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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q  

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934  

For the quarterly period ended September 30, 2002  

Commission File Number 000-26881  

E.PIPHANY, INC.

Delaware		77-0443392
(State of incorporation)		(I.R.S. Employer Identification Number)

 

1900 South Norfolk Street, Suite 310
San Mateo, California 94403

(650) 356-3800

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

     The number of shares outstanding of the registrant’s common stock, par value $0.0001 per share, as of October 31, 2002, was 72,784,392.

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E.PIPHANY, INC.

QUARTERLY REPORT ON FORM 10-Q
QUARTER ENDED SEPTEMBER 30, 2002

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PART I:    FINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS

E.PIPHANY, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of the condensed consolidated financial statements.

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E.PIPHANY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

The accompanying notes are an integral part of the condensed consolidated financial statements.

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E.PIPHANY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

The accompanying notes are an integral part of the condensed consolidated financial statements.

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E.PIPHANY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.    Basis of Presentation

     The condensed consolidated financial statements included herein have been prepared by E.piphany, Inc. (hereafter “E.piphany” or the “Company”), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). The condensed consolidated balance sheet as of December 31, 2001 is derived from audited consolidated financial statements. Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. However, E.piphany believes that the disclosures are adequate to make the information presented not misleading. These condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto included in E.piphany’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001, filed with the SEC on March 6, 2002.

     The unaudited condensed consolidated financial statements included herein reflect all adjustments (which include only normal, recurring adjustments) which are, in the opinion of management, necessary to state fairly the financial position of E.piphany and its subsidiaries as of September 30, 2002, and the results of operations for the three and nine months ended September 30, 2002 and 2001 and cash flows for the nine months ended September 30, 2002 and 2001. Certain prior period balances have been reclassified to conform to the current period presentation. The results for the three and nine months ended September 30, 2002 are not necessarily indicative of the results expected for the full fiscal year.

2.    Summary of Significant Accounting Policies

Principles of Consolidation

     The consolidated financial statements include the accounts of E.piphany and its subsidiaries. As of September 30, 2002, the Company held 90% of the capital stock of its subsidiary, Nihon E.piphany, K.K. The Company maintains an ownership percentage of 100% for all other subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.

Foreign Currency Translation

     The functional currency of our foreign subsidiaries is the local currency. The Company translates the assets and liabilities of international non-U.S. functional currency subsidiaries into dollars at the current rates of exchange in effect at the end of each period. Revenues and expenses are translated using rates that approximate those in effect during the period. Gains and losses from translation adjustments are reflected in stockholders’ equity in the condensed consolidated balance sheets under the caption “Accumulated other comprehensive losses.” Currency transaction gains or losses, derived on monetary assets and liabilities stated in a currency other than the functional currency, are recognized in current operations and have not been significant to the Company’s operating results in any period. The effect of foreign currency rate changes on cash and cash equivalents has not been significant in any period.

Cash Equivalents, Short-Term Investments and Long-Term Investments

     The Company considers all highly liquid investments with an original maturity of 90 days or less at the date of purchase to be cash equivalents. The Company has classified its short-term and long-term investments as “available for sale.” Short-term investments generally consist of highly liquid securities that the Company intends to hold for more than 90 days but less than 1 year. Long-term investments generally consist of securities that the Company intends to hold for more than one year. Such investments are carried at fair value with unrealized gains and losses reported within accumulated other comprehensive losses. Realized gains and losses and declines in value which are determined to be other-than-temporary on available-for-sale securities are included in other income, net. From time to time, we are required to obtain letters of credit that serve as collateral for our obligations to third parties under

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facility lease agreements. These letters of credit are secured by cash, cash equivalents, short-term investments and long-term investments. As of September 30, 2002, we had $9.3 million securing letters of credit, which are classified as restricted cash in the accompanying condensed consolidated balance sheet, and all of which relate to facility lease agreements that have expiration dates greater than twelve months.

Comprehensive Income (Loss)

     In June 1997, the FASB issued SFAS No. 130, “Reporting Comprehensive Income,” which E.piphany adopted beginning on January 1, 1998. SFAS No. 130 establishes standards for reporting and the display of comprehensive income and its components in a full set of general-purpose financial statements. The objective of SFAS No. 130 is to report “comprehensive income (loss),” the measure of all changes in equity of an enterprise that results from transactions and other economic events of the period other than transactions with stockholders. Comprehensive income (loss) equals the total of net income (loss) and all other non-owner changes in equity.

     The components of comprehensive losses are as follows (in thousands):

Use of Estimates in Preparation of Financial Statements

     The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the accompanying condensed consolidated financial statements. Actual results could differ from those estimates.

Impairment of Long-Lived Assets and Identifiable Intangible Assets

     The Company evaluates long-lived assets and certain identifiable intangibles, excluding goodwill, for impairment on a periodic basis and whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair market value.

Revenue Recognition

     E.piphany recognizes revenue as follows:

     Licenses. Licenses fees are recognized as revenue upon contract execution, provided all delivery obligations have been met, fees are fixed or determinable and collection is probable. We consider all arrangements with payment terms extending beyond six months to not be fixed and determinable, and revenue is recognized as payments become due from the customer. If collection is not considered probable, revenue is recognized when the fee is collected. The Company uses the residual method to recognize revenue when a license agreement includes one or more elements to be delivered at a future date and vendor specific objective evidence of the fair value of all undelivered elements exists. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is recognized as revenue. If vendor specific objective evidence does not exist to allocate the total fee to all delivered and undelivered elements of the arrangement, revenue is deferred until the earlier of the time at which (1) such evidence does exist for the undelivered elements, or (2) all elements are delivered. Fees from license agreements that include the right to receive unspecified future products are recognized over the term of the arrangement or, if the term is not specified, the estimated economic life of the product. When we receive license fees from resellers, we recognize revenue when the above criteria have been met and we receive persuasive evidence that the reseller has sold the subject licenses through to the end-user.

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     When licenses are sold together with consulting and implementation services, license fees are recognized upon delivery, provided that (1) the criteria set forth in the above paragraph have been met, (2) payment of the license fees is not dependent upon the performance of the consulting and implementation services, and (3) the services are not essential to the functionality of the software. For arrangements that do not meet the above criteria, both the product license revenues and services revenues are recognized under the percentage of completion contract method in accordance with the provisions of Statement of Position 81-1, “Accounting for Performance of Construction Type and Certain Production Type Contracts” (“SOP 81-1”). To date, when E.piphany has been primarily responsible for the implementation of the software, services have been considered essential to the functionality of the software products, and therefore, license and service revenues have been recognized pursuant to SOP 81-1. Prior to 2001, E.piphany was primarily responsible for the implementation services with respect to the majority of its license arrangements. During 2001 and 2002, third-party consulting organizations have been primarily responsible for the implementation services with respect to the majority of E.piphany’s license arrangements, and therefore, less license revenues have been recognized pursuant to SOP 81-1.

     Maintenance Agreements. Maintenance agreements generally require E.piphany to provide technical support and unspecified software updates to customers. Revenue derived from technical support and software updates is recognized ratably over the term of the maintenance agreement and is included in services revenue in the accompanying condensed consolidated statements of operations.

     Consulting, Implementation and Training Services. E.piphany provides consulting, implementation and training services to its customers. Revenue from such services is generally recognized as the services are performed.

Accounts Receivable and Deferred Revenue

     Accounts receivable consists of amounts due from customers for which revenue has been recognized. Deferred revenue consists of amounts received from customers for which revenue has not been recognized. Deferred license revenue is recognized upon delivery of our product, as services are rendered, or as other requirements requiring deferral are satisfied. Deferred maintenance revenue is recognized ratably over the term of the maintenance agreement and deferred services revenue is recognized as services are rendered.

Concentration of Credit Risk and Significant Customers

     The Company’s customers are primarily based in Asia, Australia, Canada, Europe, Latin America and the United States. The Company performs credit evaluations of its prospective customers and generally does not require collateral on accounts receivable. The Company maintains reserves for potential credit losses; historically, such reserves have been adequate to cover actual losses incurred. No individual customer account receivable balance accounted for more than 10% of our accounts receivable as of December 31, 2001 or September 30, 2002.

     Revenue comprising more than 10% of total amounts by customers is as follows:

Recent Accounting Pronouncements

     In June 2001, the Financial Accounting Standards Board (“FASB”) approved for issuance Statement of Financial Accounting Standard No. 141 “Business Combinations” (“SFAS 141”) and No. 142 “Goodwill and Other Intangible Assets” (“SFAS 142”). Major provisions of these statements are as follows: (1) all business combinations initiated after June 30, 2001 must use the purchase method of accounting; the pooling of interest method of accounting is prohibited except for transactions initiated before July 1, 2001, (2) intangible assets acquired in a business combination must be recorded separately from goodwill if they arise from contractual or other legal rights or are separable from the acquired entity and can be sold, transferred, licensed, rented or exchanged, either individually or as part of a related contract, asset or liability, (3) goodwill and intangible assets with indefinite lives are not amortized but are tested for impairment periodically using a fair value approach, except in certain circumstances,

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and whenever there is an impairment indicator; other intangible assets will continue to be valued and amortized over their estimated lives, (4) in-process research and development will continue to be written off immediately, (5) all acquired goodwill must be assigned to reporting units for purposes of impairment testing and segment reporting, and (6) effective January 1, 2002, existing goodwill was no longer subject to amortization.

     The Company adopted the provisions of SFAS 141 and SFAS 142 as of January 1, 2002. Beginning on January 1, 2002, unamortized goodwill and other intangible assets were subject to new accounting pronouncements SFAS 141 and SFAS 142. As a result, acquired goodwill and other intangible assets with indefinite useful lives were no longer amortized, but will continue to be subject to impairment tests on an annual basis, and on an interim basis in certain circumstances. SFAS 142 also requires the completion of a transitional impairment test, with any impairment treated as a cumulative effect of a change in accounting principle. The Company completed the transitional impairment test upon adoption, which did not result in an impairment charge. The Company has not recorded any impairment charge during the nine months ended September 30, 2002. The Company plans to complete an annual impairment test during the fourth quarter of 2002. We have recorded significant impairment charges in the past and to the extent that events or circumstances cause our assumptions to change, additional charges, which could be material, may be required.

     In November 2001, the Emerging Issues Task Force (“EITF”) reached consensus on EITF No. 01-09, “Accounting for Consideration Given by a Vendor to a Customer or a Reseller of the Vendor’s Products.” EITF No. 01-09 addresses the accounting for consideration given by a vendor to a customer and is a codification of EITF No. 00-14, “Accounting for Certain Sales Incentives,” EITF No. 00-22 “Accounting for ‘Points’ and Certain Other Time-Based or Volume-Based Sales Incentives Offers and Offers for Free Products or Services to be Delivered in the Future” and EITF No. 00-25, “Vendor Income Statement Characterization of Consideration Paid to a Reseller of the Vendor’s Products.” The adoption of these EITF statements did not have a material effect on our financial position or results of operations.

     In November 2001, the staff of the FASB reached consensus on Topic No. D-103, entitled “Income Statement Characterization of Reimbursements Received for Out of Pocket Expenses Incurred” (“Topic D-103”). This topic addresses whether reimbursements received for out of pocket expenses incurred should be characterized in the income statement as revenue or as a reduction of expenses incurred. The staff of the FASB concluded that reimbursements received for out of pocket expenses incurred should be characterized as revenue in the income statement. Prior to January 1, 2002, we recorded reimbursements as a reduction of cost of services revenues. Beginning in the first quarter of 2002, we have adopted Topic D-103 and have recorded reimbursable expenses as services revenue. For all comparative periods, reimbursable expenses have been reclassified into services revenues, with a corresponding increase in cost of revenues. The impact of Topic D-103 on services revenues and cost of revenues for the three and nine months ended September 30, 2001 and 2002 is presented as follows (in thousands):

     With the adoption of Topic D-103, the Company typically recognizes reimbursable expenses as revenue when an agreement to bill the customer for reimbursable expenses exists, the expenses have been incurred and billed, and collection is probable.

     In July 2002, the staff of the FASB issued Statement of Financial Accounting Standards No. 146, “Accounting for Costs Associated with Exit and Disposal Activities” (“SFAS 146”). This statement revises the accounting treatment

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for the cost of exit and disposal activities under Emerging Issues Task Force Issue 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity” (“EITF No. 94-3”). SFAS 146 requires companies to record exit or disposal costs when they are “incurred” and can be measured at fair value. The recorded liability will subsequently be adjusted for changes in estimated cash flows. Commitment to a plan to exit an activity or dispose of long-lived assets will no longer be sufficient to record a one-time charge for most anticipated costs. The provisions of SFAS 146 are effective prospectively for exit or disposal activities initiated after December 31, 2002. Companies may not restate previously issued financial statements for the effect of the provisions of SFAS 146 and liabilities that a company previously recorded under EITF Issue No. 94-3 will not be affected. We do not believe that the adoption of SFAS 146 will have a material impact on our consolidated financial statements.

3.    Related Party Transactions

     In July 1998, we loaned $640,000 to Roger Siboni, our chief executive officer, to purchase 2,400,000 shares of our common stock at $0.26 2/3 per share. This loan is secured by 539,151 shares of E.piphany common stock. This loan is due on July 1, 2008 and accrues interest at 5.88% per annum compounded monthly. As of September 30, 2002, Mr. Siboni has made a payment totaling $193,000, the outstanding principle balance of this loan was $447,000 and accrued interest was $161,000. Subsequent to September 30, 2002, Mr. Siboni made an additional payment of $214,000. Mr. Siboni has indicated and the Company expects that this loan will be repaid by August 2004.

     Mr. Siboni was also offered a loan of $250,000 per year for a period beginning August 1, 1998 and ending July 31, 2000, drawable on a monthly basis. This loan bears interest at 5.6% per annum compounded monthly. Amounts drawn on this loan as of January 1, 2000 were paid in full upon Mr. Siboni’s first sale of E.piphany stock. Mr. Siboni then continued to draw down from this loan through July 31, 2000. As of September 30, 2002, the outstanding balance of this loan including accrued interest was $43,000. Mr. Siboni has indicated and the Company expects that this loan will be repaid by December 2003.

     As of September 30, 2002, Mr. Siboni was a member of the board of directors of two of E.piphany’s customers. Total revenues to E.piphany from these customers were $55,000 and $166,000 for the three and nine months ended September 30, 2002, respectively. Total revenues to E.piphany from these customers were $54,000 and $144,000 for the three and nine months ended September 30, 2001, respectively. E.piphany had accounts receivable balances from these customers totaling $0 and $81,000 as of September 30, 2002 and December 31, 2001, respectively.

     In addition, as of September 30, 2002, three of E.piphany’s customers had board members that were also on E.piphany’s Board of Directors. Total revenues to E.piphany from these customers were $72,000 and $886,000 for the three and nine months ended September 30, 2002, respectively. Total revenues to E.piphany from these customers were $84,000 and $290,000 for the three and nine months ended September 30, 2001, respectively. There were no outstanding accounts receivable balances from these customers as of September 30, 2002 or December 31, 2001.

4.    Computation of Basic and Diluted Net Loss Per Share

     Basic and diluted net loss per common share are presented in conformity with SFAS No. 128, “Earnings Per Share,” (“SFAS No. 128”) for all periods presented. In accordance with SFAS No. 128, basic net loss per common share has been computed using the weighted average number of shares of common stock outstanding during the period, less shares subject to repurchase. The following table presents the calculation of basic and diluted net loss per share (in thousands, except per share amounts):

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     The Company excludes potentially dilutive securities from its diluted net loss per share computation when their effect would be antidilutive to net loss per share amounts. The following common stock equivalents were excluded from the net loss per share computation (in thousands):

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2001				2002				2001				2002
Options excluded due to the exercise price exceeding the average fair market value of the Company’s common stock during the period			4,021				11,480				4,158				11,112
Options for which the exercise price was less than the average fair market value of the Company’s common stock during the period that were excluded as inclusion would decrease the Company’s net loss per share			3,295				922				5,340				2,042
Common shares excluded resulting from common stock subject to repurchase			1,403				89				2,115				301
Total common stock equivalents excluded from diluted net loss per common share			8,719				12,491				11,613				13,455

5.    Commitments and Contingencies

Litigation

     As of the date hereof, there is no material litigation pending against us other than as disclosed in the paragraph below. From time to time, we may become a party to litigation and subject to claims incident to the ordinary course of our business. Although the results of litigation and claims cannot be predicted with certainty, we believe that the final outcome of such matters will not have a material adverse effect on our business, results of operations or financial condition.

     The Company, three of our current and former officers, and three underwriters in our initial public offering (“IPO”) were named as defendants in a consolidated shareholder lawsuit in the United States District Court for the Southern District of New York, In re E.piphany, Inc. Initial Public Offering Securities Litigation, 01-CV-6158. This is one of a number of actions coordinated for pretrial purposes as In re Initial Public Offering Securities Litigation, 21 MC 92. Plaintiffs in the coordinated proceeding have brought claims under the federal securities laws against numerous underwriters, companies, and individuals, alleging generally that defendant underwriters engaged in improper and undisclosed activities concerning the allocation of shares in the IPOs of more than 300 companies during the period from late 1998 through 2000. Among other things, plaintiffs allege that the underwriters’ customers had to pay excessive brokerage commissions and purchase additional shares of stock in the aftermarket in order to receive favorable allocations of shares in an IPO. The consolidated amended complaint in our case seeks unspecified damages on behalf of a purported class of purchasers of our common stock between September 21, 1999 and December 6, 2000. The court has appointed a lead plaintiff for the consolidated action. The underwriter and issuer defendants have filed motions to dismiss. The individual defendants have been dismissed from the action without prejudice pursuant to a tolling agreement. We believe we have meritorious defenses to the claims against us and will defend ourselves vigorously.

Restructuring Costs

     In the third quarter ended September 30, 2001, the Company initiated a plan to restructure its worldwide operations by reducing its workforce and consolidating its operating facilities and recorded a restructuring charge of $32.4 million. Additional charges of $10.5 million and $0.5 million were recorded during the quarters ended December 31, 2001 and March 31, 2002, respectively, which primarily reflected changes in the estimated costs of abandoning certain facilities associated with the plan initiated during the quarter ended September 30, 2001. In the quarter ended June 30, 2002, the Company further reduced its workforce and initiated a plan to abandon additional facilities, and recorded a restructuring charge of $11.2 million. Additional charges of $0.4 million were recorded during the quarter ended September 30, 2002, which primarily reflected changes in the estimated costs of the write-off of property and equipment associated with the charge taken during the quarter ended June 30, 2002.

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     The following table summarizes restructuring charges recorded during the nine months ended September 30, 2002 (in thousands):

     Severance and related charges primarily resulted from involuntary termination benefits, including the acceleration of certain stock option grants in connection with terminated employees, and payroll taxes. In the quarter ended September 30, 2001, the company reduced its workforce by approximately 13%, and in the quarter ended June 30, 2002, by approximately 14%. The terminations included sales and marketing, research and development and general administrative personnel, and were across all geographic regions.

     Write-off of property and equipment primarily relates to leasehold improvements and other property and equipment which have been impaired as a result of the abandonment of leased facilities and the reduction of headcount.

     Lease abandonment costs related to the abandonment of leased facilities in Atlanta, Boston, Chicago, New York, San Mateo, Hong Kong, Singapore and the United Kingdom. Lease abandonment costs reflected remaining lease liabilities and brokerage fees stated at actual costs reduced by estimated sublease income. The Company calculated the estimated costs of abandoning these leased facilities, including estimated sublease costs and income, with the assistance of market information trend analyses provided by a commercial real estate brokerage firm retained by the Company.

     As the estimates used in calculating the restructuring costs are subject to changing market conditions and other factors that are outside of the control of the Company, adjustments to these estimates could result in material increases or decreases in the currently accrued amounts. During the nine months ended September 30, 2002, the Company paid $9.7 million in severance and related charges and lease abandonment costs, of which $7.8 million related to the charge recorded in September 30, 2001 and $1.9 million related to the charge recorded in June 30, 2002. Actual future cash requirements may differ materially from the accrual balance at September 30, 2002. As of September 30, 2002, $31.9 million of lease termination costs, net of anticipated sublease income, remains accrued and is expected to be utilized by 2017.

6. Segment Information

     E.piphany is organized and operates as one business segment, which manages the design, development, marketing and sale of software products and related services. The Company distributes its products in the United States and in foreign countries through direct sales personnel and indirect channel partners.

     Revenue by geographic region is as follows (in thousands):

7.    Goodwill and Purchased Intangible Assets

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     Prior to the adoption of SFAS 142, the Company periodically assessed the impairment of long-lived assets, including identifiable intangibles in accordance with the provisions of SFAS No. 121, “Accounting for the Impairment of Long Lived Assets and for Long Lived Assets to be Disposed of.” The Company also periodically assessed the impairment of enterprise level goodwill in accordance with the provisions of Accounting Principles Board Opinion No. 17, “Intangible Assets” (“APB 17”). As part of its review of its third quarter of 2001 financial results, the Company performed an impairment assessment of identifiable intangible assets and goodwill in connection with all of its acquisitions. The impairment assessment was performed with the assistance of independent valuation experts to determine whether any impairment existed. The impairment indicators included, but were not limited to, the significant decline in the Company’s stock price, the net book value of assets, which significantly exceeded the Company’s market capitalization, and the overall decline in industry growth rates, which have negatively impacted the Company’s revenues and forecasted revenue growth rates, which precipitated the Company’s reduction in workforce and overall restructuring in the quarter ended September 30, 2001. As a result, the Company recorded a $1.7 billion impairment charge to reduce goodwill and other intangible assets associated with all of its acquisitions to reflect their estimated fair market value. Fair market value was determined based on discounted future cash flows for the acquisitions that had separately identifiable cash flows. Prior to recording the impairment charge, the Company’s quarterly amortization expense was approximately $274.1 million compared to amortization expense of approximately $17.0 million in the quarter following the impairment charge.

     In the first quarter of 2002, the Company adopted SFAS 142. SFAS 142 supersedes APB 17 and states that goodwill and intangible assets with indefinite lives are no longer amortized but are reviewed for impairment annually, or more frequently if impairment indicators arise. The Company has not recorded any impairment charge during the nine months ended September 30, 2002. The Company plans to complete an annual impairment test during the fourth quarter of 2002. Separable intangible assets that are not deemed to have an indefinite life will continue to be amortized over their useful lives.

     A reconciliation of previously reported net loss and net loss per share to the amounts adjusted for the exclusion of amortization of goodwill and assembled workforce, net of the related income tax effect, is as follows (in thousands, except per share amounts):

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     Information regarding the Company’s other intangible assets is as follows (in thousands):