NEOFORMA INC/CA/ - 10-Q Quarterly Report

	December 31, 2001*			June 30, 2002
Current assets:
Cash and cash equivalents	$	15,663		$	17,605
Accounts receivable, net of allowance for doubtful accounts of $321 and $375 as of December 31, 2001 and June 30, 2002, respectively		1,377			1,586
Prepaid expenses and other current assets		4,357			6,103
Deferred debt costs, current portion		175			—

Total current assets		21,572			25,294
Property and equipment, net		29,127			24,984
Intangibles, net of amortization		311			—
Capitalized partnership costs, net of amortization		241,530			208,014
Non-marketable investments		745			745
Other assets		2,951			2,161

Total assets	$	296,236		$	261,198

Current liabilities:
Notes payable, current portion:
Due to related party	$	—		$	19,000
Other		5,164			4,477

Total notes payable, current portion		5,164			23,477
Accounts payable		5,592			4,254
Accrued payroll		4,708			4,371
Other accrued liabilities		4,680			3,898
Deferred revenue		1,764			2,435

Total current liabilities		21,908			38,435

Deferred revenue, less current portion		2,111			1,986

Notes payable, less current portion:
Due to related party		19,000			—
Other		1,635			819

Total notes payable, less current portion		20,635			819

Stockholders’ equity:
Common stock, $0.001 par value:
Authorized — 300,000 shares at June 30, 2002
Issued and outstanding: 16,691 and 17,146 shares at December 31, 2001 and June 30, 2002, respectively		17			17
Warrants		3,688			3,688
Additional paid-in capital		806,556			813,995
Notes receivable from stockholders		(6,143	)		(6,138	)
Deferred compensation		(11,042	)		(6,146	)
Unrealized loss on available-for-sale securities		(1	)		(1	)
Accumulated deficit		(541,493	)		(585,457	)

Total stockholders’ equity		251,582			219,958

Total liabilities and stockholders’ equity	$	296,236		$	261,198

	Three Months Ended June 30,						Six Months Ended June 30,
	2001			2002			2001			2002
Revenue:
Marketplace revenue:
Related party, net of amortization of partnership costs of $3,763, $17,011, $5,763 and $30,903 for the three months ended June 30, 2001 and 2002 and the six months ended June 30, 2001 and 2002, respectively (see Note 2)	$	—		$	—		$	—		$	—
Other		257			160			527			489

Total Marketplace revenue		257			160			527			489
Trading Partner Services revenue:
Trading partner services (see Note 2)		536			421			1,064			704
Sales of used equipment		237			—			237			—

Total Trading Partner Services revenue		773			421			1,301			704

Total revenue		1,030			581			1,828			1,193

Operating expenses:
Cost of equipment sold		216			—			216			—
Cost of services		3,695			2,382			8,089			4,681
Operations		4,220			3,702			8,135			7,214
Product development		4,436			4,219			9,990			8,042
Selling and marketing		7,576			3,245			17,838			7,037
General and administrative		4,844			4,360			9,853			8,281
Amortization of intangibles		7,205			—			15,014			—
Amortization of partnership costs (see Note 2)		15,640			2,960			32,604			8,990
(Gain)/loss on divested business		621			—			621			(65	)

Total operating expenses		48,453			20,868			102,360			44,180

Loss from operations		(47,423	)		(20,287	)		(100,532	)		(42,987	)
Other income (expense):
Interest income		158			199			479			247
Interest expense		(315	)		(655	)		(618	)		(1,358	)
Other income (expense)		(79	)		(55	)		(211	)		134

Net loss	$	(47,659	)	$	(20,798	)	$	(100,882	)	$	(43,964	)

Net loss per share:
Basic and diluted	$	(3.02	)	$	(1.25	)	$	(6.57	)	$	(2.67	)

Weighted average shares—basic and diluted		15,782			16,587			15,365			16,473

	Six Months Ended June 30,
	2001			2002
Cash flows from operating activities:
Net loss	$	(100,882	)	$	(43,964	)
Adjustments to reconcile net loss to net cash used in operating activities:
Employee stock compensation		559			545
Provision for doubtful accounts		773			54
Depreciation and amortization of property and equipment		5,121			5,448
Amortization of intangibles		15,014			—
Amortization of partnership costs classified as an operating expense (see Note 2)		32,604			8,990
Amortization of deferred compensation		11,122			4,675
Amortization of deferred debt costs		210			175
Net (gain) loss on divested business		621			(65	)
Change in assets and liabilities, net of divestitures:
Accounts receivable		110			(168	)
Prepaid expenses and other assets		1,309			(771	)
Accounts payable		(11,652	)		(1,338	)
Accrued liabilities and accrued payroll		944			(1,019	)
Deferred revenue		737			545

Net cash used in operating activities		(43,410	)		(26,893	)

Cash flows from investing activities:
Purchases of marketable investments		(2,660	)		—
Proceeds from the sale of marketable investments		7,834			—
Cash surrendered with divested businesses, net of cash proceeds received from divestitures		(166	)		—
Purchases of property and equipment		(4,485	)		(1,305	)

Net cash provided by (used in) investing activities		523			(1,305	)

Cash flows from financing activities:
Amortization of partnership costs offset against related party revenue (see Note 2)		5,827			31,189
Repayments of notes payable		(5,785	)		(1,503	)
Proceeds from draw under line of credit		10,000			—
Cash received related to options exercised, net of repurchases		6			178
Proceeds from the issuance of common stock under the employee stock purchase plan		349			276
Common stock repurchased, net of notes receivable issued to common stockholders		(84	)		—
Proceeds from the issuance of common stock, net of issuance costs and notes receivable issued to common stockholders		29,452			—

Net cash provided by financing activities		39,765			30,140

Net increase (decrease) in cash and cash equivalents		(3,122	)		1,942
Cash and cash equivalents, beginning of period		22,597			15,663

Cash and cash equivalents, end of period	$	19,475		$	17,605

Supplemental disclosure of cash flow information:
Cash paid during the period for interest	$	351		$	139

In March 1996, the Company was incorporated as Neoforma, Inc., in the state of California, for the purpose of providing business-to-business e-commerce services for the medical products, supplies and equipment marketplace. In November 1998, the Company re-incorporated in the state of Delaware. In September 1999, the Company changed its name to Neoforma.com, Inc. In January 2000, the Company completed its initial public offering of its common stock on the Nasdaq National Market. In August 2001, the Company changed its name to Neoforma, Inc.

Since inception, the Company has incurred significant losses, and, as of June 30, 2002, had an accumulated deficit of $585.5 million. Operating losses are expected to continue through the remainder of fiscal 2002. The Company currently anticipates that currently available funds, consisting of cash and cash equivalents, combined with cash generated through its operations and funds available through its line of credit with VHA Inc. (VHA), will be sufficient to meet anticipated needs for working capital, capital expenditures and the payment of the current portion of notes payable through at least the next 12 months. The Company’s future long-term capital needs will depend significantly on the rate of growth of its business, the timing of expanded service offerings, the success of these services once they are launched and the Company’s ability to adjust its operating expenses to an appropriate level if the growth rate of its business is slower than expected. Any projections of future long-term cash needs and cash flows are subject to substantial uncertainty. If available funds and cash generated from operations are insufficient to satisfy its long-term liquidity requirements, the Company may seek to sell additional equity or debt securities, obtain additional lines of credit, renew its existing line of credit, curtail expansion of its services, including reductions in its staffing levels and related expenses, or potentially liquidate selected assets. The Company cannot be certain that additional financing will be available on favorable terms when and if required, or at all.

The condensed consolidated financial statements included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. These Unaudited Condensed Consolidated Financial Statements and notes should be read in conjunction with the audited financial statements and notes thereto included in the Company’s Annual Report for the year ended December 31, 2001 filed on Form 10-K with the SEC. In the opinion of management, the Unaudited Condensed Consolidated Financial Statements reflect all adjustments, consisting only of recurring adjustments, necessary for a fair presentation of the Company’s financial position, results of operations and cash flows for the periods indicated. The results of operations for interim periods are not necessarily indicative of the results that may be expected for future quarters or the year ending December 31, 2002.

In November 2001, the Emerging Issues Task Force (EITF) reached a consensus on EITF Abstract No. 01-9, “Accounting for Consideration Given by Vendor to a Customer (Including a Reseller of the Vendor’s Products).” EITF No. 01-9 addresses whether consideration from a vendor to a reseller is (i) an adjustment of the selling prices of the vendor’s products and, therefore, should be classified as an offset against revenue when recognized in the vendor’s statement of operations or (ii) a cost incurred by the vendor for assets or services received from the reseller and, therefore, should be classified as a cost or expense when recognized in the vendor’s statement of operations. EITF No. 01-9 was required to be adopted no later than the first quarter of 2002 and upon adoption, companies were required to retroactively reclassify such amounts in previously issued financial statements to comply with the income statement classification requirements of EITF No. 01-9.

On July 26, 2000, the Company issued equity consideration to VHA and University HealthSystem Consortium (UHC) in connection with the Company’s outsourcing and operating agreement (Outsourcing Agreement) entered into with Novation, LLC (Novation), VHA, UHC and Healthcare Purchasing Partners International, LLC (HPPI) on May 24, 2000. The Company is capitalizing this consideration when a measurement date has occurred as defined under EITF No. 96-18. The portion of the consideration which was capitalized at the time of issuance is being amortized over the five-year estimated life of the arrangement. The remaining consideration, which is being capitalized as earned, is being amortized over the term of the arrangements which result in the consideration being earned, typically two to three years. As a result of the application of EITF No. 01-9, the Company has reclassified certain costs associated with this equity consideration, historically classified as operating expenses, to an offset against related party revenue from those parties. This treatment will result in non-cash Amortization of partnership costs being offset against related party revenue up to the lesser of such related party revenue or amortization of partnership costs in any period. Any amortization of partnership costs in excess of related party revenue in any period will continue to be classified as an operating expense. The following table summarizes the impact the application of EITF No. 01-9 had on the Company’s Unaudited Condensed Consolidated Statements of Operations:

	Three Months Ended June 30,						Six Months Ended June 30,
	2001			2002			2001			2002
Revenue:
Related party marketplace revenue	$	3,763		$	17,011		$	5,763		$	30,903
Related party implementation revenue		50			158			64			286
Offset of Amortization of partnership costs		(3,813	)		(17,169	)		(5,827	)		(31,189	)

Total related party revenue, as reported	$	—		$	—		$	—		$	—

Amortization of Partnership Costs:
Amortization of partnership costs	$	19,453		$	20,129		$	38,431		$	40,179
Offset to related party revenue		(3,813	)		(17,169	)		(5,827	)		(31,189	)

Total amortization of partnership costs reported as operating expenses	$	15,640		$	2,960		$	32,604		$	8,990

The amortization of partnership costs reported as operating expenses will be reflected as an adjustment to reconcile net loss to cash from operating activities in the Unaudited Condensed Consolidated Statements of Cash Flows. Under EITF No. 01-9, the Company accounts for the fees paid by Novation under the terms of the outsourcing and operating agreement as if they were payments made for the equity consideration provided to VHA and UHC as opposed to payments for services. As a result, these fees that are offset by amortization of partnership costs are reported as a cash flow from financing activities in the Company’s Unaudited Condensed Consolidated Statements of Cash Flows.

	June 30, 2002
	Amortized Cost		Aggregate Fair Value		Unrealized Holding Loss
			(in thousands)
Debt securities issued by states of the United States and political subdivisions of the states	$	2,299	$	2,298	$	(1	)
Corporate debt securities		706		706		—

Total	$	3,005	$	3,004	$	(1	)


	December 31, 2001
	Amortized Cost		Aggregate Fair Value		Unrealized Holding Loss
			(in thousands)
Debt securities issued by states of the United States and political subdivisions of the states	$	4,295	$	4,294	$	(1	)
Corporate debt securities		3,276		3,276		—

Total	$	7,571	$	7,570	$	(1	)

In 2000, the Company undertook various restructuring activities, including reorganizations and the divestiture of certain of the Company’s operations. As a result, the Company recorded a restructuring charge of $2.1 million. In 2001, the Company recorded a restructuring charge of $400,000 for its planned divestiture of its EquipMD subsidiary. Also in 2001, the Company recorded an additional accrual for additional costs related to idle facilities associated with its divestiture of its GAR subsidiary. Components of the restructuring accrual as of June 30, 2002 were as follows (in thousands):

	Employee Severance			Cost of Idle Facilities			Other			Total
Balance at December 31, 2001	$	248		$	371		$	510		$	1,129
Payments		—			(183	)		(39	)		(222	)
Reversal		(97	)		—			—			(97	)
Reclassifications		63			276			(339	)		—

Balance at March 31, 2002		214			464			132			810
Payments		(146	)		(189	)		(15	)		(350	)
Reversals		(68	)		—			—			(68	)
Reclassifications		—			96			(96	)		—

Balance at June 30, 2002	$	—		$	371		$	21		$	392

Basic net loss per share on a historical basis is computed using the weighted-average number of shares of common stock outstanding. Diluted net loss per common share was the same as basic net loss per share for all periods presented since the effect of any potentially dilutive securities is excluded, as the securities are anti-dilutive as a result of the Company’s net losses. The total number of weighted average shares that are excluded from the diluted loss per share calculation relating to these securities was approximately 4.5 million and 2.4 million shares for the six months ended June 30, 2001 and 2002, respectively.

	Three Months Ended June 30,						Six Months Ended June 30,
	2001			2002			2001			2002
Net loss	$	(47,659	)	$	(20,798	)	$	(100,882	)	$	(43,964	)

Basic and diluted:
Weighted average shares of common stock outstanding		16,174			16,800			15,788			16,703
Less: Weighted average shares of common stock subject to repurchase		(392	)		(213	)		(423	)		(230	)

Weighted average shares used in computing basic and diluted net loss per share		15,782			16,587			15,365			16,473

Basic and diluted net loss per common share	$	(3.02	)	$	(1.25	)	$	(6.57	)	$	(2.67	)

In November 2001, the EITF reached a consensus on EITF Abstract No. 01-9, “Accounting for Consideration Given by Vendor to a Customer (Including a Reseller of the Vendor’s Products).” EITF No. 01-9 addresses whether consideration from a vendor to a reseller is (i) an adjustment of the selling prices of the vendor’s products and, therefore, should be classified as an offset against revenue when recognized in the vendor’s statement of operations or (ii) a cost incurred by the vendor for assets or services received from the reseller and, therefore, should be classified as a cost or expense when recognized in the vendor’s statement of operations. EITF No. 01-9 was required to be adopted no later than the first quarter of 2002 and upon adoption, companies were required to retroactively reclassify such amounts in previously issued financial statements to comply with the income statement classification requirements of EITF No. 01-9. On July 26, 2000, the Company issued equity consideration to VHA and UHC in connection with its Outsourcing Agreement with Novation, VHA, UHC and HPPI. As a result of the application of EITF No. 01-9, the Company has reclassified certain costs associated with this equity consideration, historically classified as operating expenses, to an offset against related party revenue from those parties. This treatment will result in the classification of non-cash amortization of partnership costs as an offset against related party revenue, as opposed to being classified as an operating expense, up to the lesser of such related party revenue or amortization of partnership costs in any period. The adoption of EITF No. 01-9 resulted in a reduction of reported amortization of partnership costs and related party revenue by approximately $3.8 million and $17.2 million for the three months ended June 30, 2001 and 2002, respectively, and $5.8 million and $31.2 million for the six months ended June 30, 2001 and 2002, respectively. As reclassifications, these changes had no impact on the Company’s loss from operations, net loss, net loss per share or total cash flow. See Note 2 for further discussion of the application of EITF No. 01-9.

In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 142, “Goodwill and Other Intangible Assets,” which became effective for fiscal years beginning after December 15, 2001. SFAS No. 142 addresses financial accounting and reporting for acquired goodwill and other acquired intangible assets. It addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. SFAS No. 142 also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. Under SFAS No. 142, goodwill and certain other acquired intangible assets with indefinite lives are no longer subject to amortization. Intangible assets with finite lives will continue to be amortized over those lives. The adoption of this pronouncement did not have a significant impact on the Company’s financial position, results of operations or cash flows.

In August 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 addresses significant issues relating to the implementation of SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,” and requires that long-lived assets that are to be disposed of by sale be measured at the lower of book value or fair value less cost to sell. Additionally, SFAS No. 144 expands the scope of discontinued operations to include all components of an entity with operations that (i) can be distinguished from the rest of the entity and (ii) will be eliminated from the ongoing operations of the entity in a disposal transaction. SFAS No. 144 became effective for fiscal years beginning after December 15, 2001 and its provisions are to be applied prospectively. The adoption of this pronouncement in 2002 did not have a significant impact on the Company’s financial position, results of operations or cash flows.

In April 2002, the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.” SFAS No. 145 rescinds SFAS No. 4, which required all gains and losses from extinguishment of debt to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. As a result, the criteria in Accounting Principles Board Opinion No. 30 will now be used to classify those gains and losses. SFAS No. 145 also amends SFAS No. 13 to require that certain lease modifications that have economic effects similar to sale-leaseback transactions be accounted for in the same manner as sale-leaseback transactions. The Company does not expect the adoption of SFAS No. 145 to have a significant impact on the Company’s financial position, results of operations and cash flows.

In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies EITF Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” SFAS No. 146 requires that a liability for costs associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. The provisions of SFAS No. 146 are effective for exit or disposal activities that are initiated after December 31, 2002. The Company does not expect the adoption of SFAS No. 146 to have a significant impact on the Company’s financial position, results of operations and cash flows.

In July 2001, the Company, along with Merrill Lynch, Pierce, Fenner & Smith, Bear Stearns and FleetBoston Robertson Stephens (certain of the underwriters of the Company’s initial public offering (IPO)) as well as its Chairman and Chief Executive Officer, Robert J. Zollars, and its former Chief Financial Officer, Frederick Ruegsegger, were named as defendants in two securities class action lawsuits filed in federal court in the Southern District of New York (No. 01 CV 6689 and No. 01 CV 6712) on behalf of those who purchased the common stock of the Company from January 24, 2000 to December 6, 2000. These actions have since been consolidated and a consolidated amended complaint was filed in the Southern District of New York on April 24, 2002. The amended complaint alleges that the underwriters solicited and received “undisclosed compensation” from investors in exchange for allocations of stock in the Company’s IPO, and that some investors in the IPO allegedly agreed with the underwriters to buy additional shares in the aftermarket to artificially inflate the price of the Company’s stock. The Company and its officers are named in the suits pursuant to Section 11 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5 promulgated thereunder, for allegedly failing to disclose in its IPO registration statement and prospectus that the underwriters had entered into the arrangements describe above. The complaints seek unspecified damages. Approximately 300 other issuers and their underwriters have had similar suits filed against them, all of which are included in a single coordinated proceeding in the Southern District of New York. The Company is defending against this action vigorously.

Company had accelerated all principal payments under the promissory note after Med-XS failed to make scheduled payments under the promissory note and demanded Med-XS pay the entire $2.4 million immediately. Defendants filed a counterclaim, alleging breach of contract and fraud. The Company answered the counterclaims and is currently in the process of discovery. Although the Company believes that its suit ultimately will be successful, and that the full amount due under the note will be recovered, litigation is inherently uncertain and the Company cannot be certain that it will prevail in this matter.

On July 26, 2000, the Company’s stockholders voted to approve the issuance of shares and warrants to VHA and UHC in consideration for the services to be rendered pursuant to the Outsourcing Agreement. Under the terms of the Outsourcing Agreement, the Company agreed to develop and manage an e-commerce marketplace (Marketplace@Novation) to be used by VHA, UHC and HPPI member healthcare organizations as their primary purchasing tool for medical equipment and supplies. Novation agreed to serve as a contracting agent for the Company by recruiting, contracting and managing relationships with manufacturers and distributors servicing healthcare providers on the Company’s behalf. VHA and UHC agreed to provide marketing support for Marketplace@Novation, guarantee Novation’s obligations under the Outsourcing Agreement and enter into certain exclusivity provisions contained in the Outsourcing Agreement.

In consideration for the services agreed to be rendered, the Company issued warrants to VHA and UHC to purchase up to 3,084,502 shares and 751,943 shares, respectively, of the Company’s common stock, at an exercise price of $0.10 per share. Vesting on the warrants was performance based and was driven by historical gross purchasing levels by VHA and UHC member healthcare organizations that enter into commerce agreements with the Company to use Marketplace@Novation. Additionally, the Company issued to VHA and UHC 4,626,753 shares and 1,127,915 shares, respectively, of the Company’s common stock, which are subject to certain voting restrictions. This common stock was issued in consideration for services to be rendered by VHA, UHC and Novation over the term of the Outsourcing Agreement. The total valuation of the common stock issued, $291.3 million, was capitalized and recorded in capitalized partnership costs in the accompanying Unaudited Condensed Consolidated Balance Sheets and is being amortized over the estimated beneficial life of five years. Due to the performance criteria on the warrants, the valuation of the warrants is not calculated until earned. The valuation of warrants earned is calculated using the Black-Scholes pricing model using a risk free interest rate of 5.8%, expected dividend yield of zero, an average life equal to the remaining term of the Outsourcing Agreement and volatility of 70%. The valuation is recorded as earned in the capitalized partnership costs account in the accompanying Unaudited Condensed Consolidated Balance Sheets. The value of the warrant shares earned for each healthcare organization is amortized over the life of the agreement signed between the Company and that healthcare organization (generally between 2-3 years). As of June 30, 2002, VHA and UHC had earned a total of 2.4 million of the shares resulting in a total valuation of $55.3 million being capitalized in capitalized partnership costs.

As of June 30, 2002, the Company had recorded total reductions in capitalized partnership costs of $147.9 million. As a result of the adoption of EITF No. 01-9 in 2002, the Company has classified the amortization of these capitalized partnership costs as an offset against related party revenue received from Novation, VHA and UHC, up to the lesser of such related party revenue or amortization of partnership costs in any period, until the capitalized partnership costs are fully amortized. Additionally, as required under the transition guidance of EITF No. 01-9, the Company has classified prior period financial statements presented for comparative purposes to be consistent with this presentation. Any amortization of partnership costs in excess of related party revenue in any period will continue to be classified as an operating expense, and will be reflected as an adjustment to reconcile net loss to cash from operating activities in the Unaudited Condensed Consolidated Statements of Cash Flows. Under EITF No. 01-9, the Company accounts for the fees being paid by Novation under the terms of the Outsourcing Agreement and subsequent amendments as if they were payments made for the equity consideration provided to VHA and UHC as opposed to payments for services. As a result, these fees that are offset by amortization of partnership costs are reported as a cash flow from financing activities in the Company’s Unaudited Condensed Consolidated Statements of Cash Flows. See Note 2 for a further discussion of the application of EITF No. 01-9.

On October 18, 2000, the Company entered into an agreement with VHA to replace the warrant issued to VHA to purchase up to 3,084,502 shares of its common stock with 3,084,502 shares of restricted common stock. On January 25, 2001, the Company entered into an agreement with UHC to replace the warrant issued to UHC to purchase up to 563,957 shares of its common stock with 563,957 shares of restricted common stock. In each case, the restrictions on the stock are identical to the vesting performance criteria that were in place on the warrant, and thus there was no change in the accounting treatment relating to the restricted common stock versus the warrant.

On January 25, 2001, the Company entered into stock purchase agreements with VHA and UHC to purchase shares of the Company’s common stock. VHA and UHC purchased 1,183,432 and 325,443 shares, respectively, at a price of $16.90 per share. Including i2 Technologies, Inc., which participated in the strategic financing, purchasing 295,858 shares, the Company raised a total of approximately $30.5 million prior to costs associated with the sale of the shares, which were approximately $1.1 million. After the closing of the financing, VHA and UHC owned approximately 48.8% and 12.1%, respectively, of the then total shares of the Company’s outstanding common stock assuming the exercise of all outstanding options and warrants to purchase the Company’s common stock.

Concurrent with the financing, the Company also amended the Outsourcing Agreement (the Amended Outsourcing Agreement), effective on January 1, 2001. Under the terms of the Amended Outsourcing Agreement, Novation agreed to increase the minimum fee level it guaranteed to the Company under the Outsourcing Agreement, which guaranteed minimum fee level is based on a percentage of marketplace volume processed through Marketplace@Novation. The fee level is determined based on a tiered fee structure under which the incremental fee per dollar of transaction volume decreases as the marketplace volume through Marketplace@Novation increases. This structure results in a higher blended fee percentage at lower volume levels and a lower blended fee percentage at higher volume levels. Under the terms of the Amended Outsourcing Agreement, the payments Novation is required to make are subject to quarterly maximums. These maximums are based on a predetermined schedule with increasing dollar amounts through 2002. Beginning in 2003 through the remaining term of the Amended Outsourcing Agreement, these maximums are calculated based on Novation’s financial performance, as defined. In certain historical periods, the fees from Novation have been limited by these maximums. The Amended Outsourcing Agreement also included modifications to certain revenue sharing, supplier recruitment and supplier implementation provisions of the Outsourcing Agreement.

In April 2001, the Company entered into a $25 million revolving credit agreement with VHA. Under the credit agreement, as amended in February 2002, until May 31, 2003, the Company is able to borrow funds up to an amount based on a specified formula dependent on the gross volume of transactions through Marketplace@Novation. Funds that the Company borrows under this credit agreement bear interest at a rate of 10% per year and are secured by substantially all of the Company’s assets. All amounts outstanding under this line of credit, both principal and interest, are due and payable on May 31, 2003. In the event that the Company (i) sells any stock as part of an equity financing, (ii) obtains funding in connection with a debt financing or other lending transaction that is either unsecured or subordinate to the lien of VHA under the credit agreement or (iii) enters into a debt financing or other lending transaction secured by the Company’s assets as of the date entered into the credit agreement, then the maximum of $25 million the Company could potentially borrow under the credit agreement will be reduced by an amount equal to the cash proceeds it receives from any of these transactions. As of June 30, 2002, the Company had outstanding principal borrowings of $19.0 million under the line of credit and remaining available funds of $6.0 million.

In September 2001, the Company, Novation, VHA, UHC and HPPI amended the Amended Outsourcing Agreement (the Amendment). Pursuant to the Amendment, all parties agreed to expand the definition of marketplace volume to include supply chain data captured for marketplace member purchasing when the initial transaction itself was not facilitated by the Company’s connectivity solution. As a result, the Company will be able to provide its trading partners within Marketplace@Novation information relating to all purchases made by members from suppliers that have agreed to provide this transaction data as part of their participation in Marketplace@Novation. This amendment accelerates the Company’s ability to capture critical supply chain data and will also enable the Company to capture important purchasing information without first requiring full adoption of its connectivity services.

As a result of the terms of the Outsourcing Agreement and the subsequent amendments between the Company and VHA, UHC and Novation, certain executive officers of VHA, UHC and Novation sat on the board of the Company as of June 30, 2002. Such individuals were: Robert J. Baker, President and CEO of UHC; Mark McKenna, President of Novation; Curt Nonomaque, Executive Vice President of VHA; and C. Thomas Smith, President and CEO of VHA. The compensation these individuals receive for serving on the Company’s board of directors is equivalent with the other members of the board, is disclosed annually in the Company’s proxy statement for its annual meeting of stockholders and consists solely of annual stock option grants pursuant to the terms of the Company’s 1999 Equity Incentive Plan. According to representations made to the Company by VHA, UHC and Novation, none of the Company’s directors who are officers of VHA, UHC or Novation benefit directly from the options granted to them, because any profits generated by the exercise and sale of these option shares, when and if exercised, must be surrendered to VHA, UHC or Novation, as the case may be.

Neoforma is a leading healthcare supply chain and information solutions company. We build and operate Internet marketplaces that empower healthcare trading partners to optimize supply chain performance and we provide complementary solutions to our trading partners that enable them to increase the value they derive from our marketplaces. Our objective is to develop the industry standard supply chain operating system for healthcare. Our solutions enable the participants in the healthcare supply chain, principally healthcare providers, manufacturers, distributors and group purchasing organizations, or GPOs, to significantly improve business processes within their organizations and among their trading partners. These solutions consist of Web-based applications and services for our customers, or trading partners, that are designed to accelerate and optimize their use of the marketplaces that we build for them. Our trading partners include GPOs, healthcare providers such as hospitals and integrated delivery networks, and the manufacturers and distributors that sell products and services to them. As of June 30, 2002, the Company’s only Internet marketplace that was generating revenue was Marketplace@Novation.

Our revenue streams currently consist of two types of revenue: marketplace revenue and trading partner services revenue. Marketplace revenue is comprised of transaction and subscription based fees paid by the buyers and the suppliers of products on our marketplaces, as well as fees paid by marketplace sponsors such as GPOs. Trading partner services revenue consists of revenue generated from the sale or license of applications and services that are complementary to our marketplace services. Trading partner services revenue currently consists of revenue relating to the sale of our Rapid Connectivity Solution, or RCS, to Global Healthcare Exchange, LLC, or GHX, revenue relating to data cleansing services provided to healthcare providers and fees from other value added services to our trading partners.

We recognize transaction fees as revenue in the period the transaction is confirmed by both the buyer and the seller. The transaction fee is based on the total purchase price as confirmed by the seller and the buyer. We receive transaction fees when (i) the initial order is placed and processed through the marketplace, and (ii) the initial order is placed outside the marketplace, but the transaction information is subsequently captured and processed through the marketplace. Marketplace subscription fees are recognized ratably over the period of the related agreement with the applicable buyer or supplier. Setup and implementation fees are recognized upon completion of the related services. With respect to software licenses, license fees are recognized when the software has been delivered and there are no other contingencies related to our performance. If license fees are contingent upon our performance subsequent to delivery, we defer recognition of such fees or the fair market value of the undelivered element requiring performance until we have completed performance. Subscription and maintenance fee revenue is recognized ratably over the period of the service agreement. Services revenue for implementation projects is generally the result of fixed fee arrangements, and due to the nature and term of the projects, we recognize such fees on a completed contract basis. Revenue for other services, including training and consulting, is recognized as services are performed for time and material arrangements. For most other fixed fee arrangements, we use the percentage of completion method based on labor input measures when appropriate, and in cases where percentage of completion is not feasible, we defer recognition of the revenue in its entirety until the contract is completed.

We are continuing to identify new potential revenue opportunities within the scope of our core strategy of developing and operating Internet marketplaces. We have identified opportunities to develop and sell additional products and services into our existing customer base that can provide significant value to trading partners using our marketplaces and could represent significant future revenue opportunities. In connection with this strategy, we have refocused our efforts on identifying opportunities to license the proprietary technology that we have developed and are developing for internal use as part of our marketplace development efforts. Although licensing these internally developed software and technology solutions has been part of our core strategy, only recently has Marketplace@Novation achieved volume levels sufficient to validate our technology and enable us to pursue technology licensing opportunities. Although our sale of RCS to GHX in August 2001 was the first such sale of our proprietary, internally developed software, we intend to continue to market our technology solutions to other marketplace providers and participants in the healthcare industry, as well as in other vertical markets.

Our operations have grown significantly since inception. We have significantly increased the number of trading partners, both hospitals and suppliers, that are participants in Marketplace@Novation, and we have introduced new and enhanced technology to offer to these trading partners within our marketplace services. In addition, we have increased the scope of our trading partner services that we offer to our marketplace participants. Because of the growth in our marketplace services, and increased adoption of our marketplace, we have generated increasing levels of marketplace volume. However, as a result of our

adoption of Emerging Issues Task Force Abstract No. 01-9, or EITF No. 01-9, our reported marketplace revenue is not reflective of the increased level of fees being received from related parties for these marketplace services. As a result of the application of EITF No. 01-9, we offset the amortization of capitalized partnership costs resulting from the equity consideration provided to related parties against the fees received from those related parties, thereby resulting in an offset of the related party revenue reported (see Note 2 to the Notes to Unaudited Condensed Consolidated Financial Statements for further discussion of the application of EITF No. 01-9). Since inception, our operating expenses have also increased, primarily due to increased costs of anticipated divestitures resulting from the write-down of the assets of several of our ancillary operations in conjunction with our plans to divest the businesses, increased costs incurred to write-down certain non-marketable investments and intangible assets and increased amortization of partnership costs relating to our outsourcing and operating agreement, or the Outsourcing Agreement, effective May 24, 2002, with Novation, LLC, or Novation, VHA Inc., or VHA, University HealthSystem Consortium, or UHC, and Healthcare Purchasing Partners International, LLC, or HPPI.

In connection with the Outsourcing Agreement, we issued approximately 4.6 million shares of our common stock to VHA, representing approximately 36% of our then outstanding common stock, and approximately 1.1 million shares of our common stock to UHC, representing approximately 9% of our then outstanding common stock. We also issued warrants to VHA and UHC, allowing VHA and UHC the opportunity to earn up to approximately 3.1 million and approximately 800,000 additional shares of our common stock, respectively, over a four-year period by meeting specified performance targets. These performance targets are based upon the historical purchasing volume of VHA and UHC member healthcare organizations that sign up to use Marketplace@Novation, which is available only to the patrons and members of VHA, UHC and HPPI. The targets increase annually to a level equivalent to total healthcare organizations representing $22 billion of combined purchasing volume at the end of 2004. These issuances of our common stock and warrants to purchase our common stock to VHA and UHC were approved by our stockholders on July 26, 2000.

In October 2000, we and VHA agreed to amend our common stock and warrant agreement to provide for the cancellation of the performance warrant to purchase approximately 3.1 million shares of our common stock. In substitution for the warrant, we issued to VHA approximately 3.1 million shares of our restricted common stock. On January 25, 2001, we and UHC agreed to amend our common stock and warrant agreement to provide for the cancellation of the remaining unexercised portion of the performance warrant to purchase approximately 600,000 shares of our common stock. In substitution for the warrant, we issued to UHC approximately 600,000 shares of our restricted common stock. Both VHA’s and UHC’s restricted shares are subject to forfeiture if the same performance targets that were contained in their original warrants are not met.

In January 2001, we amended and restated the Outsourcing Agreement, or the Amended Outsourcing Agreement, which was effective as of January 1, 2001. Under the terms of the Amended Outsourcing Agreement, Novation agreed to increase the minimum fee level it guaranteed to us under the Outsourcing Agreement, which guaranteed minimum fee level is based on a percentage of marketplace volume processed through Marketplace@Novation. The fee level is determined based on a tiered fee structure under which the incremental fee per dollar of transaction volume decreases as the marketplace volume processed through Marketplace@Novation increases. This structure results in a higher blended fee percentage at lower volume levels and a lower blended fee percentage at higher volume levels. Under the terms of the Amended Outsourcing Agreement, the payments Novation is required to make are subject to quarterly maximums. These maximums are based on a predetermined schedule with increasing dollar amounts through 2002. Beginning in 2003 through the remaining term of the Amended Outsourcing Agreement, these maximums are calculated based on Novation’s financial performance, as defined. In certain historical periods, the fees from Novation have been limited by these maximums. The Amended Outsourcing Agreement also includes modifications to revenue sharing provisions under which we agreed to share specified fees we receive for products and services sold through or related to our marketplaces. We agreed to share with Novation revenue related to transactions through Marketplace@Novation and from our other marketplaces as well as revenue related to the distribution or licensing of software and other technology solutions. We are not required to share revenue related to marketplaces sponsored by other GPOs, except for specified types of purchases. For the term of the Amended Outsourcing Agreement, we are not required to share with Novation revenue related to any of the above transactions in any quarter until we have achieved specified minimum transaction fees related to Marketplace@Novation transactions. The Amended Outsourcing Agreement also includes modifications to certain supplier recruitment and supplier implementation provisions of the Outsourcing Agreement.

In January 2001, we entered into stock purchase agreements with VHA, UHC and i2 Technologies, Inc. under which these entities purchased a total of approximately 1.8 million shares of our common stock at a price of $16.90 per share. We raised a total of $30.5 million prior to costs associated with the sale of the shares, which were $1.1 million, including an advisory fee to our investment bankers. After the closing of the financing, VHA and UHC owned 48.8% and 12.1%, respectively, of our then outstanding shares of common stock, assuming the exercise of all outstanding options and warrants to purchase our common stock.

As a result of the terms of the Outsourcing Agreement and the subsequent amendments, certain executive officers of VHA, UHC and Novation sat on our board as of June 30, 2002. Such individuals included: Robert J. Baker, President and CEO of UHC; Mark McKenna, President of Novation; Curt Nonomaque, Executive Vice President of VHA; and C. Thomas Smith, President and CEO of VHA. The compensation these individuals receive for serving on our board of directors is equivalent with the other members of the board, is disclosed annually in our proxy statement for our annual meeting of stockholders and consists solely of annual stock option grants pursuant to the terms of our 1999 Equity Incentive Plan. According to representations made to us by VHA, UHC and Novation, none of our directors who are officers of VHA, UHC or Novation benefit directly from the options granted to them, because any profits generated by the exercise and sale of these option shares, when and if exercised, must be surrendered to VHA, UHC or Novation, as the case may be.

Since inception, we have incurred significant losses and, as of June 30, 2002, had an accumulated deficit of $585.5 million. We anticipate our losses in 2002 will decrease as compared to fiscal 2001 as a result of several factors. These factors primarily relate to anticipated reductions in non-cash charges, such as amortization of intangibles, impairment of intangibles, costs of anticipated divestitures and write-down of non-marketable investments, as well as anticipated increases in fees received from related parties. Historically, these fees have been reported as related party revenue. However, as a result of the application of EITF No. 01-9, non-cash amortization of partnership costs will be offset against these fees received from related parties up to the lesser of related party revenue or amortization of partnership costs in any period, resulting in a reduction in the amortization classified as an operating expense. We expect these fees from related parties to continue to increase over the next several quarters (see Note 2 to the Notes to Unaudited Condensed Consolidated Financial Statements for further discussion of the application of EITF No. 01-9).

We have a limited operating history on which to base an evaluation of our business and prospects. You must consider our prospects in light of the risks, expenses and difficulties frequently encountered by companies in their early stage of development, particularly companies in new and rapidly evolving markets such as the online market for the purchase and sale of new products and services used by healthcare providers, including medical supplies and equipment. To address these risks, we must, among other things, increase the number of marketplaces we build and operate, expand the number of trading partners that use our marketplaces, enter into new strategic alliances, increase the functionality of our services, implement and successfully execute our business and marketing strategy, respond to competitive developments and attract, retain and motivate qualified personnel. We may not be successful in addressing these risks, and our failure to do so could seriously harm our business.

We derive our revenue from marketplace applications and services and from related trading partner applications and services we provide to our trading partners. Marketplace revenue consists primarily of transaction based fees and subscription based fees. Trading partner services revenue currently consists of software license and maintenance fees, sponsorship fees, subscription fees, implementation fees and fees from other value added services. As described below, significant management judgments and estimates must be made and used in connection with the revenue recognized in any accounting period. Material differences might result in the amount and timing of our revenue for any period if our management made different judgments or utilized different estimates.

Transaction Fees. Transaction fee revenue represents the negotiated percentage of the purchase price, or marketplace volume, of products in transactions between signed marketplace participants that are either (i) purchased by trading partners through Marketplace@Novation, or (ii) purchased through means other than our marketplace, but for which the transaction data is captured and processed through the marketplace for the benefit of our trading partner customers. The gross marketplace value of a transaction is the price of a product as agreed to by the buyer and the supplier, regardless of whether the transaction occurs through the marketplace, or whether we capture the transaction data, process it and make it available to the trading partners on the marketplace. We recognize transaction fees on a net basis, as we do not believe that we act as a principal in connection with orders to be shipped or delivered by a supplier to a purchaser because, among other things, we do not:

Software License and Maintenance Fees. Although we have had relatively immaterial amounts of software license revenue to date, we anticipate that we will generate increased software license revenue in future periods. We have applied, and will continue to apply, the provisions of Statement of Position No. 97-2, “Software Revenue Recognition,” as amended, to all transactions involving the sale of software products. We recognize revenue from the sale of software licenses when persuasive evidence of an arrangement exists, the product has been delivered, the fee is fixed and determinable and collection of the resulting receivable is reasonably assured.

Implementation and Other Services Fees. We generally recognize implementation fees and other services fees where they relate to the implementation or use of our e-commerce solution, ratably over the term of the underlying e-commerce agreement. Revenue generated by implementation and other services we perform in connection with the implementation of other software products, applications or deliverables not directly related to our e-commerce services, is recognized on a completed contract basis unless we are able to accurately estimate the amount of time required to complete the project and track the amount of work performed. If we meet these requirements, we would be able to recognize revenue on a percentage of completion method. If we utilize the percentage of completion method and actual costs to complete projects are materially different from management’s estimates of those costs, the result could have an adverse impact on our recognizable revenue.

EITF No. 01-9. As a result of the application of EITF No. 01-9, we offset the amortization of capitalized partnership costs resulting from the equity consideration provided to related parties against the fees received from those related parties, thereby resulting in a reduction of the related party revenue reported. As a result, as discussed in Note 2 to the Notes to Unaudited Condensed Consolidated Financial Statements, our reported related party marketplace revenue does not reflect the increased level of fees received from related parties for those marketplace services.

Our management must make estimates of the collectability of both our accounts receivable and our notes receivable. Management specifically analyzes accounts receivable and analyzes historical bad debts, customer concentrations, customer credit-worthiness, current economic trends and changes in our customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. Management also performs additional periodic analysis of the financial condition of debtors for which we hold notes receivable. If the financial condition of our customers or debtors were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. As of June 30, 2002, our accounts receivable balance was $1.6 million, net of allowance for doubtful accounts of $375,000. As of June 30, 2002, we had a notes receivable balance of $3.3 million, against which no allowance had been made.

On July 22, 2002, we announced that we intended to consult with the Securities and Exchange Commission, or SEC, under the direction of our Board of Directors to determine the appropriate application of EITF No. 01-9. The consultation related to the application of EITF No. 01-9 to equity consideration issued by us to VHA and UHC in connection with the Outsourcing Agreement we entered into with Novation, VHA, UHC and HPPI on May 24, 2000. Our stockholders voted to approve the issuance of the equity consideration to VHA and UHC in consideration for the services to be rendered under the Outsourcing Agreement on July 26, 2000 (see Overview – Strategic Partnerships for further discussion of the Outsourcing Agreement).

EITF No. 01-9 addresses whether consideration from a vendor to a reseller is (i) an adjustment of the selling prices of the vendor’s products and, therefore, should be classified as an offset against revenue when recognized in the vendor’s statement of operations or (ii) a cost incurred by the vendor for assets or services received from the reseller and, therefore, should be classified as a cost or expense when recognized in the vendor’s statement of operations. EITF No. 01-9 was required to be adopted no later than the first quarter of 2002 and, upon adoption, companies were required to retroactively reclassify such amounts in previously issued financial statements to comply with the income statement classification requirements of the EITF.

On August 15, 2002, we announced that we had completed our review of our initial application of EITF No. 01-9 and our consultation with the SEC and, as a result, we have determined that offsetting amortization of partnership costs against all related party revenue, including the revenue from the hospital implementation services, is the appropriate accounting treatment under EITF No. 01-9. This treatment will result in the offset of non-cash amortization of partnership costs against related party revenue up to the lesser of related party revenue or amortization of partnership costs in any period. Any amortization of partnership costs in excess of related party revenue in any period will continue to be classified as an operating expense.

We have reclassified amortization of partnership costs in this Quarterly Report on Form 10-Q for the three and six months ended June 30, 2002 and 2001, to comply with the income statement display requirements of EITF No. 01-9. As such, we have reflected the reclassification of amortization of partnership costs from operating expenses to an offset against related party revenue in the amounts of $3.8 million and $17.2 million for the three months ended June 30, 2001 and 2002, respectively, and $5.8 million and $31.2 million for the six months ended June 30, 2001 and 2002, respectively.

The amortization of partnership costs reported as operating expenses will be reflected as an adjustment to reconcile net loss to cash from operating activities in the Unaudited Condensed Consolidated Statements of Cash Flows. Under EITF No. 01-9, we account for the fees being paid by Novation under the terms of the Outsourcing Agreement and subsequent amendments as if they were payments made for the equity consideration we provided to VHA and UHC as opposed to payments for services. As a result, these fees that are offset by amortization of partnership costs are reported as a cash flow from financing activities in our Unaudited Condensed Consolidated Statements of Cash Flows.

Related Party. Related party marketplace revenue consists of payments for marketplace services from VHA, UHC and Novation. For the three months ended June 30, 2001 and 2002, related party marketplace revenue consisted solely of payments from Novation to us under the minimum fee level guarantee provisions of the Amended Outsourcing Agreement and the Amendment during those periods. As a result of the adoption of EITF No. 01-9, amortization of partnership costs resulting from the equity consideration issued to VHA and UHC is classified as an offset against related party revenue, as opposed to being classified as an operating expense, up to the lesser of such related party revenue or amortization of partnership costs in any given period. Due to the offset of approximately $3.8 million and $17.0 million of amortization of partnership costs against related party marketplace revenue for the three months ended June 30, 2001 and 2002, respectively, there was no net related party marketplace revenue for either period. See Note 2 to the Notes to Unaudited Condensed Consolidated Financial Statements for further discussion of the application of EITF No. 01-9.

Other. Other marketplace revenue consists of marketplace revenue received from trading partners, marketplace sponsors and other sources that are not related parties and generally consists of transaction based fees and subscription fees. Other marketplace revenue was $160,000 for the three months ended June 30, 2002, a decrease from $257,000 for the three months ended June 30, 2001. The decrease was primarily due to the elimination of the revenue from our NeoMD operations in the second quarter of 2002 as a result of our divestiture of those operations in March 2002.

Trading Partner Services. Trading partner services revenue consists of revenue generated from the sale of applications and services that are complementary or additive to our marketplace services. Historically, trading partner services revenue has consisted of the following: setup fees to digitize product information; subscription and transaction based fees for management and disposition of used medical equipment through our asset recovery service, which were generated by our Auction operations, which we divested in September 2001; sponsorship fees paid by sellers to feature their brands and products on our Plan service, which was terminated in late 2001; license fees from the sale of software tools and related technical information; and services revenue for implementation and consulting services paid by users of our marketplaces. The decrease in trading partner services revenue from $536,000 for the three months ended June 30, 2001 to $421,000 for the three months ended June 30, 2002 was primarily due to the divestiture of the Auction operations. Substantially all of the trading partner services revenue in the second quarter of 2001 was related to the Auction operations, whereas in the second quarter of 2002, trading partner services revenue primarily was made up of revenue relating to the sale of RCS to GHX and revenue related to data cleansing services provided to our trading partners.

Sales of Used Equipment. Sales of used equipment consisted of the gross revenue generated from the sales of used and refurbished medical equipment that we owned as part of our now divested Auction operations. We had total sales of used equipment of $237,000 for the three months ended June 30, 2001, and none for the three months ended June 30, 2002. The decrease is a direct result of the sale of the Auction operations in September 2001. Because we have sold our Auction operations, we do not anticipate that we will recognize any future revenue from sales of used equipment.

Cost of Equipment Sold. Cost of equipment sold consisted solely of the costs of owned inventory of used medical equipment held for sale as part of our Auction operations. Cost of equipment sold decreased from $216,000 for the three months ended June 30, 2001 to none for the three months ended June 30, 2002. The decrease was due to the sale of our Auction operations in September 2001. Because of the sale of our Auction operations, we do not anticipate that we will incur any future expense relating to cost of equipment sold resulting from the sale of used equipment.

Cost of Services. Cost of services consists primarily of the costs to perform e-commerce readiness services and buyer and supplier implementation activities for our marketplaces. These expenditures consist primarily of technology costs, software licenses, salaries and other personnel expenses for our services personnel and fees for independent contractors. Cost of services decreased from $3.7 million for the three months ended June 30, 2001 to $2.4 million for the three months ended June 30, 2002. The decrease was due to the fact that the services group has historically utilized contractors and consultants as a significant portion of their resources. During the latter half of 2001 and the first quarter of 2002, however, as part of our cost management efforts and the development of the skills by our full-time employees, we reduced the number of contractors and consultants utilized and instead increased our use of full-time employees, which resulted in significantly reduced costs. We expect our cost of services to increase slightly in future periods as we continue to perform e-commerce readiness services, connect both buyers and sellers to our marketplaces and support and service an increasing number of trading partners.

Operations. Operations expenses consist primarily of expenditures for the operation and maintenance of our marketplaces and our marketplace technology infrastructure, including customer service. These expenditures consist primarily of fees for independent contractors and consultants, technology costs, software licenses, salaries and other personnel expenses for our operations personnel. Operations expenses decreased from $4.2 million for the three months ended June 30, 2001 to $3.7 million for the three months ended June 30, 2002. The decrease was primarily due to a decrease in operations personnel related costs, a decrease in activity of third party consultants and decreased expenditures for additional technology costs, such as software licenses and hardware costs, associated with the enhancement of the infrastructure of our marketplaces. We expect our operations expenses to increase as we expand our operating infrastructure and add content and functionality to our marketplaces.

Product Development. Product development expenses consist primarily of personnel expenses and technology costs associated with software development, as well as fees to consultants and contractors, associated with the development and enhancement of our marketplace solutions and functionality. Product development expenses decreased from $4.4 million for the three months ended June 30, 2001 to $4.2 million for the three months ended June 30, 2002. The decrease was primarily due to reduced costs relating to product development personnel, specifically with respect to contractors and consultants. We believe that continued investment in product development is critical to attaining our strategic objectives and, as such, we intend to continue to invest in this area. As a result, we expect product development expenses to increase slightly in future periods. Internally generated software development costs subject to capitalization were not material and were expensed as incurred.

Selling and Marketing. Selling and marketing expenses consist primarily of salaries, commissions, advertising, promotions and related marketing costs. Selling and marketing expenses decreased from $7.6 million for the three months ended June 30, 2001 to $3.2 million for the three months ended June 30, 2002. The decrease was primarily due to reduced selling and marketing personnel costs and a reduction in expenses related to travel and attendance at trade shows. As part of our realignment of resources to focus on our core business model, we have been focusing the majority of our resources on product development and marketplace implementation and integration efforts. As a result, selling and marketing costs were at significantly lower levels for the three months ended June 30, 2002 as compared with the three months ended June 30, 2001. We do not expect these costs to remain at these reduced levels in future periods. We recognize that sales and marketing efforts are key to establishing ourselves as a leader in our industry and in branding our products, and as a result, we intend to continue to invest in sales and marketing activities and sell our marketplace services into the channels we have established. As a result, we expect sales and marketing costs to increase slightly over the next several quarters.

General and Administrative. General and administrative expenses consist of expenses for executive and administrative personnel, facilities, professional services and other general corporate activities. General and administrative expenses decreased from $4.8 million for the three months ended June 30, 2001 to $4.4 million for the three months ended June 30, 2002. The decrease was primarily due to reduced administrative personnel costs, including finance, accounting and administrative personnel, as well as a decrease in recruiting, legal and accounting expenses. These reductions were primarily the result of the fact that in fiscal 2001, we divested several of the operations we had acquired, including our Auction operations and certain components of our Plan services, and we incurred certain administrative costs of those entities during the first six months of 2001. Given the organizational changes and divestitures we have made to streamline our operations and to focus on our core strategy, we expect general and administrative expenses to continue at these lower levels in future periods.

Amortization of Intangibles. Intangibles include goodwill and the value of software and other intangibles purchased in acquisitions. Intangibles historically have been amortized on a straight-line basis over a period of three to seven years. Amortization of intangibles decreased from $7.2 million for the three months ended June 30, 2001 to none for the three months ended June 30, 2002. During the fourth quarter of 2001, we wrote down the intangibles related to our January 2000 acquisition of Pharos Technologies, Inc. and effectively all of the intangibles relating to the acquisition of EquipMD, Inc., operated as NeoMD, as a result of our plans to divest the NeoMD business. As such, we had no material acquisition related intangibles remaining to be amortized for the three months ended June 30, 2002.

Amortization of Partnership Costs. Amortization of partnership costs represents the amortization of the capitalized valuation of consideration given to strategic partners as part of entering into any operating relationships with those partners. To date, capitalized partnership costs have represented common stock and warrants issued to VHA and UHC in connection with entering into the Outsourcing Agreement with those entities and with their purchasing organization, Novation, as well as certain legal and accounting fees relating to entering into the Outsourcing Agreement. We subsequently canceled the warrants issued to VHA and UHC and issued them restricted common stock in substitution for the canceled warrants. The value of the common stock issued is being amortized over a five-year estimated useful life. The restricted common stock issued in substitution for the warrants is being valued, and the related valuation is being capitalized, as the shares are earned. The capitalized partnership costs relating to the restricted common stock are being amortized over the term of the Outsourcing Agreement with the healthcare organizations that resulted in the shares being earned, generally two to three years. Amortization of partnership costs classified as an operating expense decreased from $15.6 million for the three months ended June 30, 2001 to $3.0 million for the three months ended June 30, 2002. The decrease in amortization expense is the result of the increase in fees received from related parties as, under EITF No. 01-9, amortization of partnership costs is classified as an offset against related party revenue, as opposed to being classified as an operating expense, up to the lesser of such related party revenue or amortization of partnership costs in any given period. We offset approximately $3.8 million and $17.2 million of amortization of partnership costs against related party revenue for the three months ended June 30, 2001 and 2002, respectively. The amortization of partnership costs reported as operating expenses will be reflected as an adjustment to reconcile net loss to cash from operating activities in the Unaudited Condensed Consolidated Statements of Cash Flows. Under EITF No. 01-9, we account for the fees being paid by Novation under the terms of the Outsourcing Agreement and subsequent amendments as if they were payments made for the equity consideration we provided to VHA and UHC as opposed to payments for services. As a result, these fees that are offset by amortization of partnership costs are reported as a cash flow from financing activities in our Unaudited Condensed Consolidated Statements of Cash Flows.

Including the amortization offset against related party revenue under EITF No. 01-9, amortization of partnership costs increased from approximately $19.5 million to $20.1 million for the three months ended June 30, 2001 and 2002, respectively. This increase was due to the fact that there were incremental partnership costs capitalized during fiscal 2001, as VHA and UHC earned a portion of the restricted stock. As the period over which VHA and UHC can earn the restricted common stock extends four years from the date of the Outsourcing Agreement, and as we expect VHA and UHC to continue to earn the restricted stock, we expect capitalized partnership costs to continue to increase for the next several quarters. The related amortization of partnership costs will continue to decrease in future quarters as we anticipate that our related party revenue, and therefore the amount of amortization which we offset against this revenue, will continue to increase. See Note 2 to the Notes to Unaudited Condensed Consolidated Financial Statements for further discussion of the application of EITF No. 01-9. See “Liquidity and Capital Resources” for a further discussion of the Outsourcing Agreement and the related cash and accounting implications.

Amortization of Deferred Compensation. Deferred compensation represents the aggregate difference, at the date of grant, between the cost to the employee of equity-based compensation and the estimated fair value of the underlying equity instrument. In the case of stock options, deferred compensation is calculated as the difference between the exercise price of the option and the fair value of the underlying stock on the date the option was granted. This type of deferred compensation is amortized over the vesting period of the underlying options, generally four years, based on an accelerated vesting method. In connection with the grant of stock options to employees during fiscal 1998, 1999 and 2000, we recorded deferred compensation of $65.2 million. During the three months ended June 30, 2001 and 2002, we recorded $90,000 and $97,000, respectively, in reductions of this deferred compensation as a result of normal employee attrition. We recorded amortization of this deferred compensation of $3.2 million and $1.5 million during the three months ended June 30, 2001 and 2002, respectively.

In connection with the assumption of certain stock options granted to employees of EquipMD, Inc. prior to our acquisition of EquipMD, Inc., we recorded deferred compensation of $23.1 million, representing the difference between the estimated fair value of the common stock and the option exercise price of these options at the date of announcement of the acquisition. This amount is presented as a reduction of stockholders’ equity and is being amortized over the vesting period of the applicable options using an accelerated method of amortization. During the three months ended June 30, 2001 and 2002, we recorded no additional reductions of this deferred compensation as a result of normal employee attrition. We recorded amortization of deferred compensation related to these options of $1.6 million and $159,000 during the three months ended June 30, 2001 and 2002, respectively.

In late 2001 and in the first half of 2002, in connection with the award of restricted stock to certain employees and officers, we recorded deferred compensation of $3.8 million which represents the fair value of the underlying common stock at the date of grant. The restrictions on the stock lapse on various dates through February 16, 2004, subject to the continuous employment of the employees and officers with Neoforma through those dates. This amount is presented as a reduction of stockholders’ equity and will be amortized ratably over the period from the date of grant through the vesting date using the straight line method of amortization. We recorded amortization of deferred compensation related to these shares of $625,000 during the three months ended June 30, 2002.

The total deferred compensation balance of $6.1 million at June 30, 2002 is expected to be amortized as follows: $2.8 million during the remainder of fiscal 2002, $3.1 million during fiscal 2003 and $0.2 million during fiscal 2004. The amortization expense relates to options and restricted stock awarded to employees and officers in all operating expense categories. The amount of deferred compensation has been separately allocated to these categories in our Unaudited Condensed Consolidated Statements of Operations. The amount of deferred compensation expense to be recorded in future periods could continue to decrease if options or restricted stock for which accrued but unvested compensation has been recorded are forfeited, or increase if additional restricted stock grants are made.

(Gain)/Loss on Divested Businesses. (Gain)/loss on divested businesses for the three months ended June 30, 2001 consisted of the net gain or loss incurred as a result of the divestiture of the US Lifeline, USL, and FDI operations during the quarter. The gain or loss on divested businesses is calculated by reducing the consideration paid to us for the divested operations by the net book value of all assets and liabilities transferred with the divested operations. The divestiture of USL resulted in a gain of $500,000 on the sale of the net assets, and the divestiture of FDI resulted in a loss of $1.1 million on the sale of the net assets. The resulting net loss on divested businesses during the three months ended June 30, 2001 was $621,000. There were no such divestitures for the three months ended June 30, 2002.

Income Taxes. As of December 31, 2001, we had federal and state net operating loss carryforwards of $324.0 million and $266.7 million, respectively, which will be available to reduce future taxable income. These net operating loss carryforwards expire on various dates through 2021. A valuation allowance has been recorded for the entire deferred tax asset as a result of uncertainties regarding the realization of the asset due to our lack of earnings history. Federal and state tax laws impose significant restrictions on the amount of the net operating loss carryforwards that we may utilize in a given year.

Novation to us under the minimum fee level guarantee provisions of the Amended Outsourcing Agreement during those periods. As a result of the adoption of EITF No. 01-9, amortization of partnership costs resulting from the equity consideration issued to VHA and UHC is classified as an offset against related party revenue, as opposed to being classified as an operating expense, up to the lesser of such related party revenue or amortization of partnership costs in any given period. Due to the offset of approximately $5.8 million and $30.9 million of amortization of partnership costs against related party marketplace revenue for the six months ended June 30, 2001 and 2002, respectively, there was no net related party marketplace revenue for either period. See Note 2 to the Notes to Unaudited Condensed Consolidated Financial Statements for further discussion of the application of EITF No. 01-9.

Other. Other marketplace revenue consists of marketplace revenue received from trading partners, marketplace sponsors and other sources that are not related parties and generally consists of transaction based fees and subscription fees. Other marketplace revenue was $489,000 for the six months ended June 30, 2002, a decrease from $527,000 for the six months ended June 30, 2001. The decrease was primarily due to the elimination of the revenue from our NeoMD operations in the second half of 2002 as a result of our divestiture of those operations in March 2002, offset by an increase in other marketplace revenue generated by suppliers as a result of increased marketplace participation.

Trading Partner Services. Trading partner services revenue consists of revenue generated from the sale of complementary applications and services to users and potential users of our marketplaces. Historically, trading partner services revenue has consisted of the following: setup fees to digitize product information; subscription and transaction based fees for management and disposition of used medical equipment through our asset recovery service, which were generated by our Auction operations, which we divested in September 2001; sponsorship fees paid by sellers to feature their brands and products on our Plan service, which was terminated in late 2001; license fees from the sale of software tools and related technical information; and services revenue for implementation and consulting services paid by users of our marketplaces. The decrease in trading partner services revenue from $1.1 million for the six months ended June 30, 2001 to $704,000 for the six months ended June 30, 2002 was primarily due to the divestiture of the Plan, Auction and USL operations in late 2001. Substantially all of the trading partner services revenue for the first six months of 2001 was related to the FDI, Auction and USL operations, all of which were divested later in 2001, whereas in the first half of 2002, trading partner services revenue primarily was made up of revenue relating to the sale of RCS to GHX and revenue from data cleansing services we provided to our trading partners.

Sales of Used Equipment. Sales of used equipment consisted of the gross revenue generated from the sales of used and refurbished medical equipment that we owned as part of our Auction service. We had total sales of used equipment of $237,000 for the six months ended June 30, 2001, and none for the six months ended June 30, 2002. The decrease is a direct result of the sale of the Auction operations in September 2001. Because we have sold our Auction operations, we do not anticipate that we will recognize any future revenue from sales of used equipment.

Cost of Equipment Sold. Cost of equipment sold consisted solely of the costs of owned inventory of used medical equipment held for sale as part of our Auction operations. Cost of equipment sold decreased from $216,000 for the six months ended June 30, 2001 to none for the six months ended June 30, 2002. The decrease was due to the sale of our Auction operations in September 2001. Because of the sale of our Auction operations, we do not anticipate that we will incur any future expense relating to cost of equipment sold resulting from the sale of used equipment.

Cost of Services. Cost of services consists primarily of the costs to perform e-commerce readiness services and buyer and supplier implementation activities for our marketplaces. These expenditures consist primarily of technology costs, software licenses, salaries and other personnel expenses for our services personnel and fees for independent contractors. Cost of services decreased from $8.1 million for the six months ended June 30, 2001 to $4.7 million for the six months ended June 30, 2002. The decrease was due to the fact that the services group has historically utilized contractors and consultants as a significant portion of their resources. During 2001 and the first half of 2002, however, as part of our cost management efforts and the development of the skills by our full-time employees, we reduced the number of contractors and consultants utilized and instead increased our use of full-time employees, which resulted in significantly reduced costs. We expect our cost of services to increase slightly in future periods as we continue to perform e-commerce readiness services, connect both buyers and sellers to our marketplaces and support and service an increasing number of trading partners.

Operations. Operations expenses consist primarily of expenditures for the operation and maintenance of our marketplaces and our marketplace technology infrastructure, including customer service. These expenditures consist primarily of fees for independent contractors and consultants, technology costs, software licenses, salaries and other personnel expenses for our operations personnel. Operations expenses decreased from $8.1 million for the six months ended June 30, 2001 to $7.2 million for the six months ended June 30, 2002. The decrease was primarily due to a decrease in operations personnel related costs, a decrease in activity of third party consultants and decreased expenditures for additional technology costs, such as software

Product Development. Product development expenses consist primarily of personnel expenses and technology costs associated with software development, as well as fees to consultants and contractors, associated with the development and enhancement of our marketplace solutions and functionality. Product development expenses decreased from $10.0 million for the six months ended June 30, 2001 to $8.0 million for the six months ended June 30, 2002. The decrease was primarily due to reduced costs relating to product development personnel, specifically with respect to contractors and consultants. We believe that continued investment in product development is critical to attaining our strategic objectives and, as such, we intend to continue to invest in this area. As a result, we expect product development expenses to increase slightly in future periods. Internally generated software development costs subject to capitalization were not material and were expensed as incurred.

Selling and Marketing. Selling and marketing expenses consist primarily of salaries, commissions, advertising, promotions and related marketing costs. Selling and marketing expenses decreased from $17.8 million for the six months ended June 30, 2001 to $7.0 million for the six months ended June 30, 2002. The decrease was primarily due to reduced selling and marketing personnel costs and a reduction in expenses related to travel and attendance at trade shows. As part of our realignment of resources to focus on our core business model, we have been focusing the majority of our resources on product development and marketplace implementation and integration efforts. As a result, selling and marketing costs were at significantly lower levels for the six months ended June 30, 2002 as compared with the six months ended June 30, 2001. We do not expect these costs to remain at these reduced levels in future periods. We recognize that sales and marketing efforts are key to establishing ourselves as a leader in our industry and in branding our products, and as a result, we intend to continue to invest in sales and marketing activities and sell our marketplace services into the channels we have established. As a result, we expect sales and marketing costs to increase slightly over the next several quarters.

General and Administrative. General and administrative expenses consist of expenses for executive and administrative personnel, facilities, professional services and other general corporate activities. General and administrative expenses decreased from $9.9 million for the six months ended June 30, 2001 to $8.3 million for the six months ended June 30, 2002. The decrease was primarily due to reduced administrative personnel costs, including finance, accounting and administrative personnel, as well as a decrease in recruiting, legal and accounting expenses. These reductions were primarily the result of the fact that in fiscal 2001, we divested several of the operations we had acquired, including our Auction operations and certain components of our Plan services, and we incurred certain administrative costs of those entities during the first six months of 2001. Given the organizational changes and divestitures we have made to streamline our operations and to focus on our core strategy, we expect general and administrative expenses to continue at these lower levels in future periods.

Amortization of Intangibles. Intangibles include goodwill and the value of software and other intangibles purchased in acquisitions. Intangibles historically have been amortized on a straight-line basis over a period of three to seven years. Amortization of intangibles decreased from $15.0 million for the six months ended June 30, 2001 to none for the six months ended June 30, 2002. During the fourth quarter of 2001, we wrote down the intangibles related to our January 2000 acquisition of Pharos Technologies, Inc. and effectively all of the intangibles relating to the acquisition of EquipMD, operated as NeoMD, as a result of our plans to divest the NeoMD business. As such, we had no acquisition related intangibles remaining to be amortized for the six months ended June 30, 2002.

Amortization of Partnership Costs. Amortization of partnership costs represents the amortization of the capitalized valuation of consideration given to strategic partners as part of entering into any operating relationships with those partners. To date, capitalized partnership costs have represented common stock and warrants issued to VHA and UHC in connection with entering into the Outsourcing Agreement with those entities and with their purchasing organization, Novation, as well as certain legal and accounting fees relating to entering into the Outsourcing Agreement. We subsequently canceled the warrants issued to VHA and UHC and issued them restricted common stock in substitution for the canceled warrants. The value of the common stock issued is being amortized over a five-year estimated useful life. The restricted common stock issued in substitution for the warrants is being valued, and the related valuation is being capitalized, as the shares are earned. The capitalized partnership costs relating to the restricted common stock are being amortized over the term of the Outsourcing Agreement with the healthcare organizations that resulted in the shares being earned, generally two to three years. Amortization of partnership costs classified as an operating expense decreased from $32.6 million for the six months ended June 30, 2001 to $9.0 million for the six months ended June 30, 2002. The decrease in amortization expense is the result of the increase in fees received from related parties as, under EITF No. 01-9, amortization of partnership costs is classified as an offset against related party revenue, as opposed to being classified as an operating expense, up to the lesser of such related party revenue or amortization of partnership costs in any given period. We offset approximately $5.8 million and $31.2 million of amortization of partnership costs against related party revenue for the six months ended June 30, 2001 and 2002, respectively. The amortization of partnership costs reported as operating expenses will be reflected as an adjustment to reconcile net loss to cash from operating activities in the Unaudited Condensed Consolidated Statements of Cash Flows. Under EITF No. 01-9, we account for the fees being paid by Novation under the terms of the Outsourcing Agreement and subsequent amendments as if they were payments made for the equity consideration we provided to VHA and UHC as opposed to payments for services. As a result, these fees that are offset by amortization of partnership costs, are reported as a cash flow from financing activities in our Unaudited Condensed Consolidated Statements of Cash Flows.

Including the amortization offset against related party revenue under EITF No. 01-9, amortization of partnership costs increased from approximately $38.4 million to $40.2 million for the six months ended June 30, 2001 and 2002, respectively. This increase was due to the fact that there were incremental partnership costs capitalized during fiscal 2001, as VHA and UHC earned a portion of the restricted stock. As the period over which VHA and UHC can earn the restricted common stock extends four years from the date of the Outsourcing Agreement, and as we expect VHA and UHC to continue to earn the restricted stock, we expect capitalized partnership costs to continue to increase for the next several quarters. The related amortization of partnership costs will continue to decrease in future quarters as we anticipate that our related party revenue, and therefore the amount of amortization which we offset against this revenue, will continue to increase. See Note 2 to the Notes to Unaudited Condensed Consolidated Financial Statements for further discussion of the application of EITF No. 01-9. See “Liquidity and Capital Resources” for a further discussion of the Outsourcing Agreement and the related cash and accounting implications.

Amortization of Deferred Compensation. Deferred compensation represents the aggregate difference, at the date of grant, between the cost to the employee of equity-based compensation and the estimated fair value of the underlying equity instrument. In the case of stock options, deferred compensation is calculated as the difference between the exercise price of the option and the fair value of the underlying stock on the date the option was granted. This type of deferred compensation is amortized over the vesting period of the underlying options, generally four years, based on an accelerated vesting method. In connection with the grant of stock options to employees during fiscal 1998, 1999 and 2000, we recorded deferred compensation of $65.2 million. During the six months ended June 30, 2001 and 2002, we recorded $775,000 and $213,000, respectively, in reductions of this deferred compensation as a result of normal employee attrition. We recorded amortization of this deferred compensation of $6.5 million and $3.0 million during the six months ended June 30, 2001 and 2002, respectively.

In connection with the assumption of certain stock options granted to employees of EquipMD prior to our acquisition of EquipMD, we recorded deferred compensation of $23.1 million, representing the difference between the estimated fair value of the common stock and the option exercise price of these options at the date of announcement of the acquisition. This amount is presented as a reduction of stockholders’ equity and is being amortized over the vesting period of the applicable options using an accelerated method of amortization. During the six months ended June 30, 2001 and 2002, we recorded none and $224,000, respectively, in additional reductions of this deferred compensation as a result of normal employee attrition. We recorded amortization of deferred compensation related to these options of $4.6 million and $527,000 during the six months ended June 30, 2001 and 2002, respectively.

In late 2001 and in the first half of 2002, in connection with the award of restricted stock to certain employees and officers, we recorded deferred compensation of $3.8 million, which represents the fair value of the underlying common stock at the date of grant. The restrictions on the stock lapse on various dates through February 16, 2004, subject to the continuous employment of the employees and officers with Neoforma through those dates. This amount is presented as a reduction of stockholders’ equity and will be amortized ratably over the period from the date of grant through the vesting date using the straight line method of amortization. We recorded amortization of deferred compensation related to these shares of $1.2 million during the six months ended June 30, 2002.

(Gain)/Loss on Divested Businesses. Gain/loss on divested businesses consists of the net gain or loss incurred as a result of the divestiture of the USL and FDI operations during the first half of 2001 and the divestiture of the NeoMD operations in the first half of 2002. The gain or loss on divested businesses is calculated by reducing the consideration paid to us for the divested operations by the net book value of all assets and liabilities transferred with the divested operations. The divestiture of USL in 2001 resulted in a gain of $500,000 on the sale of the net assets, and the divestiture of FDI resulted in a loss of $1.1 million on the sale of the net assets. The resulting net loss on divested businesses during the six months ended June 30, 2001 was $621,000. The divestiture of the NeoMD operations in the first quarter of 2002 resulted in a net gain of $65,000.

Other Income (Expense). Other income (expense) consists of interest and other income and expense. Interest income decreased from $479,000 for the six months ended June 30, 2001 to $247,000 for the six months ended June 30, 2002. The decrease in interest income was due to the decrease in our average net cash and cash equivalents balance as a result of our utilization of cash to fund our operations in fiscal 2001 and 2002. Interest expense increased from $618,000 for the six months ended June 30, 2001 to $1.4 million for the six months ended June 30, 2002. The increase in interest expense was due primarily to interest costs associated with our line of credit with VHA. Other expense was $211,000 for the six months ended June 30, 2001

In January 2000, we completed our initial public offering, or IPO, and issued 805,000 shares of our common stock at an initial public offering price of $130.00 per share. Net cash proceeds to us from the IPO were approximately $95.3 million. From our inception until our IPO, we financed our operations primarily through private sales of preferred stock through which we raised net proceeds of $88.5 million. We have also financed our operations through an equipment loan and lease financing facility and bank and other borrowings. As of June 30, 2002, we had outstanding bank, other borrowings and notes payable of $24.3 million, and we had $17.6 million of cash, cash equivalents and investments.

In April 2001, we entered into a $25 million revolving credit agreement with VHA. Under the credit agreement, as amended in February 2002, until May 31, 2003, we are able to borrow funds up to an amount based on a specified formula dependent on the gross volume of transactions through Marketplace@Novation. Funds that we borrow under this credit agreement bear interest at a rate of 10% per year and are secured by substantially all of our assets. All amounts outstanding under this line of credit, both principal and interest, are due and payable on May 31, 2003, if not repaid sooner. In the event that we (i) sell any of our stock as part of an equity financing, (ii) obtain funding in connection with a debt financing or other lending transaction that is either unsecured or subordinate to the lien of VHA under the credit agreement or (iii) enter into a debt financing or other lending transaction secured by assets we owned as of the date we entered into the credit agreement, then the maximum of $25 million we could potentially borrow under the credit agreement will be reduced by an amount equal to the cash proceeds we receive from any of these transactions. As of June 30, 2002, we had outstanding borrowings of $19.0 million under the line of credit and remaining available funds of $6.0 million.

In May 2001, we entered into a leasing facility with CapitalWerks, LLC, or CapitalWerks, to provide us with a $10.2 million lease line facility to finance the purchase of capital equipment, software and other assets. After several unsuccessful attempts by us to access the line of credit, on April 14, 2002, we sent to CapitalWerks notification of our termination of the line of credit agreement and a demand for repayment of the initial “access fee” we had paid to open the line of credit. We believe that CapitalWerks did not ever have any intention of fulfilling its obligations required under the line of credit agreement with us and therefore breached the agreement. We are actively engaged in efforts to obtain repayment of this “access fee” and accrued interest from CapitalWerks, which ultimately may involve the initiation of legal proceedings.

In July 1999, Comdisco provided us with a $2.5 million loan and lease facility to finance computer hardware and software equipment. Amounts borrowed to purchase hardware bear interest at 9% per annum and are payable in 48 monthly installments consisting of interest only payments for the first nine months and principal and interest payments for the remaining 36 months, with a balloon payment of the remaining principal payable at maturity. Amounts borrowed to purchase software bear interest at 8% per annum and are payable in 30 monthly installments consisting of interest only payments for the first four months and principal and interest payments for the remaining 26 months, with a balloon payment of the remaining principal payable at maturity. The computer equipment purchased with the proceeds of the loans secures this facility. In connection with this facility, we issued Comdisco a warrant to purchase 13,771 shares of our Series D preferred stock, which converted into 13,771 shares of our common stock upon the closing of our IPO, at an exercise price of $11.80 per share. As of June 30, 2002, we had outstanding borrowings of $663,000 under this facility.

In August 1999, in connection with the GAR acquisition, we issued a promissory note in the principal amount of $7.8 million payable monthly over five years bearing interest at a rate of 7% per year. In July 2001, we modified the terms of this promissory note in exchange for the release of the security interest the note holder had in the assets of our Auction operations. Per the revised terms of the note, we repaid $750,000 of the balance of the note in August 2001, and an additional $500,000 was cancelled by the note holder. The remaining balance due on the promissory note is to be paid in equal monthly installments, with interest accruing at 7% per year, over the subsequent 30 months. As of June 30, 2002, the outstanding balance on the note was $1.8 million.

In March 2000, we entered into an agreement with Ariba, Inc., or Ariba, under which we have the right to offer Ariba’s ORMX procurement solution to users of our marketplace. We paid Ariba a substantial upfront fee for use of the ORMX procurement solution and, under the terms of the agreement, we were to pay specified fees for transactions occurring through Ariba’s network, subject to minimum monthly amounts. The agreement also provided for joint marketing activities and sales planning. We are currently in dispute with Ariba with regards to the terms of the agreement and our obligations to make payments to Ariba. As of June 30, 2002, we have not accrued any amounts under this agreement.

In July 2000, in recognition for the advisory services rendered in connection with the terminated Healthvision and Eclipsys mergers, our outsourcing and operating agreement and our acquisition of EquipMD, we entered into a promissory note with our investment banker for these transactions in the amount of $6.0 million. The note was payable in quarterly payments of $1.5 million, commencing on January 1, 2001. In April 2001, we amended the terms of the note such that the remaining balance was payable in two installments: the first $2.0 million payable in May 2001 and the remaining $2.5 million payable in April 2002. At June 30, 2002, the remaining balance on the note was $2.5 million.

In July 2000, as part of the acquisition of certain assets of NCL, we issued a promissory note to each of the four principals of NCL in the amount of $62,500 each. These notes are payable in twenty-four equal monthly installments, with the first payment due on August 15, 2000. As of June 30, 2002, the total balance of the four notes was $10,000. In addition, as part of the acquisition, we also agreed to pay $250,000 on July 14, 2002, two years from the closing date of the acquisition. This payment is to be distributed in equal amounts of $62,500 to each of the four principals of NCL. As of June 30, 2002, no payments had been made against this commitment. In July 2002, all remaining balances were paid.

As discussed in Note 2 to the Notes to Unaudited Condensed Consolidated Financial Statements, we adopted EITF No. 01-9 effective January 1, 2002. As a result of the application of EITF No. 01-9, we have classified certain costs associated with equity consideration provided to VHA and UHC in connection with the Outsourcing Agreement as an offset against related party revenue from VHA, UHC and Novation. This treatment will result in the offset of non-cash amortization of partnership costs against related party revenue up to the lesser of such related party revenue or amortization of partnership costs in any period. Any amortization of partnership costs in excess of related party revenue in any period will continue to be classified as an operating expense, and will be reflected as an adjustment to reconcile net loss to cash from operating activities on the Unaudited Condensed Consolidated Statements of Cash Flows. Under EITF No. 01-9, we account for the fees being paid by Novation under the terms of the Outsourcing Agreement as if they were payments made for the equity consideration we provided to VHA and UHC as opposed to payments for services. As a result, these fees that are offset by amortization of partnership costs are reported as a cash flow from financing activities in our Unaudited Condensed Consolidated Statements of Cash Flows.

Net cash provided by financing activities was $30.1 million for the six months ended June 30, 2002 as compared to $39.8 million for the six months ended June 30, 2001. Net cash provided by financing activities for the six months ended June 30, 2002 related to fees received from VHA and UHC under the guaranteed minimum fee level provisions of the Amended Outsourcing Agreement, cash received related to options exercised, and proceeds from the issuance of common stock under our employee stock purchase plan, partially offset by repayments of notes payable.

We currently anticipate that our available funds, consisting of $17.6 million in cash and cash equivalents, combined with cash generated through our operations and funds available to us through our line of credit with VHA, will be sufficient to meet our anticipated needs for working capital, capital expenditures and the payment of the current portion of notes payable through at least the next 12 months. Our future long-term capital needs will depend significantly on the rate of growth of our business, the timing of expanded service offerings, the success of these services once they are launched and our ability to adjust our operating expenses to an appropriate level if the growth rate of our business is slower than expected. Buyers and suppliers of products and services used by healthcare providers might not accept our business model of providing Internet and electronic marketplaces for the purchase and sale of such products and services and,

as a result, we may not succeed in increasing our revenue to the extent necessary to be cash flow positive during 2002 and beyond. Any projections of future long-term cash needs and cash flows are subject to substantial uncertainty. If our available funds and cash generated from operations are insufficient to satisfy our long-term liquidity requirements, or if an event of default occurs under our credit agreement with VHA and we are required to repay all outstanding indebtedness under the credit agreement, we would need to seek additional sources of funding, such as selling additional equity or debt securities or obtaining additional lines of credit. We would also likely need to curtail expansion of our services, including reductions in our staffing levels and related expenses, or potentially liquidate selected assets. If our management decides that it is in our best interest to raise cash to strengthen our balance sheet, broaden our investor base, increase the liquidity of our stock or for any other reason, we may decide to issue equity or debt, even if all of our current funding sources remain available to us. If we issue additional securities to raise funds, those securities may have rights, preferences or privileges senior to those of the rights of our common stock and our stockholders may experience dilution. We cannot be certain that additional financing will be available to us on favorable terms when required, or at all.

In November 2001, the Emerging Issues Task Force reached a consensus on EITF Abstract No. 01-9, “Accounting for Consideration Given by Vendor to a Customer (Including a Reseller of the Vendor’s Products).” EITF No. 01-9 addresses whether consideration from a vendor to a reseller is (i) an adjustment of the selling prices of the vendor’s products and, therefore, should be classified as an offset against revenue when recognized in the vendor’s statement of operations or (ii) a cost incurred by the vendor for assets or services received from the reseller and, therefore, should be classified as a cost or expense when recognized in the vendor’s statement of operations. EITF No. 01-9 was required to be adopted no later than the first quarter of 2002 and upon adoption, companies were required to retroactively reclassify such amounts in previously issued financial statements to comply with the income statement classification requirements of EITF No. 01-9. On July 26, 2000, we issued equity consideration to VHA and UHC in connection with the Outsourcing Agreement. As a result of the application of EITF No. 01-9, we have reclassified certain costs associated with this equity consideration, historically classified as operating expenses, to an offset against related party revenue from those parties. This treatment will result in the classification of non-cash amortization of partnership costs as an offset against related party revenue, as opposed to being classified as an operating expense, up to the lesser of such related party revenue or amortization of partnership costs in any period. The adoption of EITF No. 01-9 resulted in a reduction of reported amortization of partnership costs and related party revenue by approximately $3.8 million and $17.2 million for the three months ended June 30, 2001 and 2002, respectively, and $5.8 million and $31.2 million for the six months ended June 30, 2001 and 2002, respectively. As reclassifications, these changes had no impact on our loss from operations, net loss, net loss per share or total cash flow. See Note 2 to the Notes to Unaudited Condensed Consolidated Financial Statements for further discussion of the application of EITF No. 01-9.

In July 2001, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standard, or SFAS, No. 142, “Goodwill and Other Intangible Assets,” which became effective for fiscal years beginning after December 15, 2001. SFAS No. 142 addresses financial accounting and reporting for acquired goodwill and other acquired intangible assets. It addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. SFAS No. 142 also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. Under SFAS No. 142, goodwill and certain other acquired intangible assets with indefinite lives are no longer subject to amortization. Intangible assets with finite lives will continue to be amortized over those lives. The adoption of this pronouncement did not have a significant impact on our financial position, results of operations or cash flows.

In August 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 addresses significant issues relating to the implementation of SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,” and requires that long-lived assets that are to be disposed of by sale be measured at the lower of book value or fair value less cost to sell. Additionally, SFAS No. 144 expands the scope of discontinued operations to include all components of an entity with operations that (1) can be distinguished from the rest of the entity and (2) will be eliminated from the ongoing operations of the entity in a disposal transaction. SFAS No. 144 became effective for fiscal years beginning after December 15, 2001 and its provisions are to be applied prospectively. The adoption of this pronouncement in 2002 did not have a significant impact on our financial position, results of operations or cash flows.

In April 2002, the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.” SFAS No. 145 rescinds SFAS No. 4, which required all gains and losses from extinguishment of debt to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. As a result, the criteria in Accounting Principles Board Opinion No. 30 will now be used to classify those gains and losses. SFAS No. 145 also amends SFAS No. 13 to require that certain lease modifications that have economic effects similar to sale-leaseback transactions be accounted for in the same manner as sale-leaseback transactions. We do not expect the adoption of SFAS No. 145 to have a significant impact on our financial position, results of operations and cash flows.

In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies EITF Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” SFAS No. 146 requires that a liability for costs associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002. We do not expect the adoption of SFAS No. 146 to have a significant impact on our financial position, results of operations and cash flows.

We have focused our efforts on building and operating Internet and electronic marketplaces that aggregate buyers and suppliers of products and services used by healthcare providers, including medical supplies and equipment. This business model is new and unproven and depends upon buyers and sellers in this market adopting a new way to purchase and sell products and services. If buyers and sellers of products and services used by healthcare providers do not accept our business model, demand for our applications and services may not develop as we expect and the price of our common stock could decline. Some buyers and suppliers could be reluctant to accept our relatively new and unproven approach, which may not be consistent with their existing internal organization and procurement processes. Some buyers and suppliers may prefer to use traditional methods of buying and selling products and services, such as using paper catalogs and interacting in person or by phone with representatives of manufacturers or distributors.

We have experienced losses from operations in each period since our inception, including a net loss of $44.0 million for the six months ended June 30, 2002. In addition, as of June 30, 2002, we had an accumulated deficit of $585.5 million. We have not achieved profitability, and we expect to continue to incur substantial operating losses in future quarters, primarily as a result of increases in costs and expenses relating to executing our strategy of building and operating Internet marketplaces for our trading partners. We will not achieve profitability unless we are able to significantly increase our revenue while adequately controlling our operating expenses, and we cannot assure you that we will ever be profitable.

In addition, as a result of our limited operating history, the emerging nature of our market and the evolving nature of our business model, we have had difficulty accurately forecasting our revenue. We incur expenses based predominantly on operating plans and estimates of future revenue. Our expenses are to a large extent fixed. We may be unable to adjust our spending in a timely manner to compensate for any unexpected revenue shortfalls. Accordingly, a failure to meet our revenue projections would have an immediate and negative impact on operating results.

We expect to rely significantly on our relationship with Novation and, to a lesser extent, our relationship with Medbuy Corporation, or Medbuy, along with other strategic allies such as GHX, to bring buyers and suppliers to our marketplaces. Under our Amended Outsourcing Agreement, Novation is our exclusive agent for signing up suppliers to participate in Marketplace@Novation, subject to limited exceptions. Accordingly, we rely on Novation to attract suppliers to Marketplace@Novation and, if Novation is unable to attract a sufficient number of suppliers, the value of Marketplace@Novation to buyers will be substantially decreased and our business will suffer. Novation currently requires suppliers to participate in Marketplace@Novation as a requirement to sell contracted products to hospitals served by Novation. If Novation ceases to require Marketplace@Novation participation as a contract requirement, our ability to recruit suppliers to Marketplace@Novation may be seriously harmed. We expect to rely significantly on VHA, UHC and Medbuy to recruit and retain providers to our marketplaces. These partners use a variety of marketing initiatives and financial incentives to drive adoption and use of our marketplaces by healthcare providers. If these partners cease using such marketing initiatives and financial incentives our ability to recruit healthcare providers to our marketplaces also may be seriously harmed.

We believe that we must establish relationships with GPOs in addition to Novation to increase our ability to build new marketplaces. GPOs represent groups of buyers in the negotiation of purchasing contracts with sellers and, consequently, have the ability to significantly influence the purchasing decisions of their members. Our relationship with Novation could make it more difficult to attract other GPOs to engage our services. The inability to enter into and maintain favorable relationships with other GPOs and the hospitals they represent could impact the breadth of our customer base and could harm our growth and revenue. One of the largest GPOs, Premier Inc., has a long-term, exclusive agreement for e-commerce services with one of our competitors, medibuy.com, Inc.

If we do not maintain and expand the functionality and reliability of our marketplaces, buyers and suppliers of products used by healthcare providers may not use our marketplaces. We must continue to develop the capability to integrate our marketplaces with enterprise software systems used by many suppliers of products and by many large healthcare organizations. We may incur significant expenses in developing these capabilities and may not succeed in developing them in a timely manner. In addition, developing the capability to integrate our marketplaces with suppliers’ and buyers’ enterprise software systems will require the continued cooperation of and collaboration with the companies that develop and market these systems. Suppliers and buyers use a variety of different enterprise software systems provided by third-party vendors or developed internally. This lack of uniformity increases the difficulty and cost of developing the capability to integrate with the systems of a large number of suppliers and buyers. Failure to provide these capabilities would limit the efficiencies that our marketplaces provide and may deter many buyers and suppliers from using our marketplaces, particularly large healthcare organizations.

If we were delayed or unable to integrate the systems of these organizations, our financial situation would be adversely affected. In addition, under our agreements with Novation and Medbuy, we must meet detailed functionality and service level requirements. To the extent we are unable to or are delayed in providing this functionality, we may be unable to attract buyers and suppliers to our marketplaces, and our financial situation may be adversely affected. We incur significant costs in providing functionality to our marketplaces and in integrating buyers and suppliers to our marketplaces, and we may never generate sufficient revenue to offset these costs.

We have processed a limited number and variety of transactions on our marketplaces compared to the number and variety we expect to process in the future. Our systems may not accommodate increased use while providing acceptable overall performance. We must continue to expand and adapt our network infrastructure to accommodate additional trading partners and increased marketplace volumes, which will be expensive. If our systems do not continue to provide acceptable performance as use of our marketplaces increases, our reputation may be damaged and we may lose trading partners that use our marketplaces.

We expect that a significant portion of the products to be sold through and fees to be generated from our marketplaces will come from a limited number of key manufacturers and distributors or as a result of purchases made from these manufacturers and distributors. If any of these key manufacturers or distributors cease doing business with us, the fees we generate through our marketplaces would be significantly reduced. Our supplier agreements are nonexclusive and, accordingly, these suppliers can sell their products, supplies and equipment to buyers directly or through our competitors.

We may decide that it would be in our best interests to make acquisitions to acquire new technologies, expand our product offering or for other reasons. Integrating newly acquired organizations and technologies into our company could be expensive, time consuming and may strain our resources. In addition, we may lose current users of our marketplaces if any acquired companies have relationships with competitors of our users. Consequently, we may not be successful in integrating any acquired businesses or technologies and may not achieve anticipated revenue and cost benefits. In addition, future acquisitions could result in potentially dilutive issuances of equity securities or the incurrence of debt, contingent liabilities or amortization expenses related to intangible assets, any of which could harm our business.

We have undertaken to enter product information into our database and categorize the information for search purposes. If we do not do so in a timely manner, we will encounter difficulties in expanding our marketplaces. Timely entering of this information in our database depends upon a number of factors, including the format of the data provided to us by suppliers and our ability to accurately enter the data in our product database, any of which could delay the actual entering of the data. If we fail to input data accurately, our reputation could be damaged, we could lose users of our marketplaces, and we may incur liability.

Our current and potential competitors’ services may achieve greater market acceptance than ours. Our existing and potential competitors may have longer operating histories in the healthcare supply chain market, greater name recognition, larger customer bases or greater financial, technical and marketing resources than we do. As a result of these factors, our competitors and potential competitors may be able to respond more quickly to market forces, undertake more extensive marketing campaigns for their brands and services and make more attractive offers to buyers and suppliers, potential employees and strategic partners. In addition, new technologies may increase competitive pressures. We cannot be certain that we will be able to expand our buyer and supplier base or retain our current buyers and suppliers. We may not be able to compete successfully against our competitors, and competition could seriously harm our revenue, gross margins and market share.

Our business strategy includes entering into strategic alliances with leading technology and healthcare-related companies to increase the number of marketplaces we build and operate, increase the number of trading partners that utilize our marketplaces, increase the number and variety of products and services that we offer and provide additional functionality, services and content to our trading partners. We may not succeed in entering into new strategic alliances, and even if we do succeed, we may not achieve our objectives through these alliances. For example, we are currently in discussions with Medbuy to restructure our relationship and our strategy in the Canadian marketplace, and we may not succeed in restructuring this relationship in a manner that is satisfactory to us. In addition, we have not yet succeeded in establishing new strategic alliances to increase the number of marketplaces that we build and operate. Our alliances do not, and future relationships may not, afford us any exclusive marketing or distribution rights.

Many of these companies have multiple relationships and they may not regard us as significant for their business. These companies may pursue relationships with our competitors or develop or acquire services that compete with our services. In addition, in many cases these companies may terminate these relationships with little or no notice. If any existing alliance is terminated or we are unable to enter into new alliances with leading technology and healthcare-related companies, we may be unable to increase the attractiveness of our marketplaces or provide satisfactory services to buyers and suppliers of products and services.

If suppliers do not provide us in a timely manner with accurate, complete and current information about the products they offer, promptly update this information when it changes and provide us with accurate and timely invoicing data, our database will be less useful to buyers. We cannot guarantee that the product information available from our marketplaces will always be accurate, complete and current, or that it will comply with governmental regulations. This could expose us to liability if this incorrect information harms users of our services or results in decreased adoption and use of our marketplaces. We also rely on suppliers using our marketplaces to comply with all applicable governmental regulations, including packaging, labeling, hazardous materials, health and environmental regulations and licensing and record keeping requirements. Any failure of our suppliers to comply with applicable regulations could expose us to civil or criminal liability or could damage our reputation.

Some participants in our marketplaces are our stockholders or are affiliated with our stockholders or have strategic relationships with us. For example, VHA and UHC, the owners of Novation, own approximately 5.8 million and 1.7 million shares of our common stock, respectively. In addition, VHA and UHC own approximately 3.1 million shares and 0.6 million shares, respectively, of restricted common stock which was subject to restrictions upon issuance, and of which a portion is still subject to those restrictions. These relationships may deter other GPOs, suppliers or users, particularly those that compete directly with these participants, from participating in our marketplaces due to perceptions of bias in favor of one party over another. This could limit the number of marketplaces we operate, the array of products offered on our marketplaces, damage our reputation and limit our ability to maintain or increase the number of our trading partners.

We have grown rapidly and will need to continue to grow our business to execute our strategy. Our total number of employees grew from six as of December 31, 1997 to 205 as of June 30, 2002, although the number of employees has not grown consistently. For example, in May 2000, we reduced the number of our employees from approximately 330 to approximately 250. These changes, and the growth in the number of our trading partners and marketplace volume through our marketplaces, have placed significant demands on management as well as on our administrative, operational and financial resources and controls. Any future growth or organizational changes would likely cause similar, and perhaps increased, strain on our systems and controls.

In July 2001, we were named as a defendant in two securities class action lawsuits filed in federal court in the Southern District of New York relating to our IPO by stockholders who purchased our common stock during the period from January 24, 2000, to December 6, 2000. Since that time, additional lawsuits have been filed asserting federal securities claims arising from our IPO. The lawsuits also name certain of the underwriters, Merrill Lynch, Pierce, Fenner & Smith, Bear Stearns, and Fleet Boston Robertson Stephens, as well as our Chairman and CEO and our former CFO, as defendants. The lawsuits contain substantially identical allegations, which are that the prospectus and the registration statement for the IPO failed to disclose that the underwriters solicited and received excessive commissions from investors, and that some investors in the IPO agreed to buy more shares of our common stock in the secondary market, at predetermined prices, in a scheme to artificially inflate the price of our common stock. Although we believe that the claims made against us and our current and former employees in these suits are without merit, they could be time-consuming, costly to defend and require us to pay significant damages.

The performance of our server and networking hardware and software infrastructure is critical to our business and reputation and our ability to process transactions, provide high quality customer service and attract and retain users of our services. Currently, our infrastructure and systems are located at one site with Exodus, a division of Cable and Wireless Plc, in Sunnyvale, California, which is an area susceptible to earthquakes. We also have a fail-over system for marketplace transaction processing located in Atlanta, Georgia.

A significant barrier to the widespread adoption of e-commerce is the secure transmission of personally identifiable information of Internet users as well as other confidential information over public networks. If any compromise or breach of security were to occur, it could harm our reputation and expose us to possible liability. We support encrypted communications protocols and encrypt certain information on our servers to protect user information during transactions, and we employ a security consulting firm that periodically tests our security measures. Despite these efforts, a party may be able to circumvent our security measures and could misappropriate proprietary information or cause interruptions in our operations. We may be required to make significant expenditures to protect against security breaches or to alleviate problems caused by any breaches and under certain contracts with marketplace participants would be liable for contractual damages due to security breaches.

We expect to derive a portion of our future revenue from information services that require the aggregation and blinding of transaction and supply chain data from our marketplace participants. To execute on our data services strategy, we must be able to secure the consent of our marketplace participants to various uses of their transaction and supply chain data. To secure such consent, we must be able to assure our marketplace participants that we will at all times protect the confidentiality of their transaction and supply chain data. If we are unable to provide such assurance, or if we fail to meet the levels of assurance provided, our ability to execute on our data services strategy may be seriously impaired.

We may from time to time be subject to claims of infringement of other parties’ proprietary rights or claims that our own trademarks, patents or other intellectual property rights are invalid. Any claims regarding our intellectual property, with or without merit, could be time consuming and costly to defend, divert management attention and resources or require us to pay significant damages. License agreements may not be available on commercially reasonable terms, if at all. In addition, there has been an increase in the number of patent applications related to the use of the Internet to perform business processes. Enforcement of intellectual property rights in the Internet sector will become a greater source of risk as the number of business process patents increases. The loss of access to any key intellectual property right, including use of the Neoforma brand name, could result in our inability to operate our current business.

We currently rely on software that we have licensed from a number of suppliers. We will continue to rely on commercial software vendors where appropriate to speed the delivery of our solutions, while reducing the costs of custom code development and maintenance. These licenses may not continue to be available to us on commercially reasonable terms, or at all. In addition, the licensors may not continue to support or enhance the licensed software. In the future, we expect to license other third party technologies to enhance our services, to meet evolving user needs or to adapt to changing technology standards.

We are subject to federal and state laws regulating the receipt, storage and distribution of healthcare information, which could have a material adverse effect on our ability to operate our business. Laws governing the receipt, storage and distribution of health information exist at both the federal and state level. The Health Insurance Portability and Accountability Act, or HIPAA, of 1996 and the implementing regulations from the Department of Health and Human Services, or HHS, mandate the use of standard transactions and identifiers, prescribed security measures and other provisions by April 2003. Certain regulations of the Food and Drug Administration, or FDA, and the Hospital Conditions of Participation for the Medicare and Medicaid programs require protection of and security for health information and appropriate patient access to such information. Some of the transactions at our marketplaces may involve surgical case kits or purchases of products for patient home delivery; these products may contain patient names and other health information subject to these laws governing the receipt, storage and distribution of health information.

It may be expensive to implement security or other measures designed to comply with the HIPAA, FDA and Medicare confidentiality and security requirements or with any new legislation or regulations. Moreover, these and future laws may restrict or prevent us from delivering health information electronically. If we fail to comply with these regulatory requirements, we could face a variety of civil fines and liabilities, associated costs of defense, increased costs of security, and costs of compliance with confidentiality requirements. We may also be required to significantly curtail our use of data received, stored or distributed by our marketplaces. In addition, because we represent that our marketplaces meet these regulatory requirements, our success will also depend on other healthcare participants complying with these regulations.

A federal law commonly known as the Medicare/Medicaid anti-kickback law, and several similar state laws, prohibit payments that are intended to induce the acquisition, arrangement for or recommendation of the acquisition of healthcare products or services. The application and interpretation of these laws are complex and difficult to predict and could constrain our financial and marketing relationships, including but not limited to our fee arrangements with suppliers or our ability to obtain supplier company sponsorship for our products. The GPO industry is currently being subjected to a “limited scope” audit by the HHS Office of Inspector General to determine compliance with the Medicare/Medicaid anti-kickback law. Because anything detrimental to the core business of our GPO and trading partners could adversely impact our business, negative substantive findings by any of these or future investigations could potentially adversely affect our business. In particular, violations of these fraud and abuse laws are punishable by civil and criminal fines and penalties, which could result in restrictions on our operations, increased costs of compliance with remedies and require us to restructure our financial arrangements with our GPO and trading partners.

The healthcare industry is highly regulated and is subject to changing political, economic and regulatory influences. Regulation of the healthcare organizations with which we do business could impact the way in which we are able to do business with these organizations. In addition, factors such as changes in the laws described above regarding the regulation of healthcare information and the laws and policies governing reimbursement for healthcare expenses affect the purchasing practices and operation of healthcare organizations. Changes in regulations affecting the healthcare industry, such as any increased regulation by HHS, the Justice Department or the FDA of healthcare information or the purchase and sale of products used by healthcare providers could require us to make unplanned enhancements of our services, or result in delays or cancellations of orders or reduce demand for our services. Federal and state legislatures have periodically considered programs to reform or amend the U.S. healthcare system at both the federal and state level. These programs may contain proposals to increase governmental involvement in healthcare, lower reimbursement rates or otherwise change the environment in which healthcare industry providers, including GPOs and companies such as us, operate. The New York Times has published a series of articles critical of the GPO industry, and a subcommittee of the United States Senate Judiciary Committee held a hearing on April 30, 2002 regarding possible abuses by the GPO industry. The New York Times articles and the Senate hearings focused on whether the contracting strategies and processes used by GPOs unfairly disadvantage smaller suppliers and whether the fees paid by suppliers and the financial interests of the GPOs and their executives in suppliers create conflicts of interest. The Senate Judiciary

Committee has indicated a desire to form a panel of industry experts to develop industry guidelines for these areas of concern, and members of the Senate Judiciary Committee have also asked the Justice Department to examine GPO compliance with antitrust laws. We do not know what effect these articles and Senate Judiciary Committee actions will have on our business, but because anything detrimental to the core business of our GPO partners could adversely impact our business, negative substantive findings by the Senate Judiciary Committee, the Justice Department or other regulatory and enforcement bodies could potentially adversely affect our business and consequently our stock price.

A number of legislative and regulatory proposals under consideration by federal, state, local and foreign governmental organizations may lead to laws or regulations concerning various aspects of the Internet, such as user privacy, taxation of goods and services provided over the Internet and the pricing, content and quality of services. Legislation could dampen the growth in Internet usage and decrease or limit its acceptance as a communications and commercial medium. If enacted, these laws and regulations could limit the market for our services. In addition, existing laws could be applied to the Internet, including consumer privacy laws. Legislation or application of existing laws could expose companies involved in e-commerce to increased liability, which could limit the growth of e-commerce.

In July 2002, Nasdaq proposed certain rule changes in connection with the recent, widely publicized corporate governance reform initiatives. Those rule changes have not yet been adopted, and it is currently uncertain whether they will be adopted in the form proposed or modified prior to adoption. But, if they were adopted in their currently proposed form today, and no temporary relief from their application or phase-in time period during which to come into compliance were provided, we would be out of compliance with certain requirements of the rules, including, but not limited to, the requirement that (i) a majority of the Board of Directors be independent, and (ii) the audit committee have at least three independent directors. There is a risk that we will not be able to recruit the requisite number of qualified directors to satisfy the new rules, and failure to do so, or to comply more generally with such new rules, could result in our delisting from Nasdaq, which could materially impair stockholders’ ability to engage in transactions involving our stock and impair the liquidity of our stock.

Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio. We do not use derivative financial instruments in our investment portfolio. We invest in high-credit quality issuers and, by policy, limit the amount of credit exposure to any one issuer. As stated in our investment policy, we ensure the safety and preservation of our invested principal funds by limiting default risk, market risk and reinvestment risk. We mitigate default risk by investing in safe and high-credit quality securities and by constantly positioning our portfolio to respond appropriately to a significant reduction in a credit rating of any investment issuer, guarantor or depository. The portfolio includes only marketable securities with active secondary or resale markets to ensure portfolio liquidity.

In July 2001, we, along with Merrill Lynch, Pierce, Fenner & Smith, Bear Stearns and FleetBoston Robertson Stephens (certain of the underwriters of our IPO) as well as our Chairman and Chief Executive Officer, Robert Zollars, and our former Chief Financial Officer, Frederick Ruegsegger, were named as defendants in two securities class action lawsuits filed in federal court in the Southern District of New York (No. 01 CV 6689 and No. 01 CV 6712) on behalf of those who purchased stock from January 24, 2000 to December 6, 2000. These actions have since been consolidated, and a consolidated amended complaint was filed in the Southern District of New York on April 24, 2002. The amended complaint alleges that the underwriters solicited and received “undisclosed compensation” from investors in exchange for allocations of stock in our IPO, and that some investors in the IPO allegedly agreed with the underwriters to buy additional shares in the aftermarket in order to artificially inflate the price of our stock. We and our officers are named in the suits pursuant to Section 11 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5 promulgated thereunder, for allegedly failing to disclose in our IPO registration statement and prospectus that the underwriters had entered into the arrangements describe above. The complaints seek unspecified damages. Approximately 300 other issuers and their underwriters have had similar suits filed against them, all of which are included in a single coordinated proceeding in the Southern District of New York. We intend to defend against this action vigorously.

On January 11, 2002, we filed suit against Med XS Solutions, Inc. and Med-XS Asset Services, Inc., or Med-XS, in the United States District Court, Northern District of Illinois, Eastern Division (No. 02C 0295) for the failure of Med-XS to make payments under a $2.4 million promissory note. Med-XS executed the promissory note as partial payment for the purchase of assets of our subsidiary, Neoforma GAR, Inc., which had provided Auction services. Prior to filing of the suit, we had accelerated all principal payments under the promissory note, due to Med-XS’s failure to make scheduled payments under the promissory note, and made demand to Med-XS for the entire $2.4 million. Defendants have made a counterclaim to the suit, alleging breach of contract and fraud. We have answered to the counterclaims and are currently in the process of discovery. While we believe that our suit ultimately will be successful, litigation is inherently uncertain and we cannot assure you that we will prevail in this matter.

Delaware		77-0424252
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

3061 Zanker Rd., San Jose, CA		95134
(Address of principal executive offices)		(Zip code)

		Page

PART I.	FINANCIAL INFORMATION	3

ITEM 1.	Unaudited Condensed Consolidated Financial Statements:

	Unaudited Condensed Consolidated Balance Sheets as of June 30, 2002 and December 31, 2001	3

	Unaudited Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2002 and 2001	4

	Unaudited Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2002 and 2001	5

	Notes to Unaudited Condensed Consolidated Financial Statements	7

ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	13

ITEM 3.	Quantitative and Qualitative Disclosures About Market Risk	38

PART II.	OTHER INFORMATION	39

ITEM 1.	Legal Proceedings	39

ITEM 2.	Changes in Securities and Use of Proceeds	39

ITEM 3.	Defaults Upon Senior Securities	39

ITEM 4.	Submission of Matters to a Vote of Security Holders	39

ITEM 5.	Other Information	39

ITEM 6.	Exhibits and Reports on Form 8-K	40

SIGNATURES		41

Nominee	For	Withheld	Unvoted
Richard D. Helppie	16,785,843	21,885	1,761,632
C. Thomas Smith	16,785,843	21,885	1,761,632
Robert J. Zollars	16,699,729	107,999	1,761,632

Date: August 28, 2002	NEOFORMA, INC.

	By:	/s/ ANDREW L. GUGGENHIME
		Andrew L. Guggenhime Chief Financial Officer and Secretary

	Fiscal Years
	2002			2003	2004	2005	2006
Cash equivalents and short-term investments:
Fixed rate short-term investments	$	3,005		—	—	—	—
Average interest rate		1.82	%	—	—	—	—