has voting and investment power over these
shares.
(9) Mr. McCormick is the majority stockholder of Saturn Capital, Inc. and
exercises voting and investment power over these shares.
(10) These shares are held of record by Nevada Bond Investment Corp. II, which
is a wholly-owned subsidiary of United Technologies Corporation. United
Technologies Corporation has the power to control Nevada Bond Investment
Corp. II, and thus shares with that entity voting and investment power over
these shares.
(11) Includes 15,000 shares held by a limited partnership controlled by an
executive officer of the Company. See also Notes (1) through (5).
(12) If Mr. Doerr and Mr. Meredith's aggregate beneficial ownership were
included in the table, the percentage ownership of all executive officers
and directors as a group before the offering would be 25.7% and after the
offering would be 23.1%.
57
<PAGE> 58
DESCRIPTION OF CAPITAL STOCK
Upon the completion of this offering, we will be authorized to issue
200,000,000 shares of common stock, $0.01 par value, and 5,000,000 shares of
undesignated preferred stock, $0.01 par value. The following description of our
capital stock does not purport to be complete and is subject to, and qualified
in its entirety by, our Certificate of Incorporation and Bylaws, which we have
included as exhibits to the registration statement of which this prospectus
forms a part.
COMMON STOCK
As of September 30, 1999, there were 30,354,958 shares of common stock and
preferred stock outstanding, held of record by 329 stockholders. These amounts
assume the conversion of all outstanding shares of preferred stock into common
stock, which is to occur upon completion of this offering. In addition, as of
September 30, 1999, there were 11,201,230 shares of common stock subject to
outstanding options. Upon completion of this offering, there will be 33,954,958
shares of common stock outstanding, assuming no exercise of outstanding stock
options.
Each share of common stock entitles its holder to one vote on all matters
to be voted upon by stockholders. Subject to preferences that may apply to any
outstanding preferred stock, holders of common stock may receive ratably any
dividends that the Board of Directors may declare out of funds legally available
for that purpose. In the event of our liquidation, dissolution or winding up,
the holders of common stock are entitled to share ratably in all assets
remaining after payment of liabilities and any liquidation preference of
preferred stock that may be outstanding. The common stock has no preemptive
rights, conversion rights or other subscription rights or redemption or sinking
fund provisions. All outstanding shares of common stock are fully paid and
non-assessable, and the shares of common stock that we will issue upon
completion of this offering will be fully paid and non-assessable.
PREFERRED STOCK
As of September 30, 1999, we had four series of convertible preferred
stock: Series A, Series B, Series C and Series D. As of September 30, 1999, the
number of outstanding shares for each series of our preferred stock was:
- 9,036,600 shares of Series A;
- 2,347,200 shares of Series B;
- 2,305,434 shares of Series C; and
- 2,362,204 shares of Series D.
Upon the closing of this offering, all outstanding shares of our preferred
stock will be converted on a one-for-one basis into 16,051,438 shares of common
stock. Thereafter, the Board of Directors will have 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 such series. The issuance of preferred stock could have
the effect of restricting dividends on the common stock, diluting the voting
power of the common stock, impairing the liquidation rights of the common stock
or delaying or preventing a change in control without further action by the
stockholders. We have no present plans to issue any shares of preferred stock
after the completion of this offering.
WARRANTS
As of September 30, 1999, there were warrants outstanding to purchase
134,400 shares of Series A preferred stock, and 61,200 shares of Series B
preferred stock. After completion of this offering, these warrants will be
exercisable for an equal number of shares of common stock. The Series A warrants
may be exercised until May 2003, and the Series B warrants may be exercised
until July 2004.
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<PAGE> 59
REGISTRATION RIGHTS
The holders of 20,754,607 shares of the common stock that will be
outstanding after this offering are entitled to require us to register the sales
of their shares under the Securities Act, under the terms of an agreement
between us and the holders of these securities. Subject to limitations specified
in this agreement, these registration rights include the following:
- an unlimited number of piggyback registration rights that require us to
register sales of a holder's shares when we undertake a public offering,
subject to the discretion of the managing underwriter of the offering to
decrease the amount that holders may register;
- two demand registration rights that holders may exercise no sooner than
180 days after our initial public offering, which require us to register
sales of a holder's shares, subject to the discretion of our Board of
Directors to delay the registration; and
- an unlimited number of rights to require us to register sales of shares
on Form S-3, a short form of registration statement permitted to be used
by some companies, which holders may exercise if they request
registration of the sale of more than $5.0 million of common stock
following the time we first qualify for the use of this form of
registration with the Securities and Exchange Commission.
We will bear all registration expenses if these registration rights are
exercised, other than underwriting discounts and commissions. These registration
rights terminate as to a holder's shares when that holder may sell those shares
under Rule 144(k) of the Securities Act, which for most parties means two years
after the acquisition of the shares from us.
ANTI-TAKEOVER PROVISIONS
DELAWARE LAW
We are subject to Section 203 of the Delaware General Corporation Law,
which regulates acquisitions of some Delaware corporations. In general, Section
203 prohibits a publicly held Delaware corporation from engaging in a "business
combination" with an "interested stockholder" for a period of three years
following the date the person becomes an interested stockholder, unless:
- our Board of Directors approved the business combination or the
transaction in which the person became an interested stockholder prior to
the date the person attained this status;
- upon consummation of the transaction that resulted in the person becoming
an interested stockholder, the person owned at least 85% of the voting
stock of the corporation outstanding at the time the transaction
commenced, excluding shares owned by persons who are directors and also
officers; or
- at or subsequent to the date the person became an interested stockholder,
our Board of Directors approved the business combination and the
stockholders other than the interested stockholder authorized the
transaction at an annual or special meeting of stockholders.
A "business combination" generally includes a merger, asset or stock sale
or other transaction resulting in a financial benefit to the interested
stockholder. In general, an "interested stockholder" is a person who, together
with the person's affiliates and associates, owns, or within three years prior
to the determination of interested stockholder status did own, 15% or more of a
corporation's voting stock.
CERTIFICATE OF INCORPORATION AND BYLAW PROVISIONS
Our Certificate of Incorporation and Bylaws, to be effective upon the
closing of this offering, divide the Board into three classes as nearly equal in
size as possible, with each class serving a three-year term. The terms are
staggered, so that one-third of the Board is to be elected each year. The
classification of the Board could have the effect of making it more difficult
than otherwise for a third
59
<PAGE> 60
party to acquire control of us, because it would typically take more than a year
for a majority of the stockholders to elect a majority of our Board. In
addition, our Certificate of Incorporation and Bylaws will provide that any
action required or permitted to be taken by our stockholders at an annual or
special meeting may be taken only if it is properly brought before the meeting,
and may not be taken by written action in lieu of a meeting. The Bylaws will
also provide that special meetings of the stockholders may be called only by the
Board of Directors, the Chairman of the Board or the Chief Executive Officer.
Under our Bylaws, stockholders wishing to propose business to be brought before
a meeting of stockholders will be required to comply with various advance notice
requirements. Finally, our Certificate of Incorporation and Bylaws will not
permit stockholders to take any action without a meeting.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for our common stock is American Stock
Transfer & Trust Co. The transfer agent's address is 40 Wall Street, New York,
NY 10005.
60
<PAGE> 61
SHARES ELIGIBLE FOR FUTURE SALE
Prior to this offering, there has been no market for our common stock.
Future sales of substantial amounts of our common stock in the public market
could adversely affect prevailing market prices. Sales of substantial amounts of
our common stock in the public market after any restrictions on sale lapse could
adversely affect the prevailing market price of the common stock and impair our
ability to raise equity capital in the future.
Upon completion of the offering, we will have 33,954,958 outstanding shares
of common stock, outstanding options to purchase 11,201,230 shares of common
stock and outstanding warrants to purchase 195,600 shares of common stock,
assuming no additional option or warrant grants or exercises after September 30,
1999. Of the 3,600,000 shares sold in the offering, 885,000 shares will be
subject to the lock-up agreements described below assuming that we sell all
shares reserved under our directed share program to the entities or persons for
whom these shares have been reserved. We expect that the remaining 2,715,000
shares, plus any shares issued upon exercise of the underwriters' over-allotment
option, will be freely tradable without restriction under the Securities Act,
unless purchased by our "affiliates" as that term is defined in Rule 144 under
the Securities Act. In general, affiliates include officers, directors and 10%
or greater stockholders.
The remaining 31,239,958 shares outstanding and 11,396,830 shares subject
to outstanding options and warrants are "restricted securities" within the
meaning of Rule 144. Restricted securities may be sold in the public market only
if the sale is registered or if it qualifies for an exemption from registration,
such as under Rule 144, 144(k) or 701 promulgated under the Securities Act,
which are summarized below. Sales of restricted securities in the public market,
or the availability of such shares for sale, could adversely affect the market
price of the common stock.
LOCK-UP AGREEMENTS
Our directors, officers, employees and various other stockholders, who
together hold substantially all of our securities, have entered into lock-up
agreements in connection with this offering. These lock-up agreements generally
provide that these holders will not offer, sell, contract to sell, grant any
option to purchase or otherwise dispose of our common stock or any securities
exercisable for or convertible into our common stock owned by them for a period
of 180 days after the date of this prospectus without the prior written consent
of the representatives of the underwriters of this offering. The lock-up
agreements executed by our employees and directors also cover any shares they
may acquire through our directed share program. Notwithstanding possible earlier
eligibility for sale under the provisions of Rules 144, 144(k) and 701, shares
subject to lock-up agreements may not be sold until these agreements expire or
are waived by the representatives of the underwriters of this offering. Assuming
that the representatives of the underwriters of this offering do not release any
security holders from the lock-up agreements, the following shares will be
eligible for sale in the public market at the following times:
- Beginning on the effective date of the registration statement of which
this prospectus forms a part, 2,715,000 of the 3,600,000 shares sold in
this offering, and 2,629,386 additional shares not subject to lock-up
agreements and eligible for sale under Rule 144(k), will be immediately
available for sale in the public market.
- Beginning 90 days after the effective date, an additional 302,991 shares
not subject to lock-up agreements will be eligible for sale pursuant to
Rule 144 and Rule 701.
- Beginning 180 days after the effective date, an additional 25,945,377
shares will be eligible for sale pursuant to Rule 144, Rule 144(k) and
Rule 701.
61
<PAGE> 62
RULE 144
In general, under Rule 144 as currently in effect, after the expiration of
the lock-up agreements, a person who has beneficially owned restricted
securities for at least one year would be entitled to sell within any
three-month period a number of shares that does not exceed the greater of:
- one percent of the number of shares of common stock then outstanding,
which will equal approximately 340,000 shares immediately after this
offering; and
- the average weekly trading volume of our common stock during the four
calendar weeks preceding the sale.
Sales under Rule 144 are also subject to requirements with respect to
manner of sale, notice and the availability of current public information about
us.
RULE 144(k)
Under Rule 144(k), a person who is not deemed to have been our affiliate at
any time during the three months preceding a sale, and who has beneficially
owned the shares proposed to be sold for at least two years, may sell these
shares without complying with the manner of sale, public information, volume
limitation or notice requirements of Rule 144.
RULE 701
Rule 701, as currently in effect, permits our employees, officers,
directors or consultants who purchased shares pursuant to a written compensatory
plan or contract to resell such shares in reliance upon Rule 144, but without
compliance with certain restrictions. Rule 701 provides that affiliates may sell
their Rule 701 shares under Rule 144 ninety days after effectiveness without
complying with the holding period requirement and that non-affiliates may sell
such shares in reliance on Rule 144 ninety days after effectiveness without
complying with the holding period, public information, volume limitation or
notice requirements of Rule 144.
EMPLOYEE PLANS
We intend to file a registration statement under the Securities Act after
the effective date of this offering to register shares to be issued pursuant to
our employee benefit plans. As a result, any options or rights exercised under
the 1996 Stock Incentive Plan, the Amended and Restated Stock Incentive Plan and
the Employee Stock Purchase Plan will also be freely tradable in the public
market. However, shares held by affiliates will still be subject to the volume
limitation, manner of sale, notice and public information requirements of Rule
144, unless otherwise resalable under Rule 701. As of September 30, 1999, we had
granted options to purchase 11,201,230 shares of common stock that had not been
exercised, of which options to purchase 821,677 shares were exercisable. In
addition, as of that date we had reserved 500,000 shares for possible future
issuance under our Employee Stock Purchase Plan. See "Risk
Factors -- Substantial Sales of Our Common Stock After the Offering Could Cause
our Stock Price to Fall", "Management -- Stock Plans" and "Description of
Capital Stock -- Registration Rights".
LEGAL MATTERS
The validity of the common stock offered hereby will be passed upon for
FreeMarkets by Morgan, Lewis & Bockius LLP, Pittsburgh, Pennsylvania. Legal
matters will be passed on for the underwriters by Ropes & Gray, Boston,
Massachusetts. Attorneys of Morgan, Lewis & Bockius LLP own 50,275 shares of our
common stock, and a partner of Morgan, Lewis & Bockius LLP who is our Assistant
Secretary holds options to purchase 20,000 shares of such stock.
62
<PAGE> 63
EXPERTS
The consolidated financial statements as of December 31, 1997 and 1998 and
September 30, 1999 and for each of the three years in the period ended December
31, 1998 and for the nine-month period ended September 30, 1999 included in this
prospectus have been so included in reliance upon the report of
PricewaterhouseCoopers LLP, independent accountants, given on the authority of
said firm as experts in auditing and accounting.
ADDITIONAL INFORMATION
We have filed with the Securities and Exchange Commission a registration
statement on Form S-1 under the Securities Act concerning the common stock
offered in this offering. This prospectus does not contain all of the
information set forth in the registration statement or its exhibits and
schedules. For further information about FreeMarkets and our common stock, we
refer you to the registration statement and to its attached exhibits and
schedules. Statements made in this prospectus concerning the contents of any
document are not necessarily complete. With respect to each document filed as an
exhibit to the registration statement, we refer you to the exhibit for a more
complete description of the matter involved.
You may inspect our registration statement and the attached exhibits and
schedules without charge at the public reference facilities maintained by the
Commission at 450 Fifth Street, N.W., Washington, D.C. 20549, and at the
regional offices of the Commission located at Seven World Trade Center, 13th
Floor, New York, NY 10048, and at 500 West Madison Street, Suite 1400, Chicago,
IL 60661. You may obtain copies of all or any part of our registration statement
from the Commission upon payment of prescribed fees. You may also inspect
reports, proxy and information statements and other information that we file
electronically with the Commission without charge at the Commission's Internet
site, http://www.sec.gov.
We intend to furnish our stockholders with annual reports containing
financial statements audited by our independent auditors and to make available
to our stockholders quarterly reports containing unaudited financial data for
each of the first three quarters of each fiscal year.
63
<PAGE> 64
FREEMARKETS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Independent Accountants........................... F-2
Consolidated Balance Sheets as of December 31, 1997 and 1998
and September 30, 1999.................................... F-3
Consolidated Statements of Operations for each of the three
years in the period ended December 31, 1998 and for the
nine-month periods ended September 30, 1998 (unaudited)
and 1999.................................................. F-4
Consolidated Statements of Stockholders' Equity for each of
the three years in the period ended December 31, 1998 and
for the nine-month period ended September 30, 1999........ F-5
Consolidated Statements of Cash Flows for each of the three
years in the period ended December 31, 1998 and for the
nine-month periods ended September 30, 1998 (unaudited)
and 1999.................................................. F-6
Notes to Consolidated Financial Statements.................. F-7
</TABLE>
F-1
<PAGE> 65
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) as of December 31, 1997 and 1998 and
September 30, 1999, and the results of their operations and their cash flows for
each of the three years in the period ended December 31, 1998 and for the
nine-month period ended September 30, 1999, in conformity with generally
accepted accounting principles. 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 in accordance with generally accepted auditing standards, 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 the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
Pittsburgh, Pennsylvania
October 15, 1999
F-2
<PAGE> 66
FREEMARKETS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------- SEPTEMBER 30,
1997 1998 1999
----------- ----------- -------------
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 1,998,884 $ 1,655,932 $ 22,258,728
Short-term investments.................................... -- -- 10,289,831
Accounts receivable, net of allowance for doubtful
accounts of $20,000, $25,000 and $114,316 as of December
31, 1997, 1998 and September 30, 1999, respectively..... 1,060,654 3,939,305 5,955,801
Other current assets...................................... 7,532 83,463 1,152,465
----------- ----------- ------------
Total current assets................................ 3,067,070 5,678,700 39,656,825
Property and equipment, net................................. 177,784 1,062,392 5,610,009
Other assets, net........................................... 91,149 128,456 410,365
----------- ----------- ------------
Total assets........................................ $ 3,336,003 $ 6,869,548 $ 45,677,199
=========== =========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 170,808 $ 738,976 $ 3,059,027
Accrued incentive compensation............................ -- 489,995 894,000
Other current liabilities................................. 55,038 623,026 1,319,865
Current portion of long-term debt......................... 58,332 12,368 666,629
----------- ----------- ------------
Total current liabilities........................... 284,178 1,864,365 5,939,521
Long-term debt.............................................. -- 413,018 1,976,427
----------- ----------- ------------
Total liabilities................................... 284,178 2,277,383 7,915,948
----------- ----------- ------------
Commitments and contingencies
Stockholders' equity:
Convertible preferred stock, $.01 par value, 50,000,000
shares authorized; 3,794,600 shares issued and
outstanding as of December 31, 1997 and 1998 and
16,051,438 shares issued and outstanding as of September
30, 1999................................................ 37,946 37,946 160,514
Common stock, $.01 par value, 200,000,000 shares
authorized; 3,656,800 and 3,935,000 shares issued and
outstanding as of December 31, 1997 and 1998,
respectively, and 14,303,520 shares issued and
outstanding as of September 30, 1999.................... 36,568 39,350 143,035
Additional capital........................................ 5,993,000 7,296,811 55,837,965
Unearned stock-based compensation......................... -- -- (1,750,845)
Stock purchase warrants................................... 398,000 398,000 30,000
Accumulated deficit....................................... (3,413,689) (3,179,942) (16,659,418)
----------- ----------- ------------
Total stockholders' equity.......................... 3,051,825 4,592,165 37,761,251
----------- ----------- ------------
Total liabilities and stockholders' equity.......... $ 3,336,003 $ 6,869,548 $ 45,677,199
=========== =========== ============
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-3
<PAGE> 67
FREEMARKETS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEARS ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
-------------------------------------- --------------------------
1996 1997 1998 1998 1999
----------- ----------- ---------- ----------- ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues................................ $ 408,820 $ 1,783,180 $7,801,250 $4,801,649 $ 13,037,297
Cost of revenues........................ 505,691 1,148,994 4,258,403 2,829,644 7,367,079
----------- ----------- ---------- ---------- ------------
Gross (loss) profit..................... (96,871) 634,186 3,542,847 1,972,005 5,670,218
----------- ----------- ---------- ---------- ------------
Operating costs:
Research and development............ 394,266 291,826 841,874 562,951 2,959,635
Sales and marketing................. 320,935 585,511 656,183 386,937 5,625,287
General and administrative.......... 629,620 837,357 2,025,899 1,129,322 5,890,462
Stock-based expense................. -- -- -- -- 4,728,184
----------- ----------- ---------- ---------- ------------
Total operating costs................... 1,344,821 1,714,694 3,523,956 2,079,210 19,203,568
----------- ----------- ---------- ---------- ------------
Operating (loss) income................. (1,441,692) (1,080,508) 18,891 (107,205) (13,533,350)
Other income, net....................... 10,504 19,808 214,856 196,165 53,874
----------- ----------- ---------- ---------- ------------
Net (loss) income....................... $(1,431,188) $(1,060,700) $ 233,747 $ 88,960 $(13,479,476)
=========== =========== ========== ========== ============
Earnings per share:
Basic............................... $ (.14) $ (.10) $ .02 $ .01 $ (1.00)
=========== =========== ========== ========== ============
Diluted............................. $ (.14) $ (.10) $ .01 $ .00 $ (1.00)
=========== =========== ========== ========== ============
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-4
<PAGE> 68
FREEMARKETS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
UNEARNED STOCK
PREFERRED COMMON ADDITIONAL STOCK-BASED PURCHASE ACCUMULATED
STOCK STOCK CAPITAL COMPENSATION WARRANTS DEFICIT TOTAL
--------- -------- ----------- ------------ ----------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1995...... -- $ 171 $ 1,025,255 -- -- $ (921,801) $ 103,625
Employee common stock purchases,
net of offering costs of
$625........................... -- 4 92,701 -- -- -- 92,705
Issuance of Series A-1
convertible preferred stock,
net of offering costs of
$188,544....................... $ 67 -- 1,511,389 -- -- -- 1,511,456
Issuance of Series A-1 stock
purchase warrants.............. -- -- (614,000) -- $ 614,000 -- --
Issuance of Series B convertible
preferred stock, net of
offering costs of $57,300...... 18 -- 515,235 -- -- -- 515,253
Issuance of Series B stock
purchase warrants.............. -- -- (18,000) -- 18,000 -- --
Net loss......................... -- -- -- -- -- (1,431,188) (1,431,188)
-------- -------- ----------- ----------- ----------- ------------ ------------
Balance at December 31, 1996...... 85 175 2,512,580 -- 632,000 (2,352,989) 791,851
Employee common stock purchases,
net of offering costs of
$600........................... -- 9 265,482 -- -- -- 265,491
Options exercised................ -- -- 5,934 -- -- -- 5,934
Issuance of Series B convertible
preferred stock, net of
offering costs of $95,303...... 21 -- 602,190 -- -- -- 602,211
Issuance of Series B stock
purchase warrants.............. -- -- (69,000) -- 69,000 -- --
Series A-1 stock purchase
warrants exercised, net of
offering costs of $170,289..... 53 -- 2,029,808 -- (490,000) -- 1,539,861
Issuance of Series A-2
convertible preferred stock,
net of offering costs of
$100,323....................... 31 -- 907,146 -- -- -- 907,177
Issuance of Series A-2 stock
purchase warrants.............. -- -- (187,000) -- 187,000 -- --
200-for-1 stock split............ 37,756 36,384 (74,140) -- -- -- --
Net loss......................... -- -- -- -- -- (1,060,700) (1,060,700)
-------- -------- ----------- ----------- ----------- ------------ ------------
Balance at December 31, 1997...... 37,946 36,568 5,993,000 -- 398,000 (3,413,689) 3,051,825
Employee common stock purchases,
net of offering costs of
$14,173........................ -- 2,600 1,283,227 -- -- -- 1,285,827
Options exercised................ -- 182 20,584 -- -- -- 20,766
Net income....................... -- -- -- -- -- 233,747 233,747
-------- -------- ----------- ----------- ----------- ------------ ------------
Balance at December 31, 1998...... 37,946 39,350 7,296,811 -- 398,000 (3,179,942) 4,592,165
Stock purchase warrants
exercised...................... -- 8,030 1,664,845 -- (368,000) -- 1,304,875
Issuance of Series C preferred
stock, net of offering costs of
$737,044....................... 7,684 -- 10,252,192 -- -- -- 10,259,876
Options exercised................ -- 100 16,150 -- -- -- 16,250
3-for-1 stock split.............. 91,262 94,960 (186,222) -- -- -- --
Issuance of Series D preferred
stock, net of offering costs of
$165,920....................... 20,578 -- 30,268,542 -- -- -- 30,289,120
Issuance of Series D stock
purchase warrants.............. -- -- -- -- 4,502,534 -- 4,502,534
Stock purchase warrants
exercised...................... 3,044 -- 4,502,534 -- (4,502,534) -- 3,044
Options exercised................ -- 595 46,618 -- -- -- 47,213
Unearned stock-based
compensation................... -- -- 1,976,495 $(1,976,495) -- -- --
Amortization of stock-based
compensation................... -- -- -- 225,650 -- -- 225,650
Net loss......................... -- -- -- -- -- (13,479,476) (13,479,476)
-------- -------- ----------- ----------- ----------- ------------ ------------
Balance at September 30, 1999..... $160,514 $143,035 $55,837,965 $(1,750,845) $ 30,000 $(16,659,418) $ 37,761,251
======== ======== =========== =========== =========== ============ ============
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-5
<PAGE> 69
FREEMARKETS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
--------------------------------------- --------------------------
1996 1997 1998 1998 1999
----------- ----------- ----------- ----------- ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net (loss) income........................... $(1,431,188) $(1,060,700) $ 233,747 $ 88,960 $(13,479,476)
Adjustments to reconcile net (loss) income
to net cash used in operating activities:
Depreciation and amortization............. 49,185 90,408 191,052 136,715 620,368
Provision for bad debts................... -- 20,000 5,000 -- 89,316
Stock-based expense....................... -- -- -- -- 4,728,184
(Gain) loss on disposal of property and
equipment............................... -- -- (3,443) -- 118,797
Cash (used in) provided by changes in:
Accounts receivable....................... (141,209) (931,866) (2,883,651) (1,230,973) (2,105,812)
Other assets.............................. 535 (3,259) (78,516) (55,538) (1,168,972)
Accounts payable.......................... (44,899) 30,595 320,437 69,500 1,496,291
Other liabilities......................... (5,591) 37,252 1,057,983 411,720 1,100,844
----------- ----------- ----------- ----------- ------------
Net cash used in operating activities... (1,573,167) (1,817,570) (1,157,391) (579,616) (8,600,460)
----------- ----------- ----------- ----------- ------------
Cash flows from investing activities:
Purchases of short-term investments......... -- -- -- -- (10,289,831)
Acquisitions of property and equipment,
net....................................... (71,381) (85,200) (775,598) (524,615) (4,431,366)
Software development costs.................. (58,714) -- -- -- --
Patent and trademark costs.................. -- -- (83,610) (22,279) (213,595)
(Purchase) redemption of restricted cash
equivalent................................ (35,000) 35,000 -- -- --
----------- ----------- ----------- ----------- ------------
Net cash used in investing activities... (165,095) (50,200) (859,208) (546,894) (14,934,792)
----------- ----------- ----------- ----------- ------------
Cash flows from financing activities:
Proceeds from debt.......................... 42,000 58,332 444,000 444,000 4,226,630
Repayment of debt........................... (7,000) (35,000) (76,946) (312,304) (2,008,960)
Proceeds from issuance of preferred stock
and exercise of stock purchase warrants,
net....................................... 2,026,709 3,049,249 -- -- 41,856,915
Proceeds from issuance of common stock,
net....................................... 92,705 271,425 1,285,827 320,060 --
Options exercised........................... -- -- 20,766 9,441 63,463
----------- ----------- ----------- ----------- ------------
Net cash provided by financing
activities............................ 2,154,414 3,344,006 1,673,647 461,197 44,138,048
----------- ----------- ----------- ----------- ------------
Net change in cash and cash equivalents....... 416,152 1,476,236 (342,952) (665,313) 20,602,796
Cash and cash equivalents at beginning of
period...................................... 106,496 522,648 1,998,884 1,998,884 1,655,932
----------- ----------- ----------- ----------- ------------
Cash and cash equivalents at end of period.... $ 522,648 $ 1,998,884 $ 1,655,932 $ 1,333,571 $ 22,258,728
=========== =========== =========== =========== ============
Supplemental disclosure:
Cash paid for interest...................... $ 11,164 $ 2,190 $ 27,783 $ 23,852 $ 94,337
=========== =========== =========== =========== ============
Supplemental non-cash disclosure:
Fixed asset additions included in accounts
payable................................... $ 5,840 $ -- $ 247,731 $ 18,437 $ 823,760
=========== =========== =========== =========== ============
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-6
<PAGE> 70
FREEMARKETS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. DESCRIPTION OF BUSINESS
FreeMarkets, Inc. (the "Company"), formerly FreeMarkets OnLine, Inc., was
formed in March 1995. The Company creates customized business-to-business online
auctions for buyers of industrial parts, raw materials and commodities.
INITIAL PUBLIC OFFERING
In September 1999, the Company filed a registration statement with the
Securities and Exchange Commission that would permit the Company to sell shares
of common stock in connection with a proposed initial public offering.
Immediately prior to the consummation of an underwritten initial public
offering, all of the outstanding shares of convertible preferred stock will
automatically convert into an equal number of shares of common stock. The result
of the conversion will be a reclassification of preferred stock to 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: FreeMarkets SA/NV, which is based in
Brussels, Belgium, and FreeMarkets Investment Company, Inc., which is based in
Wilmington, Delaware. All material intercompany transactions have been
eliminated in consolidation.
INTERIM CONSOLIDATED FINANCIAL STATEMENTS
The unaudited consolidated statements of operations and cash flows for the
nine-month period ended September 30, 1998, in the opinion of management, have
been prepared on the same basis as the audited consolidated financial
statements, and include all adjustments necessary for the fair presentation of
the results of the interim period. All adjustments reflected in the consolidated
financial statements are of a normal recurring nature. The data disclosed in the
notes to the consolidated financial statements for this period is also
unaudited.
CASH AND CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
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.
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
other comprehensive income or loss until realized. The cost of short-term
investments sold is based on the specific identification method. Accumulated
other comprehensive income related to these investments is immaterial as of
September 30, 1999.
As of September 30, 1999, short-term investments consisted of commercial
paper and corporate bonds with maturities of less than one year.
Income included in other income earned on these investments was $16,200 in
1996, $22,800 in 1997, $93,400 in 1998 and $70,300 and $302,000 in the
nine-month periods ended September 30, 1998 and 1999, respectively.
F-7
<PAGE> 71
FREEMARKETS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost and depreciated on the
straight-line method over their estimated useful lives. 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.
OTHER ASSETS
Other assets consist principally of capitalized patent and trademark costs
and capitalized software development costs, both of which are being amortized
using the straight-line method over seventeen and three years, respectively.
Qualified internally developed software costs are capitalized subsequent to the
determination of technological feasibility; such capitalization continues until
the product becomes available for general release. The carrying value of patent
and trademark costs was $4,500, $86,600 and $292,300 at December 31, 1997 and
1998 and September 30, 1999, respectively. The carrying value of software
development costs was $71,100, $23,700 and $0 at December 31, 1997 and 1998 and
September 30, 1999, respectively. Amortization expense on patent and trademark
costs and software development costs was $24,000 in 1996, $47,700 in 1997,
$48,900 in 1998 and $36,700 and $31,700 in the nine-month periods ended
September 30, 1998 and 1999, respectively.
IMPAIRMENT OF LONG-LIVED ASSETS
The carrying values of long-lived assets, which include property and
equipment and patent and trademark costs, are evaluated periodically in relation
to the operating performance and future undiscounted cash flows of the
underlying assets. Adjustments are made if the sum of expected future net cash
flows is less than carrying value.
REVENUE RECOGNITION
The Company recognizes revenue from fixed monthly fees for providing
services to clients 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, revenue is recognized as those thresholds are achieved. Commission
revenue is recognized as the direct materials and commodities that are the
subject of the Company's auctions are shipped from the winning suppliers to the
buyers in accordance with the terms of the contracts. Commission revenue was
$138,300 in 1996, $358,200 in 1997, $799,700 in 1998 and $550,100 and $1,167,800
in the nine-month periods ended September 30, 1998 and 1999, respectively.
REVENUE CONCENTRATION AND RELATED PARTY
In 1998, 77% of revenues were concentrated with two clients. For the
nine-month period ended September 30, 1999, 58% of revenues were concentrated
with the same two clients. The Company has long-term contracts with both
clients, which extend through December 2000 and September 2001, and contain
additional renewal options available at the clients' discretion. Both contracts
can be canceled by the client upon notice prior to the expiration dates.
As further discussed in Note 7, a subsidiary of United Technologies
Corporation ("UTC") invested $20,938,400 in the Company in September 1999.
Revenues from UTC were $5,294,400 in the nine-month period ended September 30,
1999, and amounts due from UTC were $1,522,700 as of September 30, 1999.
F-8
<PAGE> 72
FREEMARKETS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 Center. 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.
ADVERTISING COSTS
Advertising costs are expensed at the time the ad is first aired or the
promotion is held. Advertising expenses were $43,300 in 1996, $109,500 in 1997,
$162,100 in 1998 and $91,200 and $2,300,600 in the nine-month periods ended
September 30, 1998 and 1999, respectively.
START-UP COSTS
Start-up costs are expensed as incurred, and include costs to establish new
locations, operations or subsidiaries.
STOCK-BASED EXPENSE
The Company accounts for the grant of stock options to employees in
accordance with Statement of Financial Accounting Standard ("SFAS") No. 123,
"Accounting for Stock-Based Compensation". SFAS 123 gives companies the option
to adopt the fair value method for expense recognition of employee stock options
or to continue to account for stock options and stock-based awards 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 8. With respect to stock options granted at exercise prices
less than fair value, the Company recorded unearned stock-based compensation.
Such unearned stock-based 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.
PENNSYLVANIA OPPORTUNITY GRANT
During 1998, the Company received a $150,000 Opportunity Grant (the "PA
Grant") from the Department of Community and Economic Development of the
Commonwealth of Pennsylvania. The PA Grant provided for working capital funds to
assist the Company during a period of accelerated growth, and was earned based
upon the achievement of job creation requirements. The PA Grant is included in
other income in the consolidated statements of operations. If the Company were
to leave the City of Pittsburgh, Pennsylvania prior to November 2002, the
Commonwealth of Pennsylvania may require the Company to refund a portion of the
PA Grant; however, the Company considers the likelihood of its relocation to be
remote.
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
F-9
<PAGE> 73
FREEMARKETS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 Company began operating a service center in Brussels, Belgium in late
1998. The service center's operating loss was $1,711,100 and its revenues were
immaterial in the nine-month period ended September 30, 1999.
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.
Foreign currency gains and losses and the cumulative translation adjustment were
immaterial.
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.
The following table sets forth the computation of earnings per share:
<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
--------------------------------------- --------------------------
1996 1997 1998 1998 1999
----------- ----------- ----------- ----------- ------------
<S> <C> <C> <C> <C> <C>
Numerator:
Net (loss) income............ $(1,431,188) $(1,060,700) $ 233,747 $ 88,960 $(13,479,476)
=========== =========== =========== =========== ============
Denominator:
Weighted average common
shares..................... 10,316,599 10,618,481 11,191,670 10,990,053 13,451,407
(Denominator for basic
calculation)
Weighted average effect of
dilutive securities:
Convertible preferred
stock................... -- -- 11,383,800 11,383,800 --
Stock options and
warrants................ -- -- 4,201,141 2,850,394 --
----------- ----------- ----------- ----------- ------------
Denominator for diluted
calculation............. 10,316,599 10,618,481 26,776,611 25,224,247 13,451,407
=========== =========== =========== =========== ============
Earnings per share:
Basic........................ $ (.14) $ (.10) $ .02 $ .01 $ (1.00)
=========== =========== =========== =========== ============
Diluted...................... $ (.14) $ (.10) $ .01 $ .00 $ (1.00)
=========== =========== =========== =========== ============
</TABLE>
For 1996 and 1997, 2,878,952 and 6,321,439 potentially dilutive common
shares, respectively, were excluded because their effect was antidilutive. For
the nine-month period ended September 30,
F-10
<PAGE> 74
FREEMARKETS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1999, 20,856,078 potentially dilutive common shares were excluded because their
effect was antidilutive.
Pro forma earnings per share is computed using the weighted average number
of shares of common stock outstanding, including potentially dilutive common
shares from the convertible preferred stock (using the if-converted method),
which will automatically convert into common stock upon an initial public
offering as if converted at the original date of issuance, for both basic and
diluted earnings per share, even if inclusion is antidilutive.
The following table sets forth the computation of pro forma earnings per
share:
<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
1998 1999
------------ -----------------
<S> <C> <C>
Numerator:
Net (loss) income......................................... $ 233,747 $(13,479,476)
=========== ============
Denominator:
Weighted average common shares............................ 22,575,470 26,394,512
(Denominator for basic calculation)
Weighted average effect of dilutive securities:
Stock options and warrants............................. 4,201,141 --
----------- ------------
Denominator for diluted calculation.................... 26,776,611 26,394,512
=========== ============
Pro forma earnings per share:
Basic..................................................... $ .01 $ (.51)
=========== ============
Diluted................................................... $ .01 $ (.51)
=========== ============
</TABLE>
For the nine-month period ended September 30, 1999, 7,912,973 potentially
dilutive common shares were excluded because their effect was antidilutive.
COMPREHENSIVE INCOME OR LOSS
The Company adopted SFAS No. 130, "Reporting Comprehensive Income"
effective January 1, 1998. No material differences exist between net income
(loss) and comprehensive income (loss).
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.
RECENT ACCOUNTING PRONOUNCEMENT
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities". SFAS No. 133, which is effective, as
amended, for all quarters in fiscal years beginning after June 15, 2000,
establishes accounting and reporting standards for derivative financial
instruments and hedging activities related to those instruments, as well as
other hedging activities. As the Company does not currently engage in derivative
or hedging activities, the adoption of this standard is not expected to have a
significant impact on the Company's consolidated financial statements.
F-11
<PAGE> 75
FREEMARKETS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 3. PROPERTY AND EQUIPMENT
Property and equipment (and their related useful lives) consisted of the
following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------- SEPTEMBER 30,
1997 1998 1999
-------- ---------- -------------
<S> <C> <C> <C>
Computer and office equipment (3 to 5 years)........... $192,440 $ 884,920 $4,163,194
Furniture and fixtures (5 years)....................... 48,621 293,335 1,181,400
Leasehold improvements (5 years)....................... 16,290 95,982 927,418
-------- ---------- ----------
257,351 1,274,237 6,272,012
Less accumulated depreciation.......................... 79,567 211,845 662,003
-------- ---------- ----------
$177,784 $1,062,392 $5,610,009
======== ========== ==========
</TABLE>
Depreciation expense was $25,200 in 1996, $42,700 in 1997, $142,200 in 1998
and $100,000 and $588,700 in the nine-month periods ended September 30, 1998 and
1999, respectively. In connection with the Company's relocation to new office
space in 1999, property and equipment with net book value of approximately
$118,800 was disposed of related to the old office facility.
NOTE 4. LONG-TERM DEBT
In February 1998, the Company entered into a Line of Credit Agreement (the
"Line of Credit"), which provided for borrowings of up to $750,000. The Line of
Credit accrued interest at the lender's prime rate plus 1.0%. A non-refundable
commitment fee equal to 1.0% per annum of the average daily unused portion of
the Line of Credit was payable quarterly. As of December 31, 1998, there was
$300,000 outstanding under the Line of Credit, which has been classified as
long-term debt due to the February 1999 refinancing under the new facility
discussed below.
The Line of Credit contained restrictive covenants, including a limitation
on incurring additional indebtedness and a requirement that the Company maintain
a tangible net worth, as defined, of $500,000. The Company pledged substantially
all of its assets as collateral for the Line of Credit.
In February 1999, the Company settled all outstanding amounts under the
Line of Credit and terminated this agreement. At this time, the Company entered
into a Revolving Promissory Note (the "Revolver") and an Equipment Term Note
(the "Equipment Term Note"), both under the terms of a Loan and Security
Agreement (the "Loan and Security Agreement"). The Revolver provided for
borrowings of up to $2,000,000, with interest accruing at the lender's prime
rate plus 0.75% (9.0% at September 30, 1999). As of September 30, 1999, no
amounts were outstanding under the Revolver.
The Equipment Term Note provided for total borrowings of up to $2,000,000
that were drawn from February through August 1999. Monthly interest-only
payments were due and payable on any outstanding advances during that time
period. In September 1999, the advances under the Equipment Term Note converted
to a note payable with 36 equal monthly principal and interest installments,
which are due and payable through August 2002. The Equipment Term Note bears
interest at the lender's prime rate plus 1.0%. As of September 30, 1999, there
was $1,944,300 outstanding under the Equipment Term Note.
In September 1999, the Company's Loan and Security Agreement (the "Amended
Loan and Security Agreement") was amended to increase the available borrowings
under the Revolver from $2,000,000 to $5,000,000 and extend the expiration date
to September 2000. Interest will remain at the lender's prime rate plus 0.75%.
The amendment also provides for two additional equipment term notes (Equipment
Term Note #2) in addition to the $2,000,000 original Equipment Term Note. These
notes provide for total borrowings of up to $3,000,000 that may be drawn from
September 1999
F-12
<PAGE> 76
FREEMARKETS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
through October 2000. Monthly interest-only payments are due and payable on any
outstanding advances during that time period. In April and October 2000, these
notes automatically convert to notes payable with 36 equal monthly principal and
interest installments. These notes bear interest at the lender's prime rate plus
1.0%. As of September 30, 1999, there was $698,700 outstanding under Equipment
Term Note #2.
The Amended Loan and Security Agreement 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. The Company has
pledged substantially all of its tangible assets as collateral for the Amended
Loan and Security Agreement.
In March 1998, the Company entered into a $144,000 loan with the City of
Pittsburgh Urban Redevelopment Authority (the "URA Loan"), with interest
accruing at 6.8%. Proceeds from the URA Loan were required to be used for local
office space expansion. The URA Loan was repaid in February 1999 with proceeds
from the Equipment Term Note.
Interest expense was $11,200 in 1996, $2,200 in 1997, $27,800 in 1998 and
$24,300 and $131,700 in the nine-month periods ended September 30, 1998 and
1999, respectively. The weighted average interest rate was 10.8% in 1996, 3.7%
in 1997, 6.9% in 1998 and 8.2% and 7.6% in the nine-month periods ended
September 30, 1998 and 1999, respectively. Based on market rates currently
available, the carrying value of the Company's long-term debt as of September
30, 1999 approximates fair value.
NOTE 5. COMMITMENTS AND CONTINGENCIES
The Company leases office space and computer and office equipment under
operating leases expiring through 2004. In October 1998, the Company entered
into a new Office Lease Agreement (the "Lease"), as amended in March and June
1999, that significantly expands the Company's office space within the city of
Pittsburgh, Pennsylvania. The Lease, which provides for additional expansion
within the same building, expires in May 2004.
Operating lease rental expense amounted to $105,000 in 1996, $141,000 in
1997, $279,500 in 1998 and $607,800 in the nine-month period ended September 30,
1999. The following is a schedule of future minimum lease payments under all
operating leases through December 31 of each of the following years:
<TABLE>
<S> <C>
1999........................................................ $ 366,100
2000........................................................ 1,783,100
2001........................................................ 1,818,700
2002........................................................ 1,864,800
2003........................................................ 1,911,700
Thereafter.................................................. 1,513,700
----------
$9,258,100
==========
</TABLE>
NOTE 6. INCOME TAXES
The Company had no income tax provision in 1996, 1997 and the nine-month
periods ended September 30, 1998 and 1999 since the Company had a net taxable
loss in each of those periods. For 1998, the Company's net taxable income was
eliminated through the use of net operating loss carryforwards of approximately
$414,000. The tax benefit resulting from the use of these net operating losses
was approximately $166,000.
F-13
<PAGE> 77
FREEMARKETS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Deferred tax assets and liabilities consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------- SEPTEMBER 30,
1997 1998 1999
----------- ----------- -------------
<S> <C> <C> <C>
Net operating losses.............................. $ 1,348,000 $ 1,182,000 $ 4,726,000
Research and experimentation credits.............. 42,000 111,000 185,000
Lease termination fee............................. -- 90,000 --
Deferred stock-based expense and other............ (54,000) (46,000) 1,820,000
----------- ----------- -----------
Net deferred tax assets........................... 1,336,000 1,337,000 6,731,000
Less valuation allowance.......................... (1,336,000) (1,337,000) (6,731,000)
----------- ----------- -----------
$ -- $ -- $ --
=========== =========== ===========
</TABLE>
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, 1997 and
1998 and September 30, 1999, since the realization of these assets in future
periods is uncertain.
As of September 30, 1999, the Company had available federal net operating
loss carryforwards of approximately $11,815,000 and state net operating loss
carryforwards of approximately $10,194,000. These net operating loss
carryforwards may be used to offset future federal and state income taxes
through 2019 and 2009, respectively. As a result of the Series A-1 offering
discussed in Note 7 and concurrent ownership change, Section 382 of the Internal
Revenue Code limits the federal net operating losses incurred prior to May 1996,
which amounted to $1,298,000, available to the Company to $247,000 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 2019.
NOTE 7. STOCKHOLDERS' EQUITY
In June 1999, the Company amended its Certificate of Incorporation to
increase the preferred shares authorized for issuance from 20,000,000 to
50,000,000 and the common shares authorized for issuance from 20,000,000 to
200,000,000.
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
preferred stock and common stock. The stock split was reflected in 1997, and
resulted in a $37,756 reclassification from additional capital to preferred
stock and a $36,384 reclassification from additional capital to common stock
representing the aggregate par value of the shares issued under the stock split.
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
preferred stock and common stock. The stock split resulted in a $91,262
reclassification from additional capital to preferred stock and a $94,960
reclassification from additional capital to common stock representing the
aggregate par value of the shares issued under the stock split.
F-14
<PAGE> 78
FREEMARKETS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
CONVERTIBLE PREFERRED STOCK
In May 1996, the Company completed an offering of 4,019,400 shares of
Series A-1 convertible preferred stock ("Series A-1") at $.43 per share, with
3,157,200 callable warrants to purchase shares of the Company's preferred stock
at an exercise price of $.54 per share. The warrants were callable by the
Company, subject to the achievement of certain operational thresholds. The
proceeds from the offering totaled $1,511,456, net of offering costs of
$188,544.
In December 1996, the Company commenced an offering of 2,347,200 shares of
Series B convertible preferred stock ("Series B") at $.54 per share, of which
1,057,800 shares were issued in 1996 and 1,289,400 shares were issued in 1997.
Total proceeds from the offering, which was completed in July 1997, were
$1,117,464, net of offering costs of $152,603.
In October 1997, the Company exercised its right to call the 3,157,200
warrants issued pursuant to the Series A-1 offering. In addition, the Company
commenced an offering to sell an additional 1,860,000 shares of Series A-2
convertible preferred stock ("Series A-2") at $.54 per share. The warrant call
and the offering were completed in December 1997, resulting in total proceeds of
$2,447,038, net of offering costs of $270,612.
In April 1999, the Company completed an offering of 2,305,434 shares of
Series C convertible preferred stock ("Series C") at $4.77 per share. Total
proceeds from the offering were $10,259,876, net of offering costs of $737,044.
In September 1999, the Company completed an offering of 2,057,773 shares of
Series D convertible preferred stock ("Series D") at $14.80 per share, of which
1,414,552 shares were purchased by UTC. Proceeds from the offering were
$30,289,120, net of offering costs of $165,920. In addition, the Company granted
304,431 stock purchase warrants (the "Series D warrants") at an exercise price
of $.01 per share to UTC in exchange for release of restrictions that limited
the Company from serving certain clients. In connection with this warrant grant,
the Company recognized expense of $4,502,534 in September 1999, as determined
using the Black-Scholes pricing model. UTC exercised the Series D warrants in
September 1999, resulting in total proceeds of $3,044 and a $4,502,534 transfer
from stock purchase warrants to additional capital.
The Company's Series A-1, A-2, B, C and D preferred stock are convertible
into common stock based upon an initial conversion ratio of one-to-one, which is
subject to adjustment as defined in the Company's Certificate of Incorporation
and the respective certificates of designations that created the preferred
stock. All series of preferred stock will be converted automatically into an
equal number of shares of common stock immediately preceding the closing of an
underwritten initial public offering pursuant to an effective registration
statement under the Securities Act of 1933, as amended. The holders of Series
A-1 and A-2 preferred stock, collectively as a group, have the right to elect
one director, while the holders of Series B, C and D preferred stock and all
holders of common stock, voting as a class, have the right to elect the
remaining directors. The holders of preferred stock also have a liquidation
preference equal to the purchase price of the preferred stock, the right to
receive dividends prior to any junior preferred stock or common stock, and
certain antidilution protections, all as defined in the Company's Certificate of
Incorporation and the respective certificates of designations that created the
preferred stock.
F-15
<PAGE> 79
FREEMARKETS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company has granted preemptive rights to the holders of Series A-1, A-2
and B preferred stock, as well as to two holders of common stock. In the event
that the Company seeks to raise additional capital, these rights allow holders,
under certain circumstances, to maintain their percentage ownership of the
Company. All preemptive rights terminate upon an initial public offering of the
Company's common stock.
STOCK PURCHASE WARRANTS
In addition to the warrants issued in connection with the Series A-1
offering that were subsequently exercised in the Series A-2 offering, the
Company granted a total of 2,604,600 warrants at an exercise price of $.54 per
share to the placement agent as compensation for services rendered in connection
with the Series A-1, A-2 and B offerings. Those warrants issued to the placement
agent, which do not have a call feature, expire seven years from the date of
issuance.
The Series A-1 warrants and placement agent warrants were valued using the
Black-Scholes pricing model. The portion of the proceeds received from the
Series A-1, A-2 and B preferred stock offerings representing the value assigned
to the warrants, as well as the Series D warrants discussed above, are reflected
as stock purchase warrants in the stockholders' equity section of the
accompanying balance sheets. At the time of exercise or expiration, the Company
will transfer the value assigned to the warrants to additional capital.
In March 1999, the placement agent exercised 2,409,000 warrants, resulting
in total proceeds of $1,304,875 and a $368,000 transfer of stock purchase
warrants to additional capital.
COMMON STOCK
In 1996, the Board of Directors reserved 240,000 shares of common stock to
be issued pursuant to a qualified stock purchase plan (the "1996 Purchase Plan")
under which employees could purchase shares of common stock of the Company.
During 1996, employees purchased 219,600 shares of common stock at $.43 per
share resulting in total proceeds of $92,705, net of offering costs of $625.
In 1997, the Board of Directors reserved an additional 600,000 shares of
common stock to be issued pursuant to the 1996 Purchase Plan. During 1997,
employees purchased 531,000 shares of common stock at $.54 per share resulting
in total proceeds of $287,025, net of offering costs of $600. No further shares
may be purchased under the 1996 Purchase Plan.
In 1998, the Board of Directors reserved 780,000 shares of common stock,
which included the remaining unissued shares under the 1996 Purchase Plan, to be
issued pursuant to a qualified stock purchase plan (the "1998 Purchase Plan")
under which employees could purchase shares of common stock of the Company.
During 1998, employees purchased 780,000 shares of common stock at $1.67 per
share resulting in total proceeds of $1,285,827, net of offering costs of
$14,173. No further shares may be purchased under the 1998 Purchase Plan.
F-16
<PAGE> 80
FREEMARKETS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following is a summary of share activity for all classes of stock:
<TABLE>
<CAPTION>
STOCK
PREFERRED COMMON PURCHASE
STOCK STOCK WARRANTS
---------- ---------- ----------
<S> <C> <C> <C>
Outstanding at December 31, 1995.................... -- 10,243,800 --
Shares issued..................................... 5,077,200 219,600 --
Callable stock purchase warrants issued........... -- -- 3,157,200
Stock purchase warrants issued.................... -- -- 1,067,400
---------- ---------- ----------
Outstanding at December 31, 1996.................... 5,077,200 10,463,400 4,224,600
Shares issued, net................................ 3,149,400 493,200 --
Stock purchase warrants issued.................... -- -- 1,537,200
Stock purchase warrants exercised................. 3,157,200 -- (3,157,200)
Options exercised................................. -- 13,800 --
---------- ---------- ----------
Outstanding at December 31, 1997.................... 11,383,800 10,970,400 2,604,600
Shares issued..................................... -- 780,000 --
Options exercised................................. -- 54,600 --
---------- ---------- ----------
Outstanding at December 31, 1998.................... 11,383,800 11,805,000 2,604,600
Shares issued..................................... 4,363,207 -- --
Stock purchase warrants issued.................... -- -- 304,431
Stock purchase warrants exercised................. 304,431 2,409,000 (2,713,431)
Options exercised................................. -- 89,520 --
---------- ---------- ----------
Outstanding at September 30, 1999................... 16,051,438 14,303,520 195,600
========== ========== ==========
</TABLE>
NOTE 8. 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 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. 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 will become effective upon the completion
of an underwritten initial public offering.
F-17
<PAGE> 81
FREEMARKETS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (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. Certain executives hold options that contain
limited accelerated vesting, as defined, in the event of an initial public
offering or sale of the Company.
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 unissued shares reserved for the future
issuance of stock options, as well as add certain change-of-control provisions.
As of September 30, 1999, 15,450,000 stock options were authorized for issuance.
The following is a summary of stock option activity:
<TABLE>
<CAPTION>
NUMBER EXERCISE
OF OPTIONS PRICE
---------- --------------
<S> <C> <C>
Outstanding at December 31, 1995.............. -- --
Granted..................................... 867,000 $ .33 - $ .43
----------
Outstanding at December 31, 1996.............. 867,000 .33 - .43
Granted..................................... 564,000 .54
Forfeited................................... (354,600) .33 - .54
Exercised................................... (13,800) .43
----------
Outstanding at December 31, 1997.............. 1,062,600 .33 - .54
Granted..................................... 6,150,900 .54 - 1.67
Forfeited................................... (44,700) .33 - 1.67
Exercised................................... (54,600) .33 - .54
----------
Outstanding at December 31, 1998.............. 7,114,200 .33 - 1.67
Granted..................................... 4,331,600 1.67 - 14.80
Forfeited................................... (155,050) .54 - 14.80
Exercised................................... (89,520) .54 - 1.67
----------
Outstanding at September 30, 1999............. 11,201,230 .33 - 14.80
==========
Shares reserved for future options as of
September 30, 1999.......................... 4,090,850 N/A
</TABLE>
F-18
<PAGE> 82
FREEMARKETS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following is a summary of the options outstanding as of September 30,
1999:
<TABLE>
<CAPTION>
NUMBER EXERCISE
OF OPTIONS PRICE
---------- --------------
<S> <C> <C>
532,800 $.33 - $ .43
1,449,900 .54
4,050,000 1.08
1,114,680 1.67
42,000 2.50
1,861,000 4.77
4,800 12.50
2,146,050 14.80
----------
11,201,230
==========
</TABLE>
The following is a summary of the exercisable options as of each date:
<TABLE>
<CAPTION>
NUMBER EXERCISE
OF OPTIONS PRICE
---------- ------------
<S> <C> <C>
December 31, 1996................................ 27,600 $ .33
December 31, 1997................................ 236,610 .33 - .43
December 31, 1998................................ 580,392 .33 - .54
September 30, 1999............................... 821,677 .33 - 1.67
</TABLE>
All options were granted at exercise prices determined by the Board of
Directors. The weighted average exercise price and the weighted average
remaining contractual life for options outstanding at September 30, 1999 was
$4.29 and 8.9 years, respectively. In 1999, the Company recorded $1,976,500 of
unearned stock-based compensation, of which $225,700 was amortized in the nine-
month period ended September 30, 1999.
If compensation costs had been recognized pursuant to SFAS No. 123, the
Company's net (loss) income and earnings per share would have been changed to
the pro forma amounts shown below:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------- NINE MONTHS ENDED
1996 1997 1998 SEPTEMBER 30, 1999
----------- ----------- --------- ------------------
<S> <C> <C> <C> <C>
Net (loss) income:
As reported................. $(1,431,188) $(1,060,700) $233,747 $(13,479,476)
Pro forma................... (1,466,066) (1,113,771) (208,581) (16,051,271)
Earnings per share:
Basic:
As reported................. $(.14) $(.10) $.02 $(1.00)
Pro forma................... (.14) (.10) (.02) (1.19)
Diluted:
As reported................. (.14) (.10) .01 (1.00)
Pro forma................... (.14) (.10) (.02) (1.19)
</TABLE>
The weighted average fair value per option granted was $.10 in 1996, $.14
in 1997, $.23 in 1998 and $2.11 in the nine-month period ended September 30,
1999. The fair value of each option grant according to SFAS No. 123 is estimated
on the date of grant using the Black-Scholes pricing model with the following
assumptions:
<TABLE>
<S> <C>
Weighted average risk-free interest rate.................... 5-6%
Expected life (number of years)............................. 5
</TABLE>
------------------------
F-19
<PAGE> 83
UNDERWRITING
FreeMarkets and the underwriters named below have entered into an
underwriting agreement with respect to the shares being offered. Subject to the
terms of the underwriting agreement, each underwriter has severally agreed to
purchase the number of shares indicated in the following table. Goldman, Sachs &
Co., Morgan Stanley & Co. Incorporated, Donaldson, Lufkin & Jenrette Securities
Corporation and Wit Capital Corporation are the representatives of the
underwriters.
<TABLE>
<CAPTION>
Number of
Underwriters Shares
------------ ---------
<S> <C>
Goldman, Sachs & Co. ....................................... 1,244,500
Morgan Stanley & Co. Incorporated........................... 1,244,500
Donaldson, Lufkin & Jenrette Securities Corporation......... 655,000
Wit Capital Corporation..................................... 131,000
BancBoston Robertson Stephens Inc. ......................... 50,000
Deutsche Bank Securities Inc. .............................. 50,000
Edward D. Jones & Co., L.P. ................................ 50,000
Advest, Inc. ............................................... 25,000
Dain Rauscher Incorporated ................................. 25,000
J.J.B. Hilliard, W.L. Lyons, Inc. .......................... 25,000
Legg Mason Wood Walker, Incorporated ....................... 25,000
SoundView Technology Group, Inc. ........................... 25,000
Sutro & Co. Incorporated ................................... 25,000
U.S. Bancorp Piper Jaffray Inc. ............................ 25,000
---------
Total....................................................... 3,600,000
=========
</TABLE>
Goldman, Sachs & Co. and Morgan Stanley & Co. Incorporated will jointly
manage the order books for the offering.
If the underwriters sell more shares than the total number set forth in the
table above, the underwriters have an option to buy up to an additional 540,000
shares from FreeMarkets to cover these sales. They may exercise that option for
30 days. If any shares are purchased pursuant to this option, the underwriters
will severally purchase shares in approximately the same proportion as set forth
in the table above.
The following tables show the per share and total underwriting discounts
and commissions to be paid to the underwriters by FreeMarkets. Such amounts are
shown assuming both no exercise and full exercise of the underwriters' option to
purchase additional shares.
Paid by FreeMarkets
---------------------
<TABLE>
<CAPTION>
No Exercise Full Exercise
----------- -------------
<S> <C> <C>
Per Share.................................... $ 3.36 $ 3.36
Total........................................ $12,096,000 $13,910,400
</TABLE>
Shares sold by the underwriters to the public will initially be offered at
the initial public offering price set forth on the cover of this prospectus. Any
shares sold by the underwriters to securities dealers may be sold at a discount
of up to $2.00 per share from the initial public offering price. Any of those
securities dealers may resell any shares purchased from the underwriters to
other brokers or dealers at a discount of up to $0.10 per share from the initial
public offering price. If all the shares are not sold at the initial public
offering price, the representatives may change the offering price and the other
selling terms.
U-1
<PAGE> 84
FreeMarkets and its directors, officers, employees and other holders of
substantially all its securities have agreed, with the underwriters, subject to
limited exceptions, not to dispose of or hedge any of their common stock or
securities convertible into or exchangeable for shares of common stock during
the period from the date of this prospectus through the date 180 days after the
date of this prospectus, except with the prior written consent of the
representatives. See "Shares Eligible for Future Sale" for a discussion of
certain transfer restrictions.
Prior to this offering, there has been no public market for the common
stock. The initial public offering price for the common stock has been
negotiated among FreeMarkets and the representatives of the underwriters. Among
the factors considered in determining the initial public offering price of the
shares, in addition to prevailing market conditions, were FreeMarkets'
historical performance, estimates of FreeMarkets' business potential and
earnings prospects, an assessment of FreeMarkets' management and the
consideration of the above factors in relation to the market valuation of
companies in related businesses.
FreeMarkets' common stock has been approved for quotation on the Nasdaq
National Market under the symbol "FMKT".
In connection with the offering, the underwriters may purchase and sell
shares of common stock in the open market. These transactions may include short
sales, stabilizing transactions and purchases to cover positions created by
short sales. Short sales involve the sale by the underwriters of a greater
number of shares than they are required to purchase in the offering. Stabilizing
transactions consist of certain bids or purchases made for the purpose of
preventing or retarding a decline in the market price of the common stock while
the offering is in progress.
The underwriters may also impose a penalty bid. This occurs when a
particular underwriter repays to other underwriters a portion of the
underwriting discount received by it because the representatives have
repurchased shares sold by or for the account of such underwriter in stabilizing
or short-sale covering transactions.
These activities by the underwriters may stabilize, maintain or otherwise
affect the market price of the common stock. As a result, the price of the
common stock may be higher than the price that otherwise might exist in the open
market. If these activities are commenced, they may be discontinued by the
underwriters at any time. These transactions may be effected on the Nasdaq
National Market, in the over-the-counter market or otherwise.
The underwriters do not expect sales to discretionary accounts to exceed
five percent of the total number of shares offered.
At the request of FreeMarkets, the underwriters have reserved, at the
initial public offering price, up to 360,000 shares of common stock for sale to
a subsidiary of United Technologies Corporation; up to 350,000 shares of common
stock for sale to Kleiner Perkins Caufield & Byers IX L.P., an entity affiliated
with one of FreeMarkets' directors; and up to 175,000 shares of common stock for
sale to directors and employees of FreeMarkets. United Technologies Corporation
is one of FreeMarkets' largest stockholders and its largest customer.
The number of shares available for sale to the general public will be
reduced by the number of reserved shares sold. Any reserved shares not so
purchased will be offered by the underwriters to the general public on the same
basis as other shares offered hereby.
FreeMarkets estimates that the total expenses of the offering, excluding
underwriting discounts and commissions, will be approximately $2.2 million.
FreeMarkets has agreed to indemnify the underwriters against various
liabilities, including liabilities under the Securities Act of 1933.
On February 5, 1999, Goldman, Sachs & Co. committed to invest at least
$6,596,700 in an offering of FreeMarkets' equity securities. That private
placement was completed with the sale of
U-2
<PAGE> 85
1,382,955 shares of Series C preferred stock to Goldman, Sachs & Co. and two
affiliates on April 9, 1999, at a price of $4.77 per share. These shares
automatically convert into the same number of shares of common stock immediately
prior to the closing of this offering.
Wit Capital, a member of the National Association of Securities Dealers,
Inc., will participate in the offering as one of the representatives of the
underwriters. The National Association of Securities Dealers, Inc. approved the
membership of Wit Capital on September 4, 1997. Since that time, Wit Capital has
acted as an underwriter, e-Manager or selected dealer in over 125 public
offerings. Except for its participation as a representative in this offering,
Wit Capital has no relationship with FreeMarkets, or any of its founders or
significant stockholders.
U-3
<PAGE> 86
INSIDE BACK COVER
The inside of the back cover includes a picture of a printed circuit board
with the following text above it: "At 8:30 am, printed circuit boards for a
Global 1000 manufacturer cost $24 million. 1 day later, they cost $14 million."
A pull-out text box appears at the lower right-hand corner of the inside
back cover with the following text: "FreeMarkets recruited a global base of
suppliers whose bids fell 43% below previous prices. That's $10 million." Our
logo, with the word "FreeMarkets" beside it, appears at the bottom of the inside
back cover with the following tag-line text below it: "Redefining purchasing
power for the Global 1000."
The following text appears at the bottom left of the inside back cover:
"Each auction is a distinct event. The results of any auction cannot be
predicted, and may not be replicated."
<PAGE> 87
- -------------------------------------------------------
- -------------------------------------------------------
No dealer, salesperson or other person is authorized to give any information
or to represent anything not contained in this prospectus. You must not rely on
any unauthorized information or representations. This prospectus is an offer to
sell only the shares offered hereby, but only under circumstances and in
jurisdictions where it is lawful to do so. The information contained in this
prospectus is current only as of its date.
------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
----
<S> <C>
Prospectus Summary..................... 3
Risk Factors........................... 7
Note Regarding Forward-Looking
Statements........................... 18
Use of Proceeds........................ 19
Dividend Policy........................ 19
Capitalization......................... 20
Dilution............................... 21
Selected Consolidated Financial Data... 22
Management's Discussion and Analysis of
Financial Condition and Results of
Operations........................... 23
Business............................... 34
Management............................. 45
Certain Transactions................... 55
Principal Stockholders................. 56
Description of Capital Stock........... 58
Shares Eligible for Future Sale........ 61
Legal Matters.......................... 62
Experts................................ 63
Additional Information................. 63
Index to Financial Statements.......... F-1
Underwriting........................... U-1
</TABLE>
------------------
Through and including January 3, 2000 (the 25th day after the date of this
prospectus), all dealers effecting transactions in these securities, whether or
not participating in this offering, may be required to deliver a prospectus.
This is in addition to a dealer's obligation to deliver a prospectus when acting
as an underwriter and with respect to an unsold allotment or subscription.
- -------------------------------------------------------
- -------------------------------------------------------
- -------------------------------------------------------
- -------------------------------------------------------
3,600,000 Shares
FREEMARKETS, INC.
Common Stock
------------------
FreeMarkets Logo
------------------
GOLDMAN, SACHS & CO.
MORGAN STANLEY DEAN WITTER
------------------
DONALDSON, LUFKIN & JENRETTE
WIT CAPITAL CORPORATION
Representatives of the Underwriters
-------------------------------------------------------
-------------------------------------------------------
