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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
[X]ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2000,
or
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____ to ______
000-26287
(Commission File Number)
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KANA COMMUNICATIONS, INC.
(Exact name of Registrant as specified in its charter)
Delaware 77-0435679
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or Organization)
740 Bay Road, Redwood City, CA 94063
(Address of principal executive offices) (Zip Code)
(650) 298-9282
(Registrant's telephone number, including area code)
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Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.001 par value
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form. [_]
As of February 28, 2001, the aggregate market value of the voting stock held
by non-affiliates of the Registrant was approximately $241,444,076 based upon
the closing sales price of the Common Stock as reported on the Nasdaq Stock
Market on such date. Shares of Common Stock held by officers, directors and
holders of more than ten percent of the outstanding Common Stock have been
excluded from this calculation because such persons may be deemed to be
affiliates. The determination of affiliate status is not necessarily a
conclusive determination for other purposes.
As of February 28, 2001, the Registrant had outstanding 94,345,305 shares of
Common Stock.
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KANA COMMUNICATIONS, INC.
TABLE OF CONTENTS
ANNUAL REPORT ON FORM 10-K
FOR YEAR ENDED DECEMBER 31, 2000
PART I
Page
----
ITEM 1 BUSINESS....................................................... 3
ITEM 2 PROPERTIES..................................................... 14
ITEM 3 LEGAL PROCEEDINGS.............................................. 14
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............ 14
PART II
ITEM 5 MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS........................................... 17
ITEM 6 SELECTED CONSOLIDATED FINANCIAL DATA........................... 18
ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS......................................... 19
ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK..... 42
ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.................... 42
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.......................................... 42
PART III
ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............. 43
ITEM 11 EXECUTIVE COMPENSATION......................................... 44
ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT.................................................... 48
ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................. 49
PART IV
ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-
K............................................................. 51
SIGNATURES.............................................................. 82
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PART I
The following contains forward-looking statements within the meaning of
Section 21e of the Securities Exchange Act of 1934. Our actual results and
timing of certain events could differ materially from those anticipated in
these forward-looking statements as a result of certain factors, including, but
not limited to, those set forth under "Risk Factors," elsewhere in this report
and in our other public filings.
ITEM 1. BUSINESS
Overview
We are a leading provider of enterprise Relationship Management (eRM)
software solutions that deliver integrated communication and business
applications built on a Web-architected platform. Our eRM software solutions
redefine and extend the enterprise to incorporate customers, partners, and
suppliers in collaborative business relationships for greater long-term loyalty
and profitability. At the same time, our eRM solutions enable enterprises to
lower operating and distribution costs as they build relationships. Using our
software products and services, enterprises can:
. offer to customers, partners, and suppliers a consistent, personalized,
and comprehensive view of their business relationship so that they can
learn, buy, and get care that is relevant and targeted to their needs.
. offer customers, partners, and suppliers an integrated business
experience across their service, sales, and marketing activities.
. embrace customers, partners, and suppliers in productive and efficient
relationships through collaborative participation in automated business
processes.
. enhance the effectiveness of both online and offline relationships via
integrated communication channels and interactions methods.
. facilitate integrated information and services via a scalable, flexible,
and adaptable Web-architected platform.
Our customers range from Global 2000 companies pursuing an e-business
strategy to growing Internet companies. The following is a representative list
of our customers:
. eBay . E*Trade
. American Airlines . Kodak
. The Gap . BellSouth
No customer accounted for 10% or more of our total revenues in 1998, 1999 or
2000.
References in this annual report on Form 10-K to "Kana," "we," "our," and
"us" collectively refer to Kana Communications, Inc., a Delaware corporation,
its subsidiary and its California predecessor. Our principal executive offices
are located at 740 Bay Road, Redwood City, California 94063 and our telephone
number is (650) 298-9282.
Recent Developments
On February 28, 2001, we filed a tender offer statement on Schedule TO
announcing our offer to exchange certain eligible options outstanding under our
stock option plans for new options to purchase shares of our common stock to be
granted on or after six months and one day after the tendered options are
accepted and cancelled and for restricted shares of our common stock.
On February 21, 2001, we announced the appointment of Art M. Rodriguez as
our interim chief financial officer, replacing James C. Wood, our chief
executive officer and chairman of the board of directors, who acted as our
interim chief financial officer following the January 2001 resignation of our
former chief financial officer, Brian K. Allen, for personal reasons.
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On January 18, 2001, we announced the appointment of James C. Wood as our
new chief executive officer and chairman of the board, in connection with the
January 2001 resignation of our former chief executive officer and chairman of
the board, Michael J. McCloskey, for health reasons.
Industry Background
In today's economy, customers and partners have a variety of purchasing
options and are only a click away from being able to defect to the competition.
Whether a company is a Global 2000 enterprise, or a newly established Internet-
based business, the ability to provide a high quality interaction and
experience, and thus to establish long-term relationships and loyalty, is
critical to business survival.
Until recently, the relationships with customers and partners were based on
interactions in-person, by telephone or by letter. In order to respond to these
types of inquiries more effectively, many companies invested substantial
resources in expensive call centers and traditional direct marketing
initiatives. Call centers typically served a customer service function,
employed costly technology and did not scale effectively. Traditional direct
marketing is typically expensive and not highly effective in terms of
conversion and response rates. With the advent of the Internet and the
proliferation of electronic communications, the manner through which businesses
communicate has undergone a fundamental change: customers, partners, and
suppliers are now demanding that businesses be accessible anytime and through a
variety of channels, including the Web, wireless, e-mail, telephone, and
storefront.
Given the emerging shift to enhanced customer and partner interaction,
traditional solutions are not addressing the fundamental changes required by
enterprises. Businesses have concluded that, in order to differentiate
themselves from their competitors, they must provide superior customer
service--regardless of the customer contact channel. Therefore, it is no
surprise that according to the Gartner Group, the enterprises that are able to
synchronize customer-facing interactions across channels will outperform
competitors with siloed channels by 20 percent.
There can be negative consequences for a business if it fails to manage
these interactions effectively. These consequences can include loss of
customers, increased difficulty in acquiring new customers and a deterioration
of competitive position. IMT Strategies recently recognized the negative impact
on e-brand loyalty and customer retention associated with inconsistent service
across channels, particularly since customers are now just one click away from
switching their allegiances to a competitor or airing their complaints in
public forums. In addition, businesses face higher operating and information
technology costs without efficient and reliable management of customer and
partner interactions. Perhaps most significantly, businesses may lose the
opportunity to take advantage of new revenue-generating opportunities by
failing to capitalize upon the wealth of information conveyed through these
communications. While addressing these challenges, businesses must also be able
to deploy an enterprise relationship management solution across multiple
departments, to integrate the solution with existing business and legacy
systems and databases and to scale the solution as volumes grow.
The Kana eRM Solution
We believe that in order for companies to be successful in today's rapidly
changing global economy, they must differentiate themselves by enhancing
business relationships while simultaneously decreasing operating costs,
increasing efficiency through business process automation, eliminating
information fragmentation to reduce information technology costs, and adapting
rapidly to changing business requirements. Our products and services are
designed to meet these challenges to generate higher revenue and long-term
customer, partner, and supplier loyalty. We believe our products and services
provide the following business benefits:
. Enhanced Business Relationships and Decreased Operating Costs. Our
products provide customers, partners, suppliers, and enterprise staff
with a complete view of their interactions and activities and deliver
this information via personalized Web portals. All users benefit from a
complete view by receiving relevant information at the right time,
resulting in finer control over their business
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relationships. In addition, with greater access to information, customers,
partners, and suppliers can resolve business issues without assistance,
thus reducing the enterprise's costs for building effective relationships.
Capabilities such as managed self service make enterprise knowledge
available to customers, partners, and suppliers.
Enterprises are able to gain a complete view of business relationships
across departmental functions and communication channels. Our software
provides one-click access to complete customer histories and interactions
so that staff can provide informed, personalized, and consistent answers.
In addition, our software provides enterprises with the ability to
analyze customer information to launch customized initiatives in response
to gathered information. We believe that the resulting improvement in the
business experience enables enterprises to significantly enhance customer
satisfaction, retention, and loyalty.
. Business Process Automation for Increased Efficiency. Our software
enables enterprises to automate communication and business processes
across the organization. Our products use a combination of workflow
automation, business rules for decision-making, artificial intelligence,
analytics and advanced messaging analysis technologies to create
efficient business processes. By extending processes across the
enterprise, all departments can act upon valuable information. For
example, our software can alert a sales department of a potential lead
resulting from a service representative's interaction with a customer to
solve a problem.
Even more importantly, our products enable the enterprise to extend
business process automation outside its walls to embrace customers,
partners, and suppliers in the processes. This "extranet" workflow
capability means that users inside and outside the corporation can
collaborate as one to efficiently resolve business issues.
. Integrated Enterprise Information and Reduced Technology Costs. Our
products and services can reduce enterprise operating and information
technology costs by delivering a suite of business applications for
marketing, sales, and service functions integrated with our broad range
of electronic and traditional communication applications.
Our integrated communication applications enable customers, partners,
suppliers, and enterprise staff to mix and match as many communications
channels as needed to complete a business task, including electronic and
traditional telephone-based communications. Integrated communication
applications have the benefit of lowering operational business costs as
the enterprise can blend scarce resources efficiently to manage all types
of requests across multiple communication channels.
Our suite of business applications enables enterprises to manage the
complete marketing, sales, and service business lifecycle from building
permission-based marketing campaigns, to acquiring and keeping customers,
to managing requests for service. By integrating these applications,
enterprises can easily identify and create additional revenue-generating
opportunities without significant IT effort. For example, our business
applications can convert marketing interactions into sales by attaching
highly personalized and targeted communications in electronic direct
marketing campaigns using information gathered via requests for service
assistance.
Our communication and business applications are built on a Web-
architected foundation designed to integrate not only Kana-delivered
applications, but information and processes residing in legacy systems
and existing enterprise data sources. Our Web-based architecture extends
the useful lives of these diverse and heterogeneous information sources,
helping the enterprise to avoid expensive application redesign and
redevelopment.
Rapid Adaptation to Changing Market Conditions. Our software is built on a
Web-based architecture for rapid application customization and deployment,
network flexibility, and scalability to manage exponential growth. Based on
widely accepted industry standards, our software uses standards such as Java
J2EE, JDBC, JNDI, JMS, World Wide Web Consortium standards, HTML, XML, and
Workflow Management Coalition
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standards to facilitate rapid application customization, efficient development
cycles, and real-time adaptation to changes in business conditions. In
combination with these standards and industry-leading Web, application, and
database servers, our software can help enterprises achieve the scalability,
fault tolerance, application adaptability, and network flexibility required for
today's global business operations.
The Kana Strategy
Our strategy for achieving our goals as the leading provider of eRM software
solutions includes the following objectives:
Extend Market Leadership Position. We intend to extend our position as a
leader in the eRM software market by delivering a broad range of business and
communication applications built on a Web-architected, flexible, and scalable
platform. We intend to take advantage of our technological leadership,
strategic customer base and distribution capabilities to extend our current
position as a market leader. Moreover, we believe that, by broadening our suite
of products and services that enable companies to interact with their
customers, partners, and suppliers in the most cost-effective and efficient
ways possible, we can expand our market opportunities and solidify our position
as a leading provider of comprehensive eRM solutions and services.
Expand Our Suite of Products to Enter New Markets. We intend to expand our
suite of products to include additional marketing, sales and service
capabilities in order to enter new markets. We are working with our customers
and strategic partners to identify the strategic and functional needs of
enterprises that operate in the rapidly changing Web environment. Our focus is
to develop applications and partnerships that address those needs and integrate
them seamlessly with our existing platform to help enterprises establish
broader and deeper business relationships. We believe these applications will
be integrated to merge Web-based marketing, sales, and service transactions
with customer communications to create further revenue opportunities.
Increase Distribution Capabilities. We intend to broaden and increase our
distribution capabilities worldwide by combining the efforts of our direct
sales force and our alliances with leading e-business service and
infrastructure providers, such as Accenture LLP, Aspect, IBM, KPMG Consulting
and Siemens. By expanding existing alliances and aggressively developing new
ones, we can leverage others' sales, marketing and deployment capabilities to
help establish us as a worldwide provider of eRM products and services.
Continue Technology Leadership. We intend to continue our technology
leadership with our Web-based architecture as the leading technology platform
and market standard for eRM products and services. To deliver the high
performance required in the complex and rapidly changing eRM environment, we
have designed our products to be highly scalable, easily customizable and
readily able to integrate with existing enterprise applications and systems.
Our Web-based platform enables a complete view of all people, activities, and
interactions from one location, allowing the enterprise to scale to millions of
daily interactions and to modify automated business process in real time
without disabling the entire system.
Emphasize Customer Satisfaction. We believe that delivering complete
customer satisfaction is vital to growing our business. Our emphasis on
customer satisfaction has provided us with a strong base of customers who can
be referenced. This strategy provides many benefits, including potentially
shortened sales cycles, incremental sales opportunities to our installed-base
of customers, and new and improved products resulting from customer feedback.
We intend to remain focused on providing the highest level of satisfaction to
our customers and to continue designing our solutions to address their
enterprise needs. In addition, we intend to continue to enhance our
professional services group's capabilities, to maintain customer relationships
beyond the implementation phase and provide a superior customer experience.
Products and Services
Our Suite of eRM Software Solutions. Our suite of integrated communication
and business applications built on a Web-based platform create an advanced
technological solution for eRM. The suite consists of Kana
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eBusiness Platform, Kana Service, Kana Connect, Kana Response, Kana I-Mail,
Kana Voice, Kana mBusiness, Kana Classify, and Kana Conduits.
Kana eBusiness Platform. Kana eBusiness Platform is our Web-architected,
standards-based foundation for building, deploying, and modifying software
applications. Kana eBusiness Platform is designed for near linear scalability,
enabling the enterprise to quickly add users to service a growing customer
base. Applications built on Kana eBusiness Platform can be extended to add
features and functionality to accommodate and integrate the enterprise's
specific data and processes, including information residing in legacy systems
and data sources. Kana eBusiness Platform provides the foundation for
integrated, personalized interactions, collaborations, and transactions between
the enterprise and its customers, partners, and suppliers.
Kana Service. Kana Service is a complete customer care application that
enables the enterprise to automate contact center processes and extend those
processes to customers, partners, and suppliers for a global view of their
relationships with the enterprise. By delivering proactive service, self-
service, and assisted service in combination with integrated communication
channels, Kana Service empowers business associates to play an active part in
managing their relationships with the enterprise. At the same time, Kana
Service delivers efficiencies to significantly reduce the costs of providing
superior customer care through extensive service request and knowledge base
management capabilities.
Kana Connect. Kana Connect is our electronic direct marketing application
that enables the enterprise to proactively deliver individually targeted
messages to increase the lifetime value of customers. The application enables
marketers to profile, target and engage customers in one-to-one conversations
through permission-based, e-mail communication.
Kana Response. Kana Response is our e-mail and Web communications management
application that assists enterprises in responding to large numbers of inbound
customer e-mail communications. Kana Response provides rule-based automation,
intelligent workflow, message queuing, specialized user tools and a centralized
knowledge base of issues and responses.
Kana I-Mail. Kana I-Mail lets the enterprise engage in one-to-one real-time
communications with customers. The solution's two-way Web-based instant
messaging between the company and customer provides immediate online assistance
to the customer. Kana I-Mail delivers different service levels to customers
based on a number of factors such as the Web page the customer is browsing, the
value of the items in the customer's shopping cart, or the nature of the
customer's question to determine the appropriate service level for that
individual.
Kana Voice. Kana Voice allows customers to have a voice conversation over
the Internet. Customers simply click on a button and are connected with a live
agent online. Kana Voice also provides collaborative Web browsing, Web history
tracking, prioritization, escalation, knowledge base and agent and
administrator features.
Kana mBusiness. Kana mBusiness provides wireless access to customer and
partner Web portals to support sales and marketing inquiries, personalized
responses, service resolution, transaction confirmation, and contact
management. It uses standards such as WAP and WML so that users can easily
author content across wireless-enabled devices. Kana mBusiness also allows
wireless portals to be customized, enabling users to check and act on
marketing, sales, and service applications.
Kana Classify. Kana Classify is our advanced message classification
technology that drives automated actions. Kana Classify categorizes customer
messages and can automatically respond to customers, suggest responses for user
review or route messages to appropriate queues.
Kana Conduits. Kana Conduits integrate leading third-party applications with
Kana software. Kana Conduits for Computer Teleploy Integration (CTI) provide
integration with leading computer telephony
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applications, providing enterprise agents with a single interface to inquiries
received over various media, including the Web, e-mail and the telephone.
Additional Kana Conduits deliver such capabilities as integration with advanced
Web collaboration vendors and leading Customer Relationship Management (CRM)
vendors.
Kana Online
Kana Online is a Web-based application service that offers our software on a
hosted basis. Kana Online provides e-businesses with access to a customized
version of our software without the need to purchase, install or maintain their
own server or database infrastructure. With Kana Online, we host the back-end
infrastructure and the customer accesses our powerful functionality through a
Web browser or by deploying Kana's Power Client.
The hardware and core technology supporting Kana Online is pre-installed and
managed at Exodus Communications, Inc., a leading provider of Internet server
hosting and management solutions. We believe that Exodus is equipped to provide
the security, reliability and performance required for hosting our solution
through its nationwide network operating centers and high-speed wide area
network backbone.
Services
Professional Services. Our professional services group consists of
consulting services, customer advocacy, technical support and education
services.
Consulting Services. Our consulting services group provides a wide range of
business and technical expertise to support our customers and partners during
the implementation of solutions. This group brings deep functional and industry
knowledge to the market as well as the technical capabilities to deliver
premium consulting services for our customers and partners.
Technical Support. Our technical support group provides global support for
our customers through a number of channels, including phone and e-mail, as well
as access to the Kana Support Website.
Education Services. Our education services group delivers a full set of
training programs for our customers and partners, including a comprehensive set
of learning tracks for end users, business consultants, and developers through
instructor-led, Web-based, and onsite delivery. The group also provides up-to-
date information to our customers and partners through monthly newsletters, Web
site FAQ's, and regional user groups.
Technology
Our software incorporates industry standards, such as Java, HTML, XML, and
the J2EE framework, in order to facilitate customization and to enable
efficient development cycles. Our software offers both Web and Windows-based
interfaces and relies on commercial application servers and database platforms
to provide scalability and redundancy.
Open, Standards-Based Architecture. The architecture of our software is
"open" because it relies upon industry standards that facilitate integration
with customers' e-business and legacy databases and systems and the development
of applications on our platform. These industry standards include:
. Java;
. JDBC (Java DataBase Connectivity);
. Standard relational databases from Oracle, Microsoft, and IBM;
. JSP (Java Server Pages);
. The J2EE (Java 2 Enterprise Edition) framework; and
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. XML, for presentation layers, metadata, and integration.
The use of industry standards also permits our platform to be readily
customized to users' preferences.
Scaleable Web-Based Architecture. Our software relies on a scaleable Web-
based architecture. This architecture separates the different system
components into logical layers, supports multiple hardware and software
platforms, supports browser-based interfaces and enables the system to run on
multiple hardware platforms simultaneously in order to enhance scalability.
The tiers are the presentation, user interface, workflow, business object,
mail delivery, tracking and data layers.
Advanced Message Classification Technologies. We have focused our research
and development of advanced message classification technologies on Bayesian
Network technology. Bayesian Network technology is a classification technology
approach that combines machine learning with human expertise to infer
conclusions about new data. Using machine learning, the system automatically
builds a classification model from existing customer messages, thereby
reducing the cost and time of installation and maintenance and allowing the
system to improve as new issues arise. With human expertise, the system
enables managers to add their knowledge selectively to the system in order to
improve accuracy and adjust the model to anticipate new issues or react to
them in real time. Bayesian Network technology underlies Kana Classify, which
categorizes customer messages and drives system automation.
Ease of Platform Upgrade. Our software may be readily upgraded to new
versions of our system. New versions of the software, when installed, are
designed to recognize the historical data and configurations from the previous
version of the system and automatically convert them to the new data format.
This enables an e-business to upgrade our software without any programming or
advanced technical capability.
Sales and Marketing
Sales. Our sales strategy is to pursue targeted accounts through a
combination of our direct sales force and our strategic alliances. To date, we
have targeted our sales efforts at the e-business divisions of Global 2000
companies and at rapidly growing Internet companies. We maintain direct sales
personnel across the United States and internationally throughout Europe,
Canada, Latin America, Australia, Singapore and Japan. The direct sales force
is organized into regional teams, which include both sales representatives and
systems engineers. As of December 31, 2000, we employed in our sales force 105
persons in our offices outside of North America. Our office in the United
Kingdom is primarily responsible for sales in Europe generally. Sales managers
currently based in the United States handle other international sales and
report to our Vice President, International. Our direct sales force is
complemented by telemarketing representatives based at our headquarters in
Redwood City, California and Manchester, New Hampshire.
We complement our direct sales force with a series of reseller and sales
alliances, such as those with Accenture, Aspect, KPMG Consulting, IBM and
Siemens. Through these alliances we are able to leverage additional sales,
marketing and deployment capabilities. In the future, we intend to expand our
distribution capabilities by increasing the size of our direct sales force,
establishing additional sales offices both domestically and internationally
and broadening our alliance activities.
Marketing. Our marketing programs are targeted at e-businesses and are
currently focused on educating our target market, generating new sales
opportunities and creating awareness for our e-business customer
communications software. We conduct marketing programs worldwide to educate
our target market. In addition, we engage in a variety of marketing
activities, including:
. conducting seminars, including Web Seminars
. hosting regular customer events;
. participating in industry and technology-related conferences and trade
shows;
. establishing and maintaining close relationships with recognized industry
analysts;
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. conducting electronic and traditional direct mailings and ongoing public
relations campaigns;
. managing and maintaining our Web site;
. conducting market research;
. organizing and implementing electronic and traditional direct marketing;
and
. creating sales tools.
Our marketing organization also serves an integral role in acquiring,
organizing and prioritizing industry and customer feedback in order to help
provide product direction to our development organizations. We have a detailed
product management process that surveys customer and market needs to predict
and prioritize future customer requirements, and a product marketing team
dedicated to delivering product positioning and messaging. We also focus on
developing a range of joint marketing strategies and programs in order to
leverage our existing strategic relationships and resources. These alliances
provide collaborative resources to help extend the reach of our presence in the
marketplace. We intend to continue to pursue these alliances in the future.
Strategic Relationships
We have three types of strategic relationships: service relationships,
technology relationships, and reseller and strategic sales relationships, all
designed to expand our market coverage. These relationships are formal or
informal agreements with third parties. We view these relationships as critical
to our success in providing enterprise-wide integrated e-business products and
services.
Recently introduced, the Kana Alliance Program was developed to meet the
increasing demand by companies to partner with us. The program provides
partners with the tools, information and marketing benefits through which they
can develop, promote and sell our products and services. Companies participate
in the program at different levels based on their market presence and on mutual
commitments to establishing successful relationships.
Service Relationships. We collaborate with systems integrators such as
Accenture, CSC Consulting and KPMG Consulting. With the implementation of our
Alliance Program, formal agreements are put into place for these relationships.
These systems integrators are highly trained in our software and provide
integration and implementation services to mutual customers.
Technology Relationships. We have established relationships with technology
partners across a variety of solution areas, including sales force automation,
analytics, content management, telephony systems and IT hardware, that allow us
to provide comprehensive solutions to e-businesses. These technology
relationships are typically formalized in a written agreement and are focused
on technology initiatives and marketing. The agreements are annually renewable,
but generally may be terminated at any time by either party and do not contain
penalties for nonperformance.
Reseller and Strategic Sales Relationships. We complement our direct sales
force with reseller and strategic sales relationships with companies in
targeted geographies and industries. Our agreements with these companies are
typically in the form of value-added reseller agreements.
In 2000, we entered into a global alliance with IBM, which provides for
resale, joint development, joint marketing and other activities. In the future,
we intend to establish additional strategic relationships to further broaden
our product offerings and enhance our distribution channels.
Many of the companies with which we have initiated relationships also work
with competing software companies, and the success of the relationship will
depend on their willingness and ability to devote sufficient resources and
efforts to our products and services. Our arrangements with these parties
typically are in the form of non-exclusive agreements that may be terminated by
either party without cause or penalty and with limited notice. Therefore, we
can provide no guarantee that any of these parties will continue their
relationship with us.
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Customers
Our customers range from Global 2000 companies pursuing an e-business
strategy to growing Internet companies. As of December 31, 2000, we have
licensed our solution to more than 600 customers in a variety of industries
worldwide. The following is a list of customers that we believe are
representative of our overall customer base:
Internet Services Financial Services/Insurance Travel
Alta Vista Aetna American Airlines
eBay Ameritrade British Airways
Hotjobs Capital One Carlson Company
Lycos Chase Manhattan Delta Airlines
priceline.com Cigna Northwest Airlines
QXL E*Trade Rail Europe
National Westminster Travelocity
High-tech Southtrust Bank
Analog Devices
Fujitsu Automotive Consumer Goods
Interwoven Ford Adidas
Microsoft General Motors Avon
Peoplesoft Renault Gateway
SAP Kodak
Sony Computer Entertainment Communications/Media Maytag
Ameritech Nokia
Retail AT&T Broadband
1-800 Flowers BellSouth
Ballard Designs BT Syncordia
Barnes & Noble.com Disney
Federated MTV
Home Depot Sprint ION
J. Crew Qwest
Staples Verizon
The Gap Yahoo!
Williams-Sonoma
No customer accounted for 10% or more of our total revenues in 1998, 1999 or
2000. Although a substantial portion of our license and service revenues in any
given quarter has been, and is expected to continue to be, generated from a
limited number of customers with large financial commitment contracts, we do
not depend on any ongoing commitments from our large customers.
Research and Development
We believe that strong product development capabilities are essential to our
strategy of enhancing our core technology, developing additional applications
incorporating that technology and maintaining the competitiveness of our
product and service offerings. We have invested significant time and resources
in creating a structured process for undertaking all product development. This
process involves several functional groups at all levels within our
organization and is designed to provide a framework for defining and addressing
the activities required to bring product concepts and development projects to
market successfully. In addition, we have recruited key engineers and software
developers with experience in the customer communications and internetworking
markets and have complemented these individuals by hiring senior management
with experience in enterprise application development, sales and deployment.
As of December 31, 2000, 315 of our employees were engaged in research and
development activities. As a result of our recent workforce reductions in the
first quarter of 2001, as of February 28, 2001, 258 of our
11
employees were engaged in research and development activities. Our success
depends, in part, on our ability to enhance our existing customer interactions
solutions and to develop new services, functionality and technology that
address the increasingly sophisticated and varied needs of our prospective
customers. Delays in bringing to market new products or their enhancements, or
the existence of defects in new products or enhancements, could be exploited by
our competitors. If we were to lose market share as a result of lapses in our
product management, our business would suffer.
Competition
The market for our products and services is intensely competitive, evolving
and subject to rapid technological change. We expect the intensity of
competition to increase in the future. We currently face competition for our
products from systems designed by both in-house and third-party development
efforts. We expect that these systems will continue to be a principal source of
competition for the foreseeable future. Our competitors include a number of
companies offering one or more products for the e-business communications and
relationship management market, some of which compete directly with our
products. For example, our competitors include companies providing traditional,
client-server based customer management and communications solutions, such as
Clarify Inc. (which was recently acquired by Nortel), Cisco Systems, Inc.,
Avaya, Inc., Oracle Corporation, Pivotal Corporation, Quintus Corporation,
Siebel Systems, Inc. and Vantive Corporation (which was recently acquired by
PeopleSoft, Inc.). In addition, we compete with companies providing stand-alone
point solutions, including Annuncio, Inc., AskJeeves Inc., Brightware, Inc.
(which was recently acquired by FirePond), Broadbase, Inc. (which recently
acquired another competitor, Servicesoft), Delano Technology, Inc., Digital
Impact, Inc., eGain Communications Corp., E.piphany Inc., Live Person, Inc,
MarketFirst, Inc., Responsys.com, Inc. and Talisma Corporation. Furthermore, we
may face increased competition should we expand our product line, through
acquisition of complementary businesses or otherwise.
We believe that the principal competitive factors affecting our market
include a significant base of referenceable customers, the breadth and depth of
a given solution, product quality and performance, customer service, core
technology, product scalability and reliability, product features, the ability
to implement solutions and the value of a given solution. Although we believe
that our solution currently competes favorably with respect to these factors,
our market is relatively new and is evolving rapidly. We may not be able to
maintain our competitive position against current and potential competitors,
especially those with significantly greater financial, marketing, service,
support, technical and other resources.
Many of our competitors have longer operating histories, significantly
greater financial, technical, marketing and other resources, significantly
greater name recognition and a larger installed base of customers than do we.
In addition, many of our competitors have well-established relationships with
our current and potential customers and have extensive knowledge of our
industry. It is possible that new competitors or alliances among competitors
may emerge and rapidly acquire significant market share. We also expect that
competition will increase as a result of industry consolidations. See "Risk
Factors-We face substantial competition and may not be able to compete
effectively."
Intellectual Property
We rely upon a combination of patent, copyright, trade secret and trademark
laws to protect our intellectual property. We currently have one issued U.S.
patent and eight U.S. patent applications pending. Our pending applications, if
allowed, in conjunction with our issued patent, will cover a material portion
of our products and services. We have also filed international patent
applications corresponding to four of our U.S. applications.
In addition, we have one U.S. trademark registration and seven pending U.S.
trademark registrations, two trademark registrations in the European Union, one
trademark registration in Australia, as well as additional pending trademark
registrations in Australia, Canada, the European Union, India, Japan, South
Korea and Taiwan. Although we rely on patent, copyright, trade secret and
trademark law to protect our technology, we
12
believe that factors such as the technological and creative skills of our
personnel, new product developments, frequent product enhancements and reliable
product maintenance are more essential to establishing and maintaining a
technology leadership position. Others may develop technologies that are
similar or superior to our technology.
We generally enter into confidentiality or license agreements with our
employees, consultants and alliance partners, and generally control access to
and distribution of our software, documentation and other proprietary
information. Despite our efforts to protect our proprietary rights,
unauthorized parties may attempt to copy or otherwise obtain and use our
products or technology or to develop products with the same functionality as
our products. Policing unauthorized use of our products is difficult, and we
cannot be certain that the steps we have taken will prevent misappropriation of
our technology, particularly in foreign countries where the laws may not
protect proprietary rights as fully as do the laws of the United States. In
addition, some of our license agreements require us to place the source code
for our products into escrow. These agreements generally provide that some
parties will have a limited, non-exclusive right to use this code if:
. there is a bankruptcy proceeding instituted by or against us;
. we cease to do business without a successor; or
. we discontinue providing maintenance and support.
Substantial litigation regarding intellectual property rights exists in the
software industry. Our software products may be increasingly subject to third-
party infringement claims as the number of competitors in our industry segment
grows and the functionality of products in different industry segments
overlaps. Some of our competitors in the market for customer communications
software may have filed or may intend to file patent applications covering
aspects of their technology that they may claim our technology infringes. Some
of these competitors may make a claim of infringement against us with respect
to our products and technology. See "Risk Factors--We may become involved in
litigation over proprietary rights, which could be costly and time consuming."
Employees
As of December 31, 2000, we had 1,181 full-time employees, 320 of whom were
in our professional services group, 430 in sales and marketing, 315 in research
and development, and 116 in finance, administration and operations. We recently
restructured our organization in the first quarter of 2001 with workforce
reductions of approximately 300 employees, in order to streamline operations,
reduce costs and bring our staffing and structure in line with industry
standards and current economic conditions.
Our future performance depends in significant part upon the continued
service of our key technical, sales and marketing, and senior management
personnel, none of whom is bound by an employment agreement requiring service
for any defined period of time. The loss of the services of one or more of our
key employees could harm our business.
Our future success also depends on our continuing ability to attract, train
and retain highly qualified technical, sales and managerial personnel.
Competition for these personnel is intense, particularly in the San Francisco
Bay Area where we are headquartered. Due to the limited number of people
available with the necessary technical skills and understanding of the
Internet, we may not be able to retain or attract these key personnel in the
future. None of our employees are represented by a labor union. We have not
experienced any work stoppages and consider our relations with our employees to
be good. See "Risk Factors--We may be unable to hire and retain the skilled
personnel necessary to develop our engineering, professional services and
support capabilities in order to continue to grow," "--We may face difficulties
in hiring and retaining qualified sales personnel to sell our products and
services, which could harm our ability to increase our revenues in the future,"
and "--Our workforce reduction and financial performance may adversely affect
the morale and performance of our personnel and our ability to hire new
personnel."
13
ITEM 2. PROPERTIES
Our corporate offices are located in Redwood City, California, where we
lease approximately 60,861 square feet under a lease that expires in October
2006. As of December 31, 2000, the annual base rent for this facility was
approximately $1.9 million. Also, we lease approximately 88,094 square feet of
space in two office buildings in Manchester, New Hampshire. The lease expires
in April 2005, and we have an option to extend the lease for two additional
five-year terms. In addition, we lease facilities and offices in several cities
throughout the United States, and internationally throughout Europe, Australia,
Japan, Singapore and Latin America. The terms of these leases began to expire
in August 2000, but automatically renewed unless earlier terminated. On
February 11, 2000, we entered into an agreement to lease approximately 62,500
additional square feet in Redwood City, California under a lease that expires
in December 2010. The annual base rent for this facility for the first year is
approximately $2.4 million. We believe that our corporate office space in
Redwood City and the other facilities we currently lease will be sufficient to
meet our needs through at least the next 12 months.
ITEM 3. LEGAL PROCEEDINGS
On October 8, 1999, Genesys Telecommunications Laboratories, Inc. filed a
complaint against us in the United States District Court for the District of
Delaware. Genesys subsequently amended its complaint to allege that our
Customer Messaging System 3.0 infringes one or more claims of two Genesys
patents. In connection with the license agreement and reseller agreement that
we entered into with Genesys on December 29, 2000, the complaint was dismissed
with prejudice. We are not currently a party to any other material legal
proceedings. See "Risk Factors--We may become involved in litigation over
proprietary rights, which could be costly and time consuming."
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's annual meeting of stockholders was held on October 4, 2000
(the "Annual Meeting"). The following matters were considered and voted upon at
the Annual Meeting:
The first matter related to the election of three directors, David M.
Beirne, Robert W. Frick and Steven T. Jurvetson, to serve for a three-year term
ending in the year 2003 and until their successors are duly elected and
qualified. The votes cast and withheld for such nominees were as follows:
Name For Withheld
---- --- --------
David M. Beirne.......................................... 59,576,795 130,824
Robert W. Frick.......................................... 59,482,922 224,697
Steven T. Jurvetson...................................... 59,437,318 270,301
The second matter related to the ratification of the appointment of
PricewaterhouseCoopers LLP as our independent auditors for the year ending
December 31, 2000. The votes cast for and against this action were 56,842,368
and 2,855,773, respectively, with 9,478 votes abstaining.
Based on these voting results, each of the directors nominated was elected
and the second matter was approved.
14
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth information regarding our current executive
officers and directors (with ages as of December 31, 2000):
Name Age Position
---- --- --------
James C. Wood........... 44 Chief Executive Officer and Chairman of the Board of Directors
David B. Fowler......... 47 President
Nigel K. Donovan........ 45 Chief Operating Officer
Art M. Rodriguez........ 45 Interim Chief Financial Officer
Toya A. Rico............ 40 Chief Personnel Officer
David M. Beirne......... 36 Director
Robert W. Frick......... 63 Director
Mark S. Gainey.......... 32 Director
Eric A. Hahn............ 40 Director
Charles A. Holloway,
Ph.D................... 64 Director
Steven T. Jurvetson..... 33 Director
James C. Wood. Mr. Wood joined us in April 2000 as a director in connection
with our acquisition of Silknet Software, Inc. and served as our President from
May 2000 until he was appointed as our Chief Executive Officer and Chairman of
the Board of Directors in January 2001. Mr. Wood founded Silknet in March 1995
and served as its Chairman of the Board, President and Chief Executive Officer.
From January 1988 until November 1994, Mr. Wood served as President and Chief
Executive Officer of CODA Incorporated, a subsidiary of CODA Limited, a
financial accounting software company. Mr. Wood also served as a director of
CODA Limited from November 1988 until November 1994. Mr. Wood holds a B.S. in
Electrical Engineering from Villanova University.
David B. Fowler. Mr. Fowler joined us in connection with our acquisition of
Silknet Software, Inc. and served as our Vice President, Corporate Marketing
from April 2000 until he was appointed as our President in January 2001. Prior
to joining us, from April 1999 to April 2000, Mr. Fowler served as Vice
President--Marketing of Silknet. From April 1995 to March 1999, Mr. Fowler
served as Vice President--Sales and Marketing for Gradient Technologies, a
software company. From December 1993 to March 1995, Mr. Fowler served as Vice
President--Sales and Marketing for FTP Software. Mr. Fowler holds a B.S. in
Computer Science from Worcester Polytechnic Institute and an M.B.A. from New
York University.
Nigel K. Donovan. Mr. Donovan joined us in connection with our acquisition
of Silknet Software, Inc. and served as our Vice President, Development from
April 2000 until he was appointed as our Chief Operating Officer in January
2001. Prior to joining us, from February 1999 to April 2000, Mr. Donovan served
as Senior Vice President and Chief Operating Officer of Silknet. From November
1995 to February 1999 Mr. Donovan served as Silknet's Vice President--
Professional Services. From November 1996 to October 1998, he also served as
Silknet's Treasurer and from May 1997 to October 1998 as its Chief Financial
Officer. In addition, Mr. Donovan served as director of Silknet from October
1996 to February 1999. From March 1988 until October 1995, Mr. Donovan served
as Vice President--Professional Services of CODA Incorporated. Mr. Donovan
holds a B.A. in Accounting and Finance from the London School of Business
Studies.
Art M. Rodriguez. Mr. Rodriguez joined us in July 2000 as our Vice President
of Finance and currently serves as the interim Chief Financial Officer. Prior
to joining us, Mr. Rodriguez spent 15 years in various financial positions at
Hewlett Packard Co., most recently as the controller for the Customer Service &
Support Group. Before his work at Hewlett Packard, Mr. Rodriguez served as a
Captain in the United States Marine Corps. Mr. Rodriguez has an M.B.A. from the
University of California at Los Angeles.
Toya A. Rico. Ms. Rico joined us in January 2000 as Vice President, Human
Resources and was appointed as our Chief Personnel Officer in January 2001.
Prior to joining us, from October 1996 through May
15
1999, Ms. Rico served as Director, Human Resources at Adaptec, Inc., a
bandwidth management company. From May 1988 through September 1996, Ms. Rico
served in a variety of human resources management positions at 3Com
Corporation, a computer networking company. Ms. Rico holds a B.A. in
Communications from California State University, San Francisco.
David M. Beirne. Mr. Beirne has served as one of our directors since
September 1997. Mr. Beirne has been a Managing Member of Benchmark Capital, a
venture capital firm, since June 1997. Prior to joining Benchmark Capital, Mr.
Beirne founded Ramsey/Beirne Associates, an executive search firm, and served
as its Chief Executive Officer from October 1987 to June 1997. Mr. Beirne
serves on the board of directors of Scient Corporation, PlanetRx.com, Inc.,
Webvan Group, Inc., 1-800-FLOWERS.COM, Inc., and several private companies. Mr.
Beirne holds a B.S. in Management from Bryant College.
Robert W. Frick. Mr. Frick has served as one of our directors since August
1999. Mr. Frick previously served as the Vice Chairman of the Board, Chief
Financial Officer and head of the World Banking Group for Bank of America, as
Managing Director of BankAmerica International, and as President of Bank of
America's venture capital subsidiary. He is now retired. Mr. Frick previously
served as a director of Connectify, Inc. from its founding to its acquisition
by us, and he currently serves on the board of directors of six private
companies. Mr. Frick holds a B.S. in Civil Engineering and an M.B.A. from
Washington University in St. Louis, Missouri.
Eric A. Hahn. Mr. Hahn has served as one of our directors since June 1998.
Mr. Hahn is a founding partner of Inventures Group, a venture capital firm.
From November 1996 to June 1998, Mr. Hahn served as the Executive Vice
President and later as the Chief Technical Officer of Netscape Communications
Corporation and served as a member of Netscape's Executive Committee. Mr. Hahn
also served as General Manager of Netscape's Server Products Division,
overseeing Netscape's product development and marketing activities for
enterprise Internet, intranet and extranet servers, from November 1995 to
November 1996. Prior to joining Netscape, from February 1993 to November 1995,
Mr. Hahn was founder and Chief Executive Officer of Collabra Software, Inc., a
groupware provider that was acquired by Netscape. Mr. Hahn holds a B.S. and
Ph.D. in Computer Science from the Worcester Polytechnic Institute.
Dr. Charles A. Holloway. Dr. Holloway has served as one of our directors
since December 1996. Dr. Holloway holds the Kleiner, Perkins, Caufield & Byers
Professorship in Management at the Stanford Graduate School of Business and has
been a faculty member of the Stanford Graduate School of Business since 1968.
Dr. Holloway is also currently co-director of the Stanford Center for
Entrepreneurial Studies at the Graduate School of Business. Dr. Holloway was
the founding co-chair of the Stanford Integrated Manufacturing Association, a
cooperative effort between the Graduate School of Business and the School of
Engineering, which focuses on research and curriculum development in
manufacturing and technology. Dr. Holloway serves on the board of directors of
several private companies. Dr. Holloway holds a B.S. in Electrical Engineering
from the University of California at Berkeley and an M.S. in Nuclear
Engineering and Ph.D. in Business Administration from the University of
California, Los Angeles.
Steven T. Jurvetson. Mr. Jurvetson has served as one of our directors since
April 1997. Mr. Jurvetson has been a Managing Director of Draper Fisher
Jurvetson, a venture capital firm, since June 1995. Prior to joining Draper
Fisher Jurvetson, from July 1990 to September 1993, Mr. Jurvetson served as a
consultant with Bain & Company, a management consulting firm. Mr. Jurvetson
served as a research and development engineer at Hewlett-Packard during the
summer months from June 1987 to August 1989. Mr. Jurvetson serves on the boards
of directors of Cognigine Corporation, FastParts, Inc., iTv Corp., Tacit
Knowledge Corporation, Third Voice, Inc., ReleaseNow.com Corporation, Everdream
Corporation and Vivaldi Networks, Inc. Mr. Jurvetson holds a B.S. and an M.S.
in Electrical Engineering from Stanford University and an M.B.A. from the
Stanford Graduate School of Business.
16
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Our common stock is listed on the Nasdaq Stock Market under the Symbol
"KANA".
The following table sets forth the range of high and low closing sales
prices for each period indicated, adjusted for the two-for-three reverse stock
split effective September 1999 and the two-for-one forward stock split
effective February 2000:
High Low
------- ------
Fiscal 1999
Third Quarter (from September 22, 1999)...................... $ 26.13 $22.78
Quarter Ended December 31, 1999.............................. 122.50 24.03
Fiscal 2000
First Quarter................................................ 169.81 68.00
Second Quarter............................................... 61.88 29.63
Third Quarter................................................ 72.25 22.00
Fourth Quarter............................................... 28.36 8.84
There were approximately 712 stockholders of record as of February 28, 2001.
This number does not include stockholders whose shares are held in trust by
other entities. The actual number of stockholders is greater than this number
of holders of record. We estimate that the beneficial stockholders of the
shares of our common stock as of February 14, 2001 was approximately 86,564.
We have not paid any cash dividends on our capital stock. We currently
intend to retain our earnings to fund the development and growth of our
business and, therefore, do not anticipate paying any cash dividends in the
foreseeable future. In addition, our existing credit facilities prohibit the
payment of cash or stock dividends on our capital stock without the lender's
prior written consent. See Item 7--"Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital
Resources."
17
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the consolidated financial statements of Kana
Communications, Inc. and the notes to consolidated financial statements
included elsewhere in this annual report on Form 10-K.
The consolidated statement of operations data for each of the years in the
four-year period ended December 31, 2000, and the consolidated balance sheet
data at December 31, 1999 and 2000 are derived from our consolidated financial
statements. The diluted net loss per share computation excludes potential
shares of common stock (preferred stock, options to purchase common stock and
common stock subject to repurchase rights held by us), since their effect would
be antidilutive. See Note 1 of Notes to Consolidated Financial Statements for a
detailed explanation of the determination of the shares used to compute actual
basic and diluted net loss per share and goodwill impairment in the year ended
December 31, 2000. The historical results are not necessarily indicative of
results to be expected for any future period. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
Years Ended December 31,
-----------------------------------------
2000 1999 1998 1997
----------- --------- -------- -------
(in thousands, except per share
amounts)
Consolidated Statement of
Operations Data:
Revenues:
License........................... $ 75,360 $ 10,536 $ 2,014 $ --
Service........................... 43,887 3,528 333 617
----------- --------- -------- -------
Total revenues.................... 119,247 14,064 2,347 617
----------- --------- -------- -------
Cost of revenues:
License........................... 2,856 271 54 --
Service........................... 56,201 6,610 666 253
----------- --------- -------- -------
Total cost of revenues............. 59,057 6,881 720 253
----------- --------- -------- -------
Gross profit....................... 60,190 7,183 1,627 364
----------- --------- -------- -------
Operating expenses:
Sales and marketing............... 88,186 21,199 5,504 512
Research and development.......... 42,724 12,854 5,669 971
General and administrative........ 18,945 5,018 1,826 378
Amortization of stock-based
compensation..................... 14,715 80,476 1,456 113
Amortization of goodwill and
identifiable intangibles......... 873,022 -- -- --
In process research and
development...................... 6,900 -- -- --
Acquisition related costs......... 6,564 5,635 -- --
Goodwill impairment............... 2,084,841 -- -- --
----------- --------- -------- -------
Total operating expenses.......... 3,135,897 125,182 14,455 1,974
----------- --------- -------- -------
Operating loss..................... (3,075,707) (117,999) (12,828) (1,610)
Other income (expense), net........ 4,834 (744) 227 57
----------- --------- -------- -------
Net loss.......................... $(3,070,873) $(118,743) $(12,601) $(1,553)
=========== ========= ======== =======
Basic and diluted net loss per
share............................. $ (39.57) $ (4.61) $ (2.01) $ (0.37)
=========== ========= ======== =======
Shares used in computing basic and
diluted net loss per share
amounts........................... 77,610 25,772 6,258 4,152
=========== ========= ======== =======
December 31,
-----------------------------------------
2000 1999 1998 1997
----------- --------- -------- -------
(in thousands)
Consolidated Balance Sheet Data:
Cash, cash equivalents and short-
term investments.................. $ 76,499 $ 53,217 $ 14,035 $ 5,594
Working capital.................... 54,234 38,591 11,833 5,364
Total assets....................... 980,124 70,229 16,876 6,158
Total stockholders' equity......... $ 899,452 $ 48,500 $ 12,951 $ 5,684
18
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of the Financial Condition and Results of
Operations contains forward-looking statements within the meaning of Section
21e of the Securities Exchange Act of 1934. Our actual results and timing of
certain events could differ materially from those anticipated in these forward-
looking statements as a result of certain factors, including, but not limited
to, those set forth under "Risk Factors," elsewhere in this report and in our
other public filings.
Overview
We are a leading provider of enterprise Relationship Management (eRM)
software solutions that deliver integrated communication and business
applications built on a Web-architectured platform. We were incorporated in
July 1996 in California and were reincorporated in Delaware in September 1999.
We had no significant operations until 1997. In February 1998, we released the
first commercially available version of the Kana platform. To date, we have
derived substantially all of our revenues from licensing our software and
related services, and we have sold our products worldwide primarily through our
direct sales force.
On August 13, 1999, we completed a merger with Connectify pursuant to which
Connectify became our wholly-owned subsidiary. In connection with the merger,
we issued approximately 6,982,542 shares of our common stock in exchange for
all outstanding shares of Connectify capital stock and reserved 416,690 shares
of common stock for issuance upon the exercise of Connectify options and
warrants we assumed in connection with the merger. The merger was accounted for
as a pooling of interests.
On December 3, 1999, we completed a merger with Business Evolution pursuant
to which Business Evolution became our wholly-owned subsidiary. In connection
with the acquisition of Business Evolution, 1,890,200 shares of our common
stock were issued for all outstanding shares and warrants of Business
Evolution. This transaction was accounted for as a pooling of interests.
On December 3, 1999, we completed a merger with netDialog pursuant to which
netDialog became our wholly-owned subsidiary. In connection with the
acquisition of netDialog, 1,120,286 shares of our common stock were issued for
all outstanding shares, warrants and convertible notes of netDialog. This
transaction was accounted for as a pooling of interests.
On April 19, 2000, we completed a merger with Silknet under which Silknet
became our wholly-owned subsidiary. In connection with the Silknet merger, each
share of Silknet common stock outstanding immediately prior to the completion
of the merger was converted into the right to receive 1.66 shares of our common
stock and we assumed Silknet's outstanding stock options and warrants based on
the exchange ratio, issuing approximately 29.2 million shares of our common
stock and reserving 4.0 million shares of common stock for issuance upon the
exercise of Silknet options and warrants we assumed in connection with the
merger. The transaction was accounted for using the purchase method of
accounting. In connection with the merger, we have recorded goodwill and
intangible assets of approximately $3.8 billion, which we were amortizing over
a period of three years.
During the quarter ended December 31, 2000, we performed an impairment
assessment of the identifiable intangibles and goodwill recorded in connection
with the acquisition of Silknet. As a result of our review, we recorded a $2.1
billion impairment charge to reduce our goodwill. The remaining goodwill and
identifiable intangibles balance of approximately $800.0 million will be
amortized over the remaining useful life.
On June 12, 2000, we sold 2,500,000 shares of our common stock for gross
proceeds of $125.0 million (net proceeds of approximately $120.0 million) in a
private placement transaction.
We derive our revenues from the sale of software product licenses and from
professional services including implementation, consulting, hosting and
maintenance. License revenue is recognized when persuasive
19
evidence of an agreement exists, the product has been delivered, the
arrangement does not involve significant customization of the software,
acceptance has occurred, the license fee is fixed and determinable and
collection of the fee is probable. If the arrangement involves significant
customization of the software, the fee, excluding the portion attributable to
maintenance, is recognized using the percentage-of-completion method. Service
revenue includes revenues from maintenance contracts, implementation,
consulting and hosting services. Revenue from maintenance contracts is
recognized ratably over the term of the contract. Revenue from implementation,
consulting and hosting services is recognized as the services are provided.
Revenue under arrangements where multiple products or services are sold
together is allocated to each element based on their relative fair values.
Our cost of license revenue includes royalties due to third parties for
technology integrated into some of our products, the cost of product
documentation, the cost of the media used to deliver our products and shipping
costs. Cost of service revenue consists primarily of personnel-related
expenses, subcontracted consultants, travel costs, equipment costs and overhead
associated with delivering professional services to our customers.
Our operating expenses are classified into three general categories: sales
and marketing, research and development, and general and administrative. We
classify all charges to these operating expense categories based on the nature
of the expenditures. Although each category includes expenses that are unique
to the category, some expenditures, such as compensation, employee benefits,
recruiting costs, equipment costs, travel and entertainment costs, facilities
costs and third-party professional services fees, occur in each of these
categories.
We allocate the total costs for information services and facilities to each
functional area that uses the information services and facilities based on its
relative headcount. These allocated costs include rent and other facility-
related costs, communication charges and depreciation expense for furniture and
equipment.
Since 1997, we have incurred substantial costs to develop our products and
to recruit, train and compensate personnel for our engineering, sales,
marketing, client services and administration departments. As a result, we have
incurred substantial losses since inception and, for the twelve months ended
December 31, 2000, incurred a net loss of $3.1 billion. As of December 31,
2000, we had an accumulated deficit of $3.2 billion. We believe our future
success is contingent upon providing superior customer service, increasing our
customer base and developing our products. We expect to decrease our operating
losses for the foreseeable future.
As of December 31, 2000, we had 1,181 full-time employees. We recently
restructured our organization in the first quarter of 2001 with workforce
reductions of approximately 300 employees, in order to streamline operations,
reduce costs and bring our staffing and structure in line with industry
standards. We may reduce our workforce again in the near future.
We believe that our prospects must be considered in light of the risks,
expenses and difficulties frequently experienced by companies in early stages
of development, particularly companies in new and rapidly evolving markets like
ours. Although we have experienced significant revenue growth recently, this
trend may not continue, particularly in light of increasing competition in our
markets, the worsening economic outlook and declining expenditures on
enterprise software products. Furthermore, we may not achieve or maintain
profitability in the future.
20
QUARTERLY RESULTS OF OPERATIONS
The following tables set forth a summary of our unaudited quarterly
operating results for each of the eight quarters in the period ended December
31, 2000. The information has been derived from our unaudited consolidated
financial statements that, in management's opinion, have been prepared on a
basis consistent with the audited consolidated financial statements contained
elsewhere in this annual report and include all adjustments, consisting of only
normal recurring adjustments, necessary for a fair presentation of this
information when read in conjunction with our audited consolidated financial
statements and notes thereto. The operating results for any quarter are not
necessarily indicative of results for any future period.
Quarter Ended
-------------------------------------------------------------------------------------
Mar. 31, June 30, Sept. 30, Dec. 31, March 31, June 30, Sept. 30, Dec. 31,
1999 1999 1999 1999 2000 2000 2000 2000
-------- -------- --------- -------- --------- --------- --------- -----------
(in thousands)
Consolidated Statement
of Operations Data:
Revenues:
License................ $ 1,209 $ 1,821 $ 2,781 $ 4,725 $ 7,329 $ 15,574 $ 23,730 $ 28,727
Service................ 280 517 998 1,733 3,361 9,909 16,913 13,704
------- ------- -------- -------- -------- --------- --------- -----------
Total revenues........ 1,489 2,338 3,779 6,458 10,690 25,483 40,643 42,431
------- ------- -------- -------- -------- --------- --------- -----------
Cost of revenues:
License................ 34 38 52 147 143 658 918 1,137
Service................ 498 851 2,191 3,070 4,032 10,772 16,354 25,043
------- ------- -------- -------- -------- --------- --------- -----------
Total cost of
revenues............. 532 889 2,243 3,217 4,175 11,430 17,272 26,180
------- ------- -------- -------- -------- --------- --------- -----------
Gross profit............ 957 1,449 1,536 3,241 6,515 14,053 23,371 16,251
------- ------- -------- -------- -------- --------- --------- -----------
Operating expenses:
Sales and marketing.... 2,479 4,180 5,482 9,058 11,210 21,338 25,749 29,889
Research and
development........... 2,329 2,732 3,384 4,409 5,239 11,059 12,993 13,433
General and
administrative........ 725 1,086 1,402 1,805 1,835 3,747 6,347 7,016
Amortization of stock-
based compensation.... 520 2,734 3,377 73,845 3,320 3,593 3,790 4,012
Amortization of
goodwill and
identifiable
intangibles........... -- -- -- -- -- 247,043 312,865 313,114
In process research and
development........... -- -- -- -- -- 6,900 -- --
Acquisition related
costs................. -- -- 910 4,725 -- 6,564 -- --
Goodwill impairment.... -- -- -- -- -- -- -- 2,084,841
------- ------- -------- -------- -------- --------- --------- -----------
Total operating
expenses............. 6,053 10,732 14,555 93,842 21,604 300,244 361,744 2,452,305
------- ------- -------- -------- -------- --------- --------- -----------
Operating loss.......... (5,096) (9,283) (13,019) (90,601) (15,089) (286,191) (338,373) (2,436,054)
Other income (expense),
net.................... (125) (394) (231) 6 644 1,247 2,039 904
------- ------- -------- -------- -------- --------- --------- -----------
Net loss................ $(5,221) $(9,677) $(13,250) $(90,595) $(14,445) $(284,944) $(336,334) $(2,435,150)
======= ======= ======== ======== ======== ========= ========= ===========
As a Percentage of Total
Revenues:
Revenues:
License................ 81.2% 77.9% 73.6% 73.2% 68.6% 61.1% 58.4% 67.7%
Service................ 18.8 22.1 26.4 26.8 31.4 38.9 41.6 32.3
------- ------- -------- -------- -------- --------- --------- -----------
Total revenues........ 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
------- ------- -------- -------- -------- --------- --------- -----------
Cost of revenues:
License................ 2.3 1.6 1.4 2.3 1.3 2.6 2.3 2.7
Service................ 33.4 36.4 58.0 47.5 37.7 42.3 40.2 59.0
------- ------- -------- -------- -------- --------- --------- -----------
Total cost of
revenues............. 35.7 38.0 59.4 49.8 39.0 44.9 42.5 61.7
------- ------- -------- -------- -------- --------- --------- -----------
Gross profit............ 64.3 62.0 40.6 50.2 61.0 55.1 57.5 38.3
------- ------- -------- -------- -------- --------- --------- -----------
Selected operating
expenses:
Sales and marketing.... 166.5 178.8 145.1 140.3 104.9 83.7 63.4 70.4
Research and
development........... 156.4 116.9 89.5 68.3 49.0 43.4 32.0 31.7
General and
administrative........ 48.7 46.4 37.1 27.9 17.2 14.7 15.6 16.5
21
The amount and timing of our operating expenses generally will vary from
quarter to quarter depending on our level of actual and anticipated business
activities. Our revenues and operating results are difficult to forecast and
will fluctuate, and we believe that period-to-period comparisons of our
operating results will not necessarily be meaningful. As a result, you should
not rely upon them as an indication of future performance.
Results of Operations
The following table sets forth selected data for the periods presented
expressed as a percentage of total revenues.
Years Ended
December 31,
-------------------
2000 1999 1998
----- ----- -----
Revenues:
License................................................ 63.2% 74.9% 85.8%
Service................................................ 36.8 25.1 14.2
----- ----- -----
Total revenues........................................ 100.0 100.0 100.0
----- ----- -----
Cost of revenues:
License................................................ 2.4 1.9 2.3
Service................................................ 47.1 47.0 28.4
----- ----- -----
Total cost of revenues................................ 49.5 48.9 30.7
----- ----- -----
Gross profit............................................ 50.5 51.1 69.3
Selected operating expenses:
Sales and marketing.................................... 74.0 150.7 234.5
Research and development............................... 35.8 91.4 241.5
General and administrative............................. 15.9 35.7 77.8
COMPARISON OF THE YEARS ENDED DECEMBER 31, 2000 AND 1999
Revenues
Total revenues increased by 748% to $119.2 million for the year ended
December 31, 2000 from $14.1 million for the year ended December 31, 1999
primarily as a result of increased license revenue. License revenues increased
by 615% to $75.4 million for the year ended December 31, 2000 from $10.5
million for 1999. This increase in license revenue was due primarily to
increased market acceptance of our products, expansion of our product line and
increased sales generated by our expanded sales force and the acquisition of
Silknet. License revenue represented 63% of total revenues for the year ended
December 31, 2000 and 75% of total revenues for 1999.
Service revenues increased by 1,144% to $43.9 million for the year ended
December 31, 2000 from $3.5 million for 1999. Service revenue increased
primarily due to increased licensing activity described above, resulting in
increased revenue from customer implementations, system integration projects,
maintenance contracts and hosted service. Service revenue represented 37% of
total revenues for the year ended December 31, 2000 and 25% of total revenues
for 1999.
Revenues from international sales were $19.5 million and $1.4 million in the
years ended December 31, 2000 and 1999. Our international revenues were derived
from sales in Europe, Canada, Asia Pacific and Latin America.
Cost of Revenues
Total cost of revenues increased by 758% to $59.1 million for the year ended
December 31, 2000 from $6.9 million for the year ended December 31, 1999,
primarily due to increased cost of service revenues. Cost
22
of license revenues increased by 954% to $2.9 million for the year ended
December 31, 2000 from $271,000 for the year ended December 31, 1999, the
increase mainly associated with increased license revenues and new third party
software royalties. As a percentage of license revenues, cost of license
revenues was 4% for the year ended December 31, 2000 and 3% for the year ended
December 31, 1999. Cost of license revenues includes third party software
royalties, product packaging, documentation, production and delivery costs for
shipments to customers.
Cost of service revenues consists primarily of salaries and related expenses
for our customer support, implementation and training services organization and
allocation of facility costs and system costs incurred in providing customer
support. Cost of service revenues increased by 750% to $56.2 million for the
year ended December 31, 2000 from $6.6 million for the year ended December 31,
1999. The growth in cost of service revenues was attributable to an increase in
personnel dedicated to support our growing number of customers and related
recruiting, travel, related facility and system costs and third party
consulting expenses. Additional increases are attributable to our acquisition
of Silknet and the inclusion of its cost of service revenues from the effective
date of the merger. As a percentage of service revenues, cost of service
revenues was 128% in 2000 and 187% in 1999. We anticipate that cost of service
revenue will be relatively stable in absolute dollars in future periods.
Operating Expenses
Sales and Marketing. Sales and marketing expenses consist primarily of
compensation and related costs for sales and marketing personnel and
promotional expenditures, including public relations, advertising, trade shows,
and marketing collateral materials. Sales and marketing expenses increased by
316% to $88.2 million for the year ended December 31, 2000 from $21.2 million
for the year ended December 31, 1999. This increase was attributable primarily
to the addition of sales and marketing personnel from internal growth and the
Silknet acquisition, the expansion of our international sales offices, an
increase in sales commissions associated with increased revenues and higher
marketing costs due to expanded advertising and promotional activities. As a
percentage of total revenues, sales and marketing expenses were 74% for the
year ended December 31, 2000 and 151% for the year ended December 31, 1999.
This decrease in sales and marketing expense as a percent of total revenues was
due primarily to the increase in total revenues over the prior period. We
anticipate that sales and marketing expenses will be relatively stable in
absolute dollars, but will vary as a percentage of total revenues from period
to period.
Research and Development. Research and development expenses consist
primarily of compensation and related costs for research and development
employees and contractors and enhancement of existing products and quality
assurance activities. Research and development expenses increased by 232% to
$42.7 million for the year ended December 31, 2000 from $12.9 million for the
year ended December 31, 1999. This increase was attributable primarily to the
addition of personnel, due to internal growth and the Silknet acquisition,
product development and related benefits, and consulting expenses. As a
percentage of total revenues, research and development expenses were 36% for
the year ended December 31, 2000 and 91% for the year ended December 31, 1999.
This decrease in research and development expense as a percent of total
revenues was due primarily to the increase in total revenues over the prior
period. We expect to continue to make investments in research and development,
but anticipate that research and development expenses will be relatively stable
in absolute dollars, but will vary as a percentage of total revenues from
period to period.
General and Administrative. General and administrative expenses increased by
278% to $18.9 million for the year ended December 31, 2000 from $5.0 million
for the year ended December 31, 1999, due primarily to increased personnel from
internal growth and the Silknet acquisition, increase in allowance for doubtful
accounts, increase in legal and other professional service provider fees. As a
percentage of total revenues, general and administrative expenses were 16% for
the year ended December 31, 2000 and 36% for the year ended December 31, 1999.
This decrease in general and administrative expenses as a percent of total
revenues was due primarily to the proportionately greater increase in total
revenues than general and administrative expenses over the prior period. We
expect that general and administrative expenses will be relatively stable in
absolute dollars. However, we expect that these expenses will vary as a
percentage of total revenues from period to period.
23
Amortization of Stock-Based Compensation
In connection with the granting of stock options to our employees, we
recorded unearned stock-based compensation totaling approximately $101.0
million through December 31, 2000. This amount represents the total difference
between the exercise prices of stock options and the deemed fair market value
of the underlying common stock for accounting purposes on the date these stock
options were granted. This amount is included as a component of stockholders'
equity and is being amortized on an accelerated basis by charges to operations
over the vesting period of the options, consistent with the method described
in FASB Interpretation No. 28.
On September 6, 2000, we issued to Accenture 400,000 shares of common stock
and a warrant to purchase up to 725,000 shares of common stock pursuant to a
stock and warrant purchase agreement in connection with our global strategic
alliance. The shares of the common stock issued were fully vested, and we have
recorded a charge of approximately $14.8 million to be amortized over the
four-year term of the agreement. The portion of the warrant to purchase
125,000 shares of common stock is fully vested with the remainder becoming
vested upon the achievement of certain performance goals. The vested warrants
were valued using the Black-Scholes model resulting in a charge of $1.0
million to be amortized over the four-year term of the agreement. We will
incur a charge to stock-based compensation for the unvested portion of the
warrant when performance goals are achieved.
On December 31, 2000, Accenture earned and vested in a portion of the
warrant to purchase 121,628 shares of common stock. This vesting of shares
resulted in a stock-based charge to operations of $968,000 during the quarter
ended December 31, 2000. As of December 31, 2000, shares of common stock under
the warrant which were unvested had a fair value of approximately $5.0 million
based upon the fair market value of our common stock at such date.
On February 28, 2001, we filed a tender offer statement on Schedule TO
announcing our offer to exchange certain eligible options outstanding under
the stock option plans for new options to purchase shares of our common stock
and for restricted shares of our common stock. The new options will be granted
on or after six months and one day after the date the tendered options are
accepted and cancelled. There are options to purchase approximately 18,000,000
shares of our common stock that could be exchanged if all the options eligible
under stock option plans were tendered by the employees. We will incur a
charge to compensation expense in connection with the issuance of the
restricted shares of common stock, based upon the fair market value of the
common stock at the time of the exchange. The charge to compensation expense
will be amortized over the six month vesting term of the restricted stock. Had
the compensation cost related to the maximum number of restricted shares
issuable under the offer been determined based upon the fair market value of
$3.0625 per share at the date of the tender offer, the total compensation
charge would have approximated $6.9 million.
As of December 31, 2000, there was approximately $21.6 million of total
unearned deferred stock-based compensation remaining to be amortized.
The amortization of stock-based compensation by operating expense is
detailed as follows (in thousands):
Years ended, December
31,
----------------------
2000 1999 1998
------- ------- ------
Cost of service...................................... $ 2,816 $19,752 $ 143
Sales and marketing.................................. 8,078 34,000 564
Research and development............................. 2,831 19,864 438
General and administrative........................... 990 6,860 311
------- ------- ------
Total............................................... $14,715 $80,476 $1,456
======= ======= ======
24
Amortization of Goodwill and Identifiable Intangibles
On April 19, 2000, we completed a merger with Silknet. As a result of the
merger, $3.8 billion was allocated to goodwill and identifiable intangibles.
This amount is being amortized on a straight-line basis over a period of three
years from the date of acquisition. We recorded $873.0 million in amortization
for the year ended December 31, 2000.
In Process Research and Development
In connection with the merger of Silknet, net intangibles of $6.9 million
were allocated to in process research and development. The fair value
allocation to in-process research and development was determined by identifying
the research projects for which technological feasibility has not been achieved
and which have no alternative future use at the merger date, assessing the
stage and expected date of completion of the research and development effort at
the merger date, and calculating the net present value of the cash flows
expected to result from the successful deployment of the new technology
resulting from the in-process research and development effort.
The stages of completion were determined by estimating the costs and time
incurred to date relative to the costs and time incurred to develop the in-
process technology into a commercially viable technology or product, while
considering the relative difficulty of completing the various tasks and
obstacles necessary to attain technological feasibility. As of the date of the
acquisition, Silknet had two projects in process that were 90% complete.
The estimated net present value of cash flows was based on incremental
future cash flows from revenues expected to be generated by the technologies in
the process of development, taking into account the characteristics and
applications of the technologies, the size and growth rate of existing and
future markets and an evaluation of past and anticipated technology and product
life cycles. Estimated net future cash flows included allocations of operating
expenses and income taxes but excluded the expected completion costs of the in-
process projects, and were discounted at a rate of 20% to arrive at a net
present value. The discount rate included a factor that took into account the
uncertainty surrounding the successful deployment of in-process technology
projects. This net present value was allocated to in-process research and
development based on the percentage of completion at the merger date.
Acquisition Related Costs
In connection with the Silknet merger, we recorded $6.6 million of
transaction costs and merger-related integration expenses. These amounts
consisted primarily of merger-related advertising and announcements of $4.5
million and duplicate facility costs of $1.0 million.
Goodwill Impairment
We performed an impairment assessment of the identifiable intangibles and
goodwill recorded in connection with the acquisition of Silknet. The assessment
was performed primarily due to the significant sustained decline in our stock
price since the valuation date of the shares issued in the Silknet acquisition
resulting in our net book value of our assets prior to the impairment charge
significantly exceeding our market capitalization, the overall decline in the
industry growth rates, and our lower fourth quarter of 2000 actual and
projected operating results. As a result of our review, we recorded a $2.1
billion impairment charge to reduce goodwill. The charge was determined based
upon our estimated discounted cash flows over the remaining estimated useful
life of the goodwill using a discount rate of 20%. The assumptions supporting
the cash flows including the discount rate were determined using our best
estimates as of such date. The remaining goodwill balance of approximately
$800.0 million will be amortized over its remaining useful life. We will
continue to assess the recoverability of the remaining goodwill and intangibles
periodically in accordance with our policy.
25
Other Income (Expense), net
Other income (expense), net in 2000 consists primarily of interest earned on
cash and short-term investments and in 1999, interest expense related to
warrants issued to convertible debt holders offset by interest income. Other
income (expense), net was income of $4.8 million for the year ended December
31, 2000 and expense of $744,000 for the year ended December 31, 1999. The
increase in other income (expense), net was primarily interest income earned on
higher average cash balances and lower interest expense paid on debt.
Provision for Income Taxes
We have incurred operating losses for all periods from inception through
December 31, 2000, and therefore have not recorded a provision for income
taxes. We have recorded a valuation allowance for the full amount of our gross
deferred tax assets, as the future realization of the tax benefit is not
currently likely.
As of December 31, 2000 and December 31, 1999, we had net operating loss
carryforwards for federal and state tax purposes of approximately $122.8
million and $53.6 million, respectively. These federal and state loss
carryforwards are available to reduce future taxable income. The federal loss
carryforwards expire at various dates into the year 2020. Under the provisions
of the Internal Revenue Code of 1986, as amended, substantial changes in
ownership may limit the amount of net operating loss carryforwards that could
be utilized annually in the future to offset taxable income.
Net Loss
Our net loss was $3.1 billion and $118.7 million for the years ended
December 31, 2000, and 1999 respectively. We have experienced substantial
increases in our expenditures since our inception consistent with growth in our
operations and personnel. In addition, goodwill impairment, amortization of
goodwill and identifiable intangibles and stock based compensation charges have
contributed to the significant increase in net loss during 2000. We anticipate
that our expenditures will continue to increase in the future. Although our
revenue has grown in recent quarters, we cannot be certain that we can sustain
this growth or that we will generate sufficient revenue to attain
profitability.
COMPARISON OF THE YEARS ENDED DECEMBER 31, 1999 AND 1998
Revenue
Total revenues increased by 500% to $14.1 million for the year ended
December 31, 1999 from $2.3 million for the year ended December 31, 1998.
License revenues increased by 423% to $10.5 million for the year ended December
31, 1999 from $2.0 million for 1998. This increase in license revenue was due
primarily to increased market acceptance of our products, expansion of our
product line and increased sales generated by our expanded sales force.
Service revenues increased by 960% to $3.5 million for the year ended
December 31, 1999 from $333,000 for 1998. Service revenue increased primarily
due to increased licensing activity, resulting in increased revenue from
maintenance contracts, customer implementations and hosted service. Service
revenue represented 25% of total revenues for the year ended December 31, 1999
and 14% of total revenues for 1998.
Cost of Revenues
Total cost of revenues increased by 856% to $6.9 million for the year ended
December 31, 1999 from $720,000 for the year ended December 31, 1998, primarily
due to increased cost of service revenues. Cost of service revenues increased
by 892% to $6.6 million for the year ended December 31, 1999 from $666,000 for
the year ended December 31, 1998. The growth in cost of service revenues was
attributable primarily to an increase in personnel dedicated to support our
growing number of customers and related recruiting and travel expenses as well
as facility expenses and system costs.
26
Operating Expenses
Sales and Marketing. Sales and marketing expenses increased by 285% to $21.2
million for the year ended December 31, 1999 from $5.5 million for the year
ended December 31, 1998. This increase was attributable primarily to the
addition of sales and marketing personnel, an increase in sales commissions and
higher marketing costs due to expanded promotional activities including
advertising and trade show participation.
Research and Development. Research and development expenses increased by
127% to $12.9 million for the year ended December 31, 1999 from $5.7 million
for the year ended December 31, 1998. This increase was attributable primarily
to the addition of personnel associated with product development and related
benefits and recruiting costs and related consulting expenses.
General and Administrative. General and administrative expenses consist
primarily of compensation and related costs for administrative personnel,
legal, accounting and other general corporate expenses. General and
administrative expenses increased by 175% to $5.0 million for the year ended
December 31, 1999 from $1.8 million for the year ended December 31, 1998, due
primarily to increased personnel, consultants, facilities expenses and outside
services necessary to support our growth.
Amortization of Stock-Based Compensation
In connection with the granting of stock options to employees, we recorded
stock-based compensation totaling approximately $97.0 million through December
31, 1999. Subsequent to the mergers with Business Evolution and netDialog, we
granted options to certain employees hired from the acquired companies for an
exercise price below the fair market value of the common stock. These options
immediately vested on the date of grant. The difference between the market
value of the underlying common stock and the exercise price of the options was
recorded as compensation expense in the fourth quarter of 1999 in the amount of
approximately $60.4 million.
Acquisition Related Costs
In connection with the merger with Connectify, we recorded a nonrecurring
charge for merger integration costs of $1.2 million consisting primarily of
transaction fees for attorneys and accountants of approximately $390,000 and
employee severance benefits and facility related costs of $780,000 in 1999.
In connection with the mergers with Business Evolution and netDialog, we
recorded a nonrecurring charge for merger integration costs of $4.5 million,
consisting primarily of transaction fees for attorneys and accountants of
approximately $1.5 million, advertising and announcements of $1.7 million
incurred as of December 31, 1999, charges for the elimination of duplicate
facilities of approximately $840,000 and severance costs and certain other
related costs of approximately $433,000.
Other Income (Expense), net
Other income (expense), net consists primarily of interest earned on cash
and short-term investments, offset by interest expense related to warrants
issued to convertible debt holders. Other income, net decreased by 428% to an
expense of $744,000 for the year ended December 31, 1999 from income of
$227,000 for 1998. The decrease in other income (expense), net was due
primarily to interest expense associated with warrants issued to convertible
debt holders offset by increased interest income earned on higher average cash
balances.
Liquidity and Capital Resources
In June 2000, we completed the private placement of 2,500,000 shares of our
common stock, raising net proceeds of approximately $120.0 million.
In September 1999, we completed the initial public offering of our common
stock and realized net proceeds from the offering of approximately $51.1
million. Prior to the initial public offering, we had financed
27
our operations primarily from private sales of convertible preferred and common
stock totaling $40.8 million and, to a lesser extent, from bank borrowings and
lease financing.
As of December 31, 2000, we had $76.5 million in cash, cash equivalents and
short-term investments and $54.2 million in working capital. We estimate that
we will have approximately $20.0 million in cash, cash equivalents and short-
term investments as of March 31, 2001.
Our operating activities used $90.7 million of cash for the year ended
December 31, 2000. These uses are primarily attributable to net losses
experienced during these periods as we invested in the development of our
products, expansion of our sales force and expansion of our infrastructure to
support our growth and increase in sales leading to an increase in accounts
receivable. Our operating activities used $25.7 million of cash for the year
ended December 31, 1999.
Our investing activities consisting primarily of net sales of short-term
investments, cash acquired from the acquisition of Silknet, offset by purchases
of computer equipment, furniture, fixtures and leasehold improvements to
support our growing number of employees, provided $22.4 million of cash for the
year ended December 31, 2000. Our investing activities used $44.4 million of
cash for the year ended December 31, 1999, which is primarily due to purchases
of short-term investments and computer equipment, furniture, fixtures and
leasehold improvements.
Our financing activities provided $126.2 million in cash for the year ended
December 31, 2000, primarily due to proceeds from the private placement in June
2000 of 2,500,000 shares of our common stock, raising net proceeds of
approximately $120.0 million. Our financing activities provided $75.0 million
for the year ended December 31, 1999, primarily from the net proceeds from our
initial public offering and proceeds from notes payable and issuance of
convertible preferred stock.
We have a line of credit totaling $10.0 million, which is secured by all of
our assets, bears interest at the bank's prime rate (9.5% as of December 31,
2000), and expires on July 31, 2001. The line of credit contains certain
financial covenants including: a quick asset ratio of at least 1.75 and a
tangible net worth of at least $60,000,000. We were in compliance with all debt
covenants as of December 31, 2000. Total borrowings as of December 31, 2000 and
1999 were $1,187,000 under this line of credit. The entire balance under this
line of credit is due on the expiration date, July 31, 2001. Our total bank
debt, including the borrowings under the line of credit, was $1.6 million at
December 31, 2000.
Our capital requirements depend on numerous factors. We expect to devote
resources to continue our research and development efforts, and expand our
sales, support, marketing and product development organizations. In addition,
although we have curtailed capital expenditures, we have made commitments to
establish additional facilities and infrastructure growth, which we will need
to fund.
We have experienced substantial increases in expenditures since our
inception consistent with growth in our operations and personnel, and we
anticipate that our expenditures will continue to increase in the future. To
reduce our expenditures, we recently restructured in several areas, including
reduced staffing, expense management and curtailed capital spending. For
example, in the first quarter of 2001, we reduced our workforce by
approximately 25%, in order to streamline operations, reduce costs and bring
our staffing and structure in line with industry standards. However, these
actions will not be sufficient for us to obtain a positive cash flow.
Therefore, we plan to further reduce our expenditures. Our auditors have
included a paragraph in their report indicating that substantial doubt exists
as to our ability to continue as a going concern. We are uncertain whether our
cash balance, collections on our accounts receivable and funding from projected
operations will be sufficient to meet our working capital and operating
resource expenditure requirements for the next 12 months and believe it will be
necessary for us to substantially increase revenues and reduce expenditures. If
we are unable to substantially increase revenues, reduce expenditures and
collect upon accounts receivable or if we incur unexpected expenditures, then
we will need to raise additional funds in order to continue as a going concern.
Especially in light of our declining stock price and the extreme volatility in
the technology capital markets, additional funding may not be available on
favorable terms or at all. In addition, although there are no present
understandings, commitments or agreements with respect to any acquisition of
28
other businesses, products or technologies, we may, from time to time, evaluate
potential acquisitions of other businesses, products and technologies. In order
to consummate potential acquisitions, we may issue additional securities or
need additional equity or debt financing and any financing may be dilutive to
existing investors.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 133 "Accounting for Derivative Instruments
and Hedging Activities." SFAS 133 establishes accounting and reporting
standards for derivative instruments and for hedging activities which is
effective in the first quarter of 2001. The adoption of SFAS 133 did not have
any material effect on our results of operations, financial position or cash
flows.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements." SAB
101 provides guidance for revenue recognition under certain circumstances. SAB
101 became effective in the quarter beginning October 1, 2000. The adoption of
SAB 101 did not have a material impact on our results of operations, financial
position or cash flows.
RISK FACTORS
Our future operating results may vary substantially from period to period.
The price of our common stock will fluctuate in the future, and an investment
in our common stock is subject to a variety of risks, including but not limited
to the specific risks identified below. Inevitably, some investors in our
securities will experience gains while others will experience losses depending
on the prices at which they purchase and sell securities. Prospective and
existing investors are strongly urged to carefully consider the various
cautionary statements and risks set forth in this report and our other public
filings.
This report contains forward-looking statements that are not historical
facts but rather are based on current expectations, estimates and projections
about our business and industry, our beliefs and assumptions. Words such as
"anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates"
and variations of these words and similar expressions are intended to identify
forward-looking statements. These statements are not guarantees of future
performance and are subject to risks, uncertainties and other factors, some of
which are beyond our control, are difficult to predict and could cause actual
results to differ materially from" those expressed or forecasted in the
forward-looking statements. These risks and uncertainties include those
described in "Risks Related to Our Business,""Risks Related to Our Industry"
and elsewhere in this report. Forward-looking statements that were true at the
time made may ultimately prove to be incorrect or false. Readers are cautioned
not to place undue reliance on forward-looking statements, which reflect our
management's view only as of the date of this report. Except as required by
law, we undertake no obligation to update any forward-looking statement,
whether as a result of new information, future events or otherwise.
Risks Related to Our Business
Because we have a limited operating history, there is limited information upon
which you can evaluate our business
We are still in the early stages of our development, and our limited
operating history makes it difficult to evaluate our business and prospects. We
were incorporated in July 1996 and first recorded revenue in February 1998.
Thus, we have a limited operating history upon which you can evaluate our
business and prospects. Due to our limited operating history, it is difficult
or impossible to predict future results of operations. For example, we cannot
forecast operating expenses based on our historical results because they are
limited, and we are required to forecast expenses in part on future revenue
projections. Moreover, due to our limited operating history, any evaluation of
our business and prospects must be made in light of the risks and uncertainties
often encountered by early-stage companies in Internet-related markets. Many of
these risks are discussed in the subheadings below, and include our ability to:
. attract more customers;
. implement our sales, marketing and after-sales service initiatives, both
domestically and internationally;
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. execute our product development activities;
. anticipate and adapt to the changing Internet market;
. attract, retain and motivate qualified personnel;
. respond to actions taken by our competitors;
. continue to build an infrastructure to effectively manage growth and
handle any future increased usage; and
. integrate acquired businesses, technologies, products and services.
If we are unsuccessful in addressing these risks or in executing our
business strategy, our business, results of operations and financial condition
would be materially and adversely affected.
Our quarterly revenues and operating results may fluctuate in future periods
and we may fail to meet expectations, which may cause the price of our common
stock to decline
Our quarterly revenues and operating results are difficult to predict and
may fluctuate significantly from quarter to quarter particularly because our
products and services are relatively new and our prospects uncertain. If
quarterly revenues or operating results fall below the expectations of
investors or public market analysts, the price of our common stock could
decline substantially. Factors that might cause quarterly fluctuations in our
operating results include the factors described in the subheadings below as
well as:
. the evolving and varying demand for customer communication software
products and services for e-businesses, particularly our products and
services;
. budget and spending decisions by information technology departments of
our customers;
. costs associated with integrating our recent acquisitions, and costs
associated with any future acquisitions;
. our ability to manage our expenses;
. the timing of new releases of our products;
. the discretionary nature of our customers' purchasing and budgetary
cycles;
. changes in our pricing policies or those of our competitors;
. the timing of execution of large contracts that materially affect our
operating results;
. the mix of sales channels through which our products and services are
sold;
. the mix of our domestic and international sales;
. costs related to the customization of our products;
. our ability to expand our operations, and the amount and timing of
expenditures related to this expansion; and
. decisions by customers and potential customers to delay purchasing our
products; and
. global economic conditions, as well as those specific to large
enterprises with high e-mail volume.
We also often offer volume-based pricing, which may affect operating
margins. Most of our expenses, such as employee compensation and rent, are
relatively fixed in the short term. Moreover, our expense levels are based, in
part, on our expectations regarding future revenue levels. As a result, if
total revenues for a particular quarter are below expectations, we could not
proportionately reduce operating expenses for that quarter. Therefore, this
revenue shortfall would have a disproportionate effect on our expected
operating results for that quarter. In addition, because our service revenue is
largely correlated with our license revenue, a decline in license revenue could
also cause a decline in service revenue in the same quarter or in subsequent
quarters.
30
Due to the foregoing factors, we believe that quarter-to-quarter comparisons
of our operating results are not a good indication of our future performance.
We have a history of losses and may not be profitable in the future and may not
be able to generate sufficient revenue or funding to continue as a going
concern
Since we began operations in 1997, our revenues have not been sufficient to
support our operations, and we have incurred substantial operating losses in
every quarter. As a result of accumulated operating losses, we have a
significant accumulated deficit. This has caused some of our potential
customers to question our viability, which has in turn hampered our ability to
sell some of our products. Since inception, we have funded our business
primarily through selling our stock, not from cash generated by our business.
Our growth in recent periods has been from a limited base of customers, and we
may not be able to increase revenues sufficiently to keep pace with our growing
expenditures. We may not be able to increase the growth of our revenues in the
future. As a result, we expect to continue to experience losses and negative
cash flows, even if sales of our products and services continue to grow, and we
may not generate sufficient revenues to achieve profitability in the future.
Accordingly, we plan to reduce our operating expenses and may require
additional financing. There can be no assurance that any such financing would
be available on acceptable terms, if at all. With the decline in our stock
price, any such financing is likely to be dilutive to existing stockholders.
Our auditors have included a paragraph in their report indicating that
substantial doubt exists as to our ability to continue as a going concern.
We may incur non-cash charges related to issuances of our equity which could
harm our operating results
Further, in connection with the issuance of 400,000 shares of our common
stock and a warrant to purchase up to 725,000 shares of our common stock to
Accenture pursuant to a stock and warrant purchase agreement dated September 6,
2000, we will incur substantial charges to stock-based compensation. With
respect to the 400,000 shares of common stock, we recorded $14.8 million of
deferred stock-based compensation which will be amortized over the four-year
term of our global strategic alliance with Accenture based upon the fair market
value of our common stock on September 6, 2000, the date of closing, of $37.125
per share. With respect to the warrant, 125,000 shares of common stock were
fully vested and exercisable under the warrant and were valued on September 6,
2000 using the Black-Scholes model and are being amortized over four years. On
the unearned portion of the warrant, we will incur a charge to stock-based
compensation when certain performance goals are achieved. This charge will be
measured using the Black-Scholes valuation model and the fair market value of
our common stock at the time of achievement of these goals. Accordingly,
significant increases in our stock price could result in substantial non-cash
accounting charges and variations in our results of operations.
If we do achieve profitability, we may not be able to sustain or increase
any profitability on a quarterly or annual basis in the future.
We may be unable to hire and retain the skilled personnel necessary to develop
our engineering, professional services and support capabilities in order to
continue to grow
We may increase our sales, marketing, engineering, professional services and
product management personnel in the future. Competition for these individuals
is intense, and we may not be able to attract, assimilate or retain highly
qualified personnel in the future. Our business cannot continue to grow if we
cannot attract qualified personnel. Our failure to attract and retain the
highly trained personnel that are integral to our product development and
professional services group, which is the group responsible for implementation
and customization of, and technical support for, our products and services, may
limit the rate at which we can develop and install new products or product
enhancements, which would harm our business. We may need to increase our staff
to support new customers and the expanding needs of our existing customers,
without compromising the quality of our customer service. Since our inception,
a number of employees have left or have been terminated, and we expect to lose
more employees in the future. Recently, we restructured our organization and
terminated a significant number of employees in the process. Hiring qualified
professional
31
services personnel, as well as sales, marketing, administrative and research
and development personnel, is very competitive in our industry, particularly in
the San Francisco Bay Area, where we are headquartered, due to the limited
number of people available with the necessary technical skills. We face greater
difficulty attracting these personnel with equity incentives as a public
company than we did as a privately held company. In addition, in light of our
recent workforce reduction, we may face additional difficulty in attracting and
retaining these professionals and other key personnel. Also, the workforce
reduction may adversely affect the morale of, and our ability to retain, those
employees who are not being terminated. Because our stock price has recently
suffered a significant decline, stock-based compensation, including options to
purchase our common stock, may have diminished effectiveness as employee hiring
and retention devices. If our retention efforts are ineffective, employee
turnover could increase and our ability to provide client service and execute
our strategy would be negatively affected.
We may face difficulties in hiring and retaining qualified sales personnel to
sell our products and services, which could harm our ability to increase our
revenues in the future
Our financial success depends to a large degree on the ability of our direct
sales force to increase sales to a level required to adequately fund marketing
and product development activities. Therefore, our ability to increase revenues
in the future depends considerably upon our success in recruiting, training and
retaining additional direct sales personnel and the success of the direct sales
force. Also, it may take a new salesperson a number of months before he or she
becomes a productive member of our sales force. Our business will be harmed if
we fail to hire or retain qualified sales personnel, or if newly hired
salespeople fail to develop the necessary sales skills or develop these skills
more slowly than we anticipate.
Our workforce reduction and financial performance may adversely affect the
morale and performance of our personnel and our ability to hire new personnel
In connection with our effort to streamline operations, reduce costs and
bring our staffing and structure in line with industry standards, we recently
restructured our organization in the first quarter of 2001with reductions in
our workforce by approximately 300 employees. There may be costs associated
with the workforce reduction related to severance and other employee-related
costs, and our restructuring plan may yield unanticipated consequences, such as
attrition beyond our planned reduction in workforce. In addition, recent
trading levels of our common stock have decreased the value of the stock
options granted to employees pursuant to our stock option plans. We recently
filed a tender offer statement on Schedule TO announcing our offer to exchange
certain eligible options outstanding under our stock option plans for new
options to purchase shares of our common stock and for restricted shares of our
common stock. Our employees may not elect to tender their options outstanding
in exchange for new options and restricted stock and thus the intended result
of the shares exchange program, to create performance and retention incentives,
may not be realized. As a result of these factors, our remaining personnel may
seek employment with larger, more established companies or companies they
perceive as having less volatile stock prices.
We have appointed a new chief executive officer, a new president, a new interim
chief financial officer, and a new chief operating officer, and the integration
of these officers may interfere with our operations
In February 2001, we announced the appointment of Art. M. Rodriguez as our
interim chief financial officer, replacing James C. Wood, our chief executive
officer and chairman of the board, who was appointed as our interim chief
financial officer in January, 2001. In January 2001, we announced the
appointment of James C. Wood as our new chief executive officer, interim chief
financial officer and chairman of the board, in connection with the January
2001 resignations of our former chief executive officer and chairman of the
board, Michael J. McCloskey, for health reasons, and of our former chief
financial officer, Brian K. Allen, for personal reasons. We also announced the
appointment of David B. Fowler as our new president and Nigel K. Donovan as our
new chief operating officer. The transitions of Messrs. Rodriguez, Wood, Fowler
and Donovan has resulted and will continue to result in disruption to our
ongoing operations, and these transitions may materially harm the way that the
market perceives our company and the price of our common stock.
32
Loss of our Chief Executive Officer or any of our executive officers could harm
our business
Our future success depends to a significant degree on the skills, experience
and efforts of our senior management. In particular, we depend upon the
continued services of Mr. Wood. The loss of the services of Mr. Wood or any of
our executive officers could harm our business and operations. In addition, we
have not obtained life insurance benefiting us on any of our employees or
entered into employment agreements with our key employees. If any of our key
employees left or was seriously injured and unable to work and we were unable
to find a qualified replacement, our business could be harmed.
We face substantial competition and may not be able to compete effectively
The market for our products and services is intensely competitive, evolving
and subject to rapid technological change. In addition, changes in the
perceived needs of customers for specific products, features and services may
result in our products becoming uncompetitive. We expect the intensity of
competition to increase in the future. Increased competition may result in
price reductions, reduced gross margins and loss of market share.
We currently face competition for our products from systems designed by in-
house and third-party development efforts. We expect that these systems will
continue to be a principal source of competition for the foreseeable future.
Our competitors include a number of companies offering one or more products for
the e-business communications and relationship management market, some of which
compete directly with our products. For example, our competitors include
companies providing stand-alone point solutions, including Annuncio, Inc.,
AskJeeves, Inc., Brightware, Inc., Broadbase, Inc., Digital Impact, Inc., eGain
Communications Corp., E.piphany, Inc., Inference Corp., Marketfirst, Inc., Live
Person, Inc., Mustang Software, Inc. (which was acquired by Quintus
Corporation), Responsys.com and Servicesoft, Inc. (which was acquired by
Broadbase Software, Inc.). In addition, we compete with companies providing
traditional, client-server based customer management and communications
solutions, such as Clarify Inc. (which was acquired by Northern Telecom),
Alcatel, Cisco Systems, Inc., Lucent Technologies, Inc., Message Media, Inc.,
Oracle Corporation, Pivotal Corporation, Siebel Systems, Inc. and Vantive
Corporation (which was acquired by PeopleSoft, Inc.). Changes in our products
may also impact the ability of our sales force to effectively sell.
Furthermore, we may face increased competition should we expand our product
line, through acquisition of complementary businesses or otherwise.
Many of our competitors have longer operating histories, significantly
greater financial, technical, marketing and other resources, significantly
greater name recognition and a larger installed base of customers than we have.
In addition, many of our competitors have well-established relationships with
our current and potential customers and have extensive knowledge of our
industry. We may lose potential customers to competitors for various reasons,
including the ability or willingness of competitors to offer lower prices and
other incentives that we cannot match. Accordingly, it is possible that new
competitors or alliances among competitors may emerge and rapidly acquire
significant market share. We also expect that competition will increase as a
result of recently-announced industry consolidations, as well as future
consolidations.
We may not be able to compete successfully against current and future
competitors, and competitive pressures may seriously harm our business.
Our failure to consummate our expected sales in any given quarter could
dramatically harm our operating results because of the large size of typical
orders
Our sales cycle is subject to a number of significant risks, including
customers' budgetary constraints and internal acceptance reviews, over which we
have little or no control. Consequently, if sales expected from a specific
customer in a particular quarter are not realized in that quarter, we are
unlikely to be able to generate revenue from alternate sources in time to
compensate for the shortfall. As a result, and due to the relatively large size
of a typical order, a lost or delayed sale could result in revenues that are
lower than expected. Moreover, to the extent that significant sales occur
earlier than anticipated, revenues for subsequent quarters may be lower than
expected.
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We may not be able to forecast our revenues accurately because our products
have a long and variable sales cycle
The long sales cycle for our products may cause license revenue and
operating results to vary significantly from period to period. To date, the
sales cycle for our products has taken 3 to 12 months in the United States and
longer in foreign countries. Our sales cycle has required pre-purchase
evaluation by a significant number of individuals in our customers'
organizations. Along with third parties that often jointly market our software
with us, we invest significant amounts of time and resources educating and
providing information to prospective customers regarding the use and benefits
of our products. Many of our customers evaluate our software slowly and
deliberately, depending on the specific technical capabilities of the customer,
the size of the deployment, the complexity of the customer's network
environment, and the quantity of hardware and the degree of hardware
configuration necessary to deploy our products. In the event of an economic
downturn, the sales cycle for our products may become longer and it may require
more resources to complete sales.
Our stock price has been highly volatile and has experienced a significant
drop, particularly because our business depends on the Internet, and may
continue to be volatile and drop
The trading price of our common stock has fluctuated widely in the past and
is expected to continue to do so in the future, as a result of a number of
factors, many of which are outside our control. In addition, the stock market
has experienced extreme price and volume fluctuations that have affected the
market prices of many technology and computer software companies, particularly
Internet-related companies, and that have often been unrelated or
disproportionate to the operating performance of these companies. These broad
market fluctuations could adversely affect the market price of our common
stock. In the past, following periods of volatility in the market price of a
particular company's securities, securities class action litigation has often
been brought against that company. Securities class action litigation could
result in substantial costs and a diversion of our management's attention and
resources. Our common stock reached a high of $175.50 and traded as low as
$8.25 in the year 2000, and on February 28, 2001 the last reported sales price
of the shares on the Nasdaq Stock Market was $3.0625.
Future sales of stock could affect our stock price
If our stockholders sell substantial amounts of our common stock, including
shares issued upon the exercise of outstanding options and warrants, in the
public market, the market price of our common stock could fall. These sales
also might make it more difficult for us to sell equity or equity-related
securities in the future at a time and price that we deem appropriate.
Difficulties in implementing our products could harm our revenues and margins
Forecasting our revenues depends upon the timing of implementation of our
products. This implementation typically involves working with sophisticated
software, computing and communications systems. If we experience difficulties
with implementation or do not meet project milestones in a timely manner, we
could be obligated to devote more customer support, engineering and other
resources to a particular project. Some customers may also require us to
develop customized features or capabilities. If new or existing customers have
difficulty deploying our products or require significant amounts of our
professional services support or customized features, our revenue recognition
could be further delayed and our costs could increase, causing increased
variability in our operating results.
Our business depends on the acceptance of our products and services, and it is
uncertain whether the market will accept our products and services
We are not certain that our target customers will widely adopt and deploy
our products and services. Our future financial performance will depend on the
successful development, introduction and customer acceptance of new and
enhanced versions of our products and services. In the future, we may not be
successful in marketing our products and services, including any new or
enhanced products.
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A failure to manage our internal operating and financial functions could lead
to inefficiencies in conducting our business and subject us to increased
expenses
Our ability to offer our products and services successfully in a rapidly
evolving market requires an effective planning and management process. We have
limited experience in managing rapid growth. We have recently experienced a
period of growth that has placed a significant strain on our managerial,
financial and personnel resources. Our business will suffer if we fail to
manage this growth successfully. Our number of employees has grown more than
ten-fold since June 30, 1999, when we had 98 employees, and we expect to
continue to hire new employees at a rapid rate. Moreover, we will need to
assimilate substantially all of Silknet's operations into our operations. The
rate of our recent growth has made management of that growth more difficult.
Any additional growth will further strain our management, financial, personnel,
internal training and other resources. To manage any future growth effectively,
we must improve our financial and accounting systems, controls, reporting
systems and procedures, integrate new personnel and manage expanded operations.
Any failure to do so could negatively affect the quality of our products, our
ability to respond to our customers and retain key personnel, and our business
in general.
Delays in the development of new products or enhancements to existing products
would hurt our sales and damage our reputation
To be competitive, we must develop and introduce on a timely basis new
products and product enhancements for companies with significant e-business
customer interactions needs. Our ability to deliver competitive products may be
impacted by the resources we have to devote to the suite of products, the rate
of change of competitive products and required company responses to changes in
the demands of our customers. Any failure to do so could harm our business. If
we experience product delays in the future, we may face:
. customer dissatisfaction;
. cancellation of orders and license agreements;
. negative publicity;
. loss of revenues;
. slower market acceptance; and
. legal action by customers.
In the future, our efforts to remedy this situation may not be successful
and we may lose customers as a result. Delays in bringing to market new
products or their enhancements, or the existence of defects in new products or
their enhancements, could be exploited by our competitors. If we were to lose
market share as a result of lapses in our product management, our business
would suffer.
Technical problems with either our internal or outsourced computer and
communications systems could interrupt our Kana Online service
The success of the Kana Online service depends on the recruitment and
retainment of qualified staff as well as the efficient and uninterrupted
operation of our own and outsourced computer and communications hardware and
software systems. These systems and operations are vulnerable to damage or
interruption from human error, natural disasters, telecommunications failures,
break-ins, sabotage, computer viruses, intentional acts of vandalism and
similar adverse events. We have entered into an Internet-hosting agreement with
two data center's, Exodus Communications, Inc. to maintain all of the Kana
Online servers at Exodus' data center in Santa Clara, California servicing our
West Coast Customers, and UUNET's data center in Princeton, New Jersey
servicing our East Coast customers. Our operations depend on both Exodus' and
UUNET's ability to protect its and our systems in Exodus' and UUNET's data
center against damage or interruption. Both data centers do not guarantee that
our Internet access will be uninterrupted, error-free or secure. We have no
formal disaster recovery plan in the event of damage or interruption, and our
insurance policies may not adequately
35
compensate us for any losses that we may incur. Any system failure that causes
an interruption in our service or a decrease in responsiveness could harm our
relationships with customers and result in reduced revenues.
We are currently contemplating outsourcing the management and operation of
the Kana Online service. If we proceed with such plan with a third party, we
may have less control over the operations of the service, which could also harm
our relationships with customers and result in reduced revenues.
If we fail to build skills necessary to sell our Kana Online service, we will
lose revenue opportunities and our sales will suffer
The skills necessary to market and sell Kana Online are different from those
relating to our software products. We license our software products for a fixed
fee based on the number of concurrent users and the optional applications
purchased. We license Kana Online based on a fixed fee for installation,
configuration and training, and a variable monthly component depending on
actual customer usage. Our sales force sells both our software products and
Kana Online. Because different skills are necessary to sell Kana Online as
compared to selling software products, our sales and marketing groups may not
be able to maintain or increase the level of sales of either Kana Online or our
software products.
Our pending patents may never be issued and, even if issued, may provide little
protection
Our success and ability to compete depend to a significant degree upon the
protection of our software and other proprietary technology rights. We regard
the protection of patentable inventions as important to our future
opportunities. We currently have one issued U.S. patent and eight U.S. patent
applications pending relating to our software. Although we have filed four
international patent applications corresponding to four of our U.S. patent
applications, none of our technology is patented outside of the United States.
It is possible that:
. our pending patent applications may not result in the issuance of
patents;
. any patents issued may not be broad enough to protect our proprietary
rights;
. any issued patent could be successfully challenged by one or more third
parties, which could result in our loss of the right to prevent others
from exploiting the inventions claimed in those patents;
. current and future competitors may independently develop similar
technology, duplicate our products or design around any of our patents;
and
. effective patent protection may not be available in every country in
which we do business.
We rely upon trademarks, copyrights and trade secrets to protect our
proprietary rights, which may not be sufficient to protect our intellectual
property
We also rely on a combination of laws, such as copyright, trademark and
trade secret laws, and contractual restrictions, such as confidentiality
agreements and licenses, to establish and protect our proprietary rights. In
the United States, we currently have a registered trademark, "Kana," and seven
pending trademark applications, including trademark applications for our logo
and "KANA COMMUNICATIONS and Design." Outside of the United States, we have two
trademark registrations in the European Union, one trademark registration in
Australia, and we have additional trademark applications pending in Australia,
Canada, the European Union, India, Japan, South Korea and Taiwan. However,
despite the precautions that we have taken:
. laws and contractual restrictions may not be sufficient to prevent
misappropriation of our technology or deter others from developing
similar technologies;
. current federal laws that prohibit software copying provide only limited
protection from software "pirates," and effective trademark, copyright
and trade secret protection may be unavailable or limited in foreign
countries;
. other companies may claim common law trademark rights based upon state or
foreign laws that precede the federal registration of our marks; and
36
. policing unauthorized use of our products and trademarks is difficult,
expensive and time-consuming, and we may be unable to determine the
extent of this unauthorized use.
Also, the laws of other countries in which we market our products may offer
little or no effective protection of our proprietary technology. Reverse
engineering, unauthorized copying or other misappropriation of our proprietary
technology could enable third parties to benefit from our technology without
paying us for it, which would significantly harm our business.
We may become involved in litigation over proprietary rights, which could be
costly and time consuming
Substantial litigation regarding intellectual property rights exists in our
industry. We expect that software in our industry may be increasingly subject
to third-party infringement claims as the number of competitors grows and the
functionality of products in different industry segments overlaps. Third
parties may currently have, or may eventually be issued, patents upon which our
products or technology infringe. Any of these third parties might make a claim
of infringement against us. Many of our software license agreements require us
to indemnify our customers from any claim or finding of intellectual property
infringement. Any litigation, brought by us or others, could result in the
expenditure of significant financial resources and the diversion of
management's time and efforts. In addition, litigation in which we are accused
of infringement might cause product shipment delays, require us to develop non-
infringing technology or require us to enter into royalty or license
agreements, which might not be available on acceptable terms, or at all. If a
successful claim of infringement were made against us and we could not develop
non-infringing technology or license the infringed or similar technology on a
timely and cost-effective basis, our business could be significantly harmed.
We may face higher costs and lost sales if our software contains errors
We face the possibility of higher costs as a result of the complexity of our
products and the potential for undetected errors. Due to the mission-critical
nature of our products and services, undetected errors are of particular
concern. We have only a few "beta" customers that test new features and
functionality of our software before we make these features and functionalities
generally available to our customers. If our software contains undetected
errors or we fail to meet customers' expectations in a timely manner, we could
experience:
. loss of or delay in revenues expected from the new product and an
immediate and significant loss of market share;
. loss of existing customers that upgrade to the new product and of new
customers;
. failure to achieve market acceptance;
. diversion of development resources;
. injury to our reputation;
. increased service and warranty costs;
. legal actions by customers; and
. increased insurance costs.
We may face liability claims that could result in unexpected costs and damage
to our reputation
Our licenses with customers generally contain provisions designed to limit
our exposure to potential product liability claims, such as disclaimers of
warranties and limitations on liability for special, consequential and
incidental damages. In addition, our license agreements generally cap the
amounts recoverable for damages to the amounts paid by the licensee to us for
the product or service giving rise to the damages. However, these contractual
limitations on liability may not be enforceable and we may be subject to claims
based on errors in our software or mistakes in performing our services
including claims relating to damages to our customers' internal systems. A
product liability claim, whether or not successful, could harm our business by
increasing our costs, damaging our reputation and distracting our management.
37
Our international operations could divert management attention and present
financial issues
Our international operations are located throughout Europe, Australia,
Japan, Singapore and Brazil, and, to date, have been limited. We may expand our
existing international operations and establish additional facilities in other
parts of the world. We may face difficulties in accomplishing this expansion,
including finding adequate staffing and management resources for our
international operations. The expansion of our existing international
operations and entry into additional international markets will require
significant management attention and financial resources. In addition, in order
to expand our international sales operations, we will need to, among other
things:
. expand our international sales channel management and support
organizations;
. customize our products for local markets; and
. develop relationships with international service providers and additional
distributors and system integrators.
Our investments in establishing facilities in other countries may not
produce desired levels of revenues. Even if we are able to expand our
international operations successfully, we may not be able to maintain or
increase international market demand for our products. In addition, we have
only licensed our products internationally since January 1999 and have limited
experience in developing localized versions of our software and marketing and
distributing them internationally. Localizing our products may take longer than
we anticipate due to difficulties in translation and delays we may experience
in recruiting and training international staff.
Our growth could be limited if we fail to execute our plan to expand
internationally
For the twelve month periods ended December 31, 2000 and December 31, 1999,
we derived approximately 16% and 10%, respectively, of our total revenues from
sales outside North America. We have established offices in the United Kingdom,
Australia, Germany, Japan, Holland, France, Spain, Sweden, Singapore and
Brazil. As a result, we face risks from doing business on an international
basis, any of which could impair our internal revenues. We could, in the
future, encounter greater difficulty in accounts receivable collection, longer
sales cycles and collection periods or seasonal reductions in business
activity. In addition, our international operations could cause our average tax
rate to increase. Any of these events could harm our international sales and
results of operations.
International laws and regulations may expose us to potential costs and
litigation
Our international operations will increase our exposure to international
laws and regulations. If we cannot comply with foreign laws and regulations,
which are often complex and subject to variation and unexpected changes, we
could incur unexpected costs and potential litigation. For example, the
governments of foreign countries might attempt to regulate our products and
services or levy sales or other taxes relating to our activities. In addition,
foreign countries may impose tariffs, duties, price controls or other
restrictions on foreign currencies or trade barriers, any of which could make
it more difficult for us to conduct our business. The European Union has
enacted its own privacy regulations that may result in limits on the collection
and use of certain user information, which, if applied to the sale of our
products and services, could negatively impact our results of operations.
We may suffer foreign exchange rate losses
Our international revenues and expenses are denominated in local currency.
Therefore, a weakening of other currencies versus the U.S. dollar could make
our products less competitive in foreign markets and could negatively affect
our operating results and cash flows. We do not currently engage in currency
hedging activities. We have not yet but may in the future experience
significant foreign currency transaction losses, especially to the extent that
we do not engage in hedging.
38
Our prospects for obtaining additional financing, if required, are uncertain
and failure to obtain needed financing could affect our ability to pursue
future growth
We may need to raise additional funds to develop or enhance our products or
services, to fund expansion, to respond to competitive pressures or to acquire
complementary products, businesses or technologies. We do not have a long
enough operating history to know with certainty whether our existing cash and
expected revenues will be sufficient to finance our anticipated growth.
Additional financing may not be available on terms that are acceptable to us.
If we raise additional funds through the issuance of equity or convertible debt
securities, the percentage ownership of our stockholders would be reduced and
these securities might have rights, preferences and privileges senior to those
of our current stockholders. If adequate funds are not available on acceptable
terms, our ability to fund any potential expansion, take advantage of
unanticipated opportunities, develop or enhance products or services, or
otherwise respond to competitive pressures would be significantly limited.
We have completed four mergers, and those mergers may result in disruptions to
our business and management due to difficulties in assimilating personnel and
operations
We may not realize the benefits from the significant mergers we have
completed. In August 1999, we acquired Connectify, and in December 1999, we
acquired netDialog and Business Evolution. On April 19, 2000, we completed our
merger with Silknet. We may not be able to successfully assimilate the
additional personnel, operations, acquired technology and products into our
business. In particular, we will need to assimilate and retain key professional
services, engineering and marketing personnel. This is particularly difficult
with Business Evolution and Silknet, since their operations are located on the
east coast and we are headquartered on the west coast. Key personnel from the
acquired companies have in certain instances decided, and they may in the
future decide, that they do not want to work for us. In addition, products of
these companies will have to be integrated into our products, and it is
uncertain whether we may accomplish this easily or at all. These difficulties
could disrupt our ongoing business, distract management and employees or
increase expenses. Acquisitions are inherently risky and we may also face
unexpected costs, which may adversely affect operating results in any quarter.
The merger of Silknet into our company could adversely affect combined
financial results
If the benefits of the merger of Silknet into our company do not exceed the
costs associated with the merger, including any dilution to our stockholders
resulting from the issuance of shares in connection with the merger, our
financial results, including earnings per share, could be adversely affected.
In addition, we have recorded goodwill and intangible assets of approximately
$3.8 billion in connection with the merger.
As a result of the acquisition of Silknet, we recorded significant
intangible assets which, in accordance with generally accepted accounting
principles, are required to be reviewed for impairment when events or changes
in circumstances indicate that the carrying amount of an asset may not be
recoverable. In the fourth quarter of 2000, we reviewed the goodwill and
intangible assets related to the merger with Silknet for impairment and, as a
result of our review, we recorded an impairment charge of $2.1 billion.
If we acquire additional companies, products or technologies, we may face risks
similar to those faced in our other mergers
If we are presented with appropriate opportunities, we intend to make other
investments in complementary companies, products or technologies. We may not
realize the anticipated benefits of any other acquisition or investment. If we
acquire another company, we will likely face the same risks, uncertainties and
disruptions as discussed above with respect to our other mergers. Furthermore,
we may have to incur debt or issue equity securities to pay for any additional
future acquisitions or investments, the issuance of which could be dilutive to
our company or our existing stockholders. In addition, our profitability may
suffer because of acquisition-related costs or amortization costs for acquired
goodwill and other intangible assets.
39
Our executive officers and directors can exercise significant influence over
stockholder voting matters
As of February 28, 2001, our executive officers and directors, and their
affiliates together control approximately 16.43% of our outstanding common
stock. As a result, these stockholders, if they act together, will have a
significant impact on all matters requiring approval of our stockholders,
including the election of directors and significant corporate transactions.
This concentration of ownership may delay, prevent or deter a change in control
of our company, could deprive our stockholders of an opportunity to receive a
premium for their common stock as part of a sale of our company or our assets
and might affect the market price of our common stock.
We have adopted anti-takeover defenses that could delay or prevent an
acquisition of our company
Our board of directors has the authority to issue up to 5,000,000 shares of
preferred stock. Moreover, without any further vote or action on the part of
the stockholders, the board of directors has the authority to determine the
price, rights, preferences, privileges and restrictions of the preferred stock.
This preferred stock, if issued, might have preference over and harm the rights
of the holders of common stock. Although the issuance of this preferred stock
will provide us with flexibility in connection with possible acquisitions and
other corporate purposes, this issuance may make it more difficult for a third
party to acquire a majority of our outstanding voting stock. We currently have
no plans to issue preferred stock.
Our certificate of incorporation, bylaws and equity compensation plans
include provisions that may deter an unsolicited offer to purchase our company.
These provisions, coupled with the provisions of the Delaware General
Corporation Law, may delay or impede a merger, tender offer or proxy contest
involving our company. Furthermore, our board of directors is divided into
three classes, only one of which is elected each year. Directors are removable
by the affirmative vote of at least 66 2/3% of all classes of voting stock.
These factors may further delay or prevent a change of control of our company.
Risks Related to Our Industry
Our failure to manage multiple technologies and technological change could harm
our future product demand
Future versions of hardware and software platforms embodying new
technologies and the emergence of new industry standards could render our
products obsolete. The market for e-business customer communication software is
characterized by:
. rapid technological change;
. frequent new product introductions;
. changes in customer requirements; and
. evolving industry standards.
Our products are designed to work on a variety of hardware and software
platforms used by our customers. However, our software may not operate
correctly on evolving versions of hardware and software platforms, programming
languages, database environments and other systems that our customers use. For
example, the server component of the current version of our products runs on
the Windows NT operating system from Microsoft, and we must develop products
and services that are compatible with UNIX and other operating systems to meet
the demands of our customers. If we cannot successfully develop these products
in response to customer demands, our business could suffer. Also, we must
constantly modify and improve our products to keep pace with changes made to
these platforms and to database systems and other back-office applications and
Internet-related applications. This may result in uncertainty relating to the
timing and nature of new product announcements, introductions or modifications,
which may cause confusion in the market and harm our business. If we fail to
modify or improve our products in response to evolving industry standards, our
products could rapidly become obsolete, which would harm our business.
40
If we fail to respond to changing customer preferences in our market, demand
for our products and our ability to enhance our revenues will suffer
We must continually improve the performance, features and reliability of our
products, particularly in response to competitive offerings. Our success
depends, in part, on our ability to enhance our existing software and to
develop new services, functionality and technology that address the
increasingly sophisticated and varied needs of our prospective customers. If we
do not properly identify the feature preferences of prospective customers, or
if we fail to deliver features that meet the requirements of these customers,
our ability to market our products successfully and to increase our revenues
could be impaired. The development of proprietary technology and necessary
service enhancements entails significant technical and business risks and
requires substantial expenditures and lead time.
If the Internet and web-based communications fail to grow and be accepted as
media of communication, demand for our products and services will decline
We sell our products and services primarily to organizations that receive
large volumes of e-mail and Web-based communications. Many of our customers
have business models that are based on the continued growth of the Internet.
Consequently, our future revenues and profits, if any, substantially depend
upon the continued acceptance and use of the Internet and e-mail, which are
evolving as media of communication. Rapid growth in the use of e-mail is a
recent phenomenon and may not continue. As a result, a broad base of
enterprises that use e-mail as a primary means of communication may not develop
or be maintained. In addition, the market may not accept recently introduced
products and services that process e-mail, including our products and services.
Moreover, companies that have already invested significant resources in other
methods of communications with customers, such as call centers, may be
reluctant to adopt a new strategy that may limit or compete with their existing
investments. If businesses do not continue to accept the Internet and e-mail as
media of communication, our business will suffer.
Future regulation of the Internet may slow our growth, resulting in decreased
demand for our products and services and increased costs of doing business
Due to the increasing popularity and use of the Internet, it is possible
that state, federal and foreign regulators could adopt laws and regulations
that impose additional burdens on those companies that conduct business online.
These laws and regulations could discourage communication by e-mail or other
Web-based communications, particularly targeted e-mail of the type facilitated
by the Connectify product, which could reduce demand for our products and
services.
The growth and development of the market for online services may prompt
calls for more stringent consumer protection laws or laws that may inhibit the
use of Internet-based communications or the information contained in these
communications. The adoption of any additional laws or regulations may decrease
the expansion of the Internet. A decline in the growth of the Internet,
particularly as it relates to online communication, could decrease demand for
our products and services and increase our costs of doing business, or
otherwise harm our business. Our costs could increase and our growth could be
harmed by any new legislation or regulation, the application of laws and
regulations from jurisdictions whose laws do not currently apply to our
business, or the application of existing laws and regulations to the Internet
and other online services.
Our security could be breached, which could damage our reputation and deter
customers from using our services
We must protect our computer systems and network from physical break-ins,
security breaches and other disruptive problems caused by the Internet or other
users. Computer break-ins could jeopardize the security of information stored
in and transmitted through our computer systems and network, which could
adversely affect our ability to retain or attract customers, damage our
reputation and subject us to litigation. We have been in
41
the past, and could be in the future, subject to denial of service, vandalism
and other attacks on our systems by Internet hackers. Although we intend to
continue to implement security technology and establish operational procedures
to prevent break-ins, damage and failures, these security measures may fail.
Our insurance coverage in certain circumstances may be insufficient to cover
losses that may result from such events.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We develop products in the United States and sell these products in North
America, Europe, Asia, Australia and Latin America. Generally, our sales are
made in local currency. As a result, our financial results and cashflows could
be affected by factors such as changes in foreign currency exchange rates or
weak economic conditions in foreign markets. We do not currently use derivative
instruments to hedge against foreign exchange risk.
Our exposure to market rate risk for changes in interest rates relates
primarily to our investment portfolio. Our investments consist primarily of
short-term municipals and commercial paper, which have an average fixed yield
rate of 6.8%. These all mature within six months. We do not consider our cash
equivalents to be subject to interest rate risk due to their short maturities.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our consolidated financial statements, together with related notes and the
report of PricewaterhouseCoopers LLP, and KPMG LLP, independent accountants,
are set forth on the pages indicated in Item 14, and incorporated herein by
this reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
KPMG LLP was previously our principal accountants. On March 22, 2000, we and
KPMG LLP mutually agreed to terminate KPMG LLP's appointment as principal
accountants due to an anticipated business relationship between our two
companies. The decision to change accountants was approved by the audit
committee of our board of directors. In connection with the audits of the
fiscal years ended December 31, 1998 and 1999, and the subsequent interim
period through March 22, 2000, there were no disagreements with KPMG LLP on any
matter of accounting principles or practices, financial statement disclosure,
or auditing scope or procedures, which disagreements, if not resolved to their
satisfaction, would have caused them to make reference in connection with their
opinion to the subject matter of the disagreement. The audit reports of KPMG
LLP on our consolidated financial statements as of and for the years ended
December 31, 1998 and 1999, did not contain any adverse opinion or disclaimer
of opinion, nor were they qualified or modified as to uncertainty, audit scope,
or accounting principles.
Effective April 19, 2000, PricewaterhouseCoopers LLP was engaged as our
independent accountants. Prior to April 19, 2000, we had not consulted with
PricewaterhouseCoopers LLP regarding the application of accounting principles
to a specified transaction, either completed or proposed; or the type of audit
opinion that might be rendered on our financial statements, and either a
written report was provided to us or oral advice was provided that
PricewaterhouseCoopers LLP concluded was an important factor considered by us
in reaching a decision as to the accounting, auditing or financial reporting
issue. Additionally, prior to April 19, 2000, we had not consulted with
PricewaterhouseCoopers LLP regarding any matter that was either the subject of
a disagreement, or a reportable event.
42
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding directors and executive officers is set forth under
"Directors and Executive Officers of the Registrant" in Part I of this 10-K.
Board of Directors and Committees
We currently have authorized nine directors. At present, the board consists
of six directors divided into three classes, with each class serving for a term
of three years, and we currently have three vacancies. At each annual meeting
of stockholders, directors will be elected by the holders of common stock to
succeed the directors whose terms are expiring. Messrs. Beirne, Frick and
Jurvetson are Class I directors whose terms will expire in 2003, Mr. Hahn and
Dr. Holloway are Class II directors whose terms will expire in 2001 and Mr.Wood
is a Class III director whose term will expire in 2002. Our officers serve at
the discretion of the board.
We have established an audit committee composed of independent directors,
which reviews and supervises our financial controls, including the selection of
our auditors, reviews the books and accounts, meets with our officers regarding
our financial controls, acts upon recommendations of the auditors and takes any
further actions the audit committee deems necessary to complete an audit of our
books and accounts, as well as addressing other matters that may come before us
or as directed by the board. The audit committee currently consists of three
directors, Dr. Holloway and Messrs. Jurvetson and Frick.
We have established a compensation committee, which reviews and approves the
compensation and benefits for our executive officers, administers our stock
plans and performs other duties as may from time to time be determined by the
board. The compensation committee currently consists of two directors, Messrs.
Beirne and Hahn.
Compensation Committee Interlocks and Insider Participation
During 2000, our compensation committee consisted of Messrs. Beirne and
Hahn. Neither Mr. Beirne nor Mr. Hahn was an employee of us or our subsidiaries
during 2000 or at any time prior to 2000. None of our executive officers serves
on the board of directors or compensation committee of any entity that has one
or more executive officers serving as a member of our board of directors or
compensation committee.
Director Compensation
We currently do not compensate any non-employee member of the board.
Directors who are also our employees do not receive additional compensation for
serving as directors.
Non-employee directors are eligible to receive discretionary option grants
and stock issuances under the 1999 Stock Incentive Plan. In addition, under the
1999 Stock Incentive Plan, each new non-employee director will receive an
automatic option grant for 40,000 shares upon his or her initial appointment or
election to the board, and continuing non-employee directors will receive an
automatic option grant for 10,000 shares on the date of each annual meeting of
stockholders.
Section 16(a) Beneficial Ownership Reporting Compliance
The members of the board of directors, our executive officers and persons
who hold more than 10% of our outstanding common stock are subject to the
reporting requirements of Section 16(a) of the Securities Exchange Act of 1934,
as amended, which require them to file reports with respect to their ownership
of the common stock and their transactions in such common stock. Based upon (i)
the copies of Section 16(a) reports which we received from such persons for
their 2000 transactions in the common stock and their common stock
43
holdings, and (ii) the written representations received from one or more of
such persons that no annual Form 5 reports were required to be filed by them
for 2000, we believe that the executive officers and the board members complied
with all their reporting requirements under Section 16(a) for 2000 except as
follows: the five non-employee directors (Messrs. Beirne, Frick, Hahn, Holloway
and Jurvetson) did not file timely Form 5s to report the non-employee director
option that was automatically granted on the date of our Annual Stockholders
Meeting held on October 4, 2000; Joseph Ansanelli, Ian Cavanagh, Nigel Donovan,
David Fowler, Michael Wolfe and James Wood filed late Form 4s; James Wood,
Nigel Donovan, and Eric Carlson filed late Form 3s.
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table sets forth certain information concerning compensation
earned for the year ended December 31, 2000, by the individual who served as
our Chief Executive Officer during 2000, by the individual who is currently
serving as our Chief Executive Officer, and by each of our four other most
highly compensated current executive officers whose salary and bonus for 2000
exceeded $100,000. The listed individuals are referred to in this report as the
Named Executive Officers. No other executive officers who otherwise would have
been includable in this table on the basis of salary and bonus earned during
2000 have been excluded because they terminated employment or changed their
executive status during the year.
The salary figures include amounts the employees invested into our tax-
qualified plan pursuant to Section 401(k) of the Internal Revenue Code.
However, compensation in the form of perquisites and other personal benefits
that constituted less than the lesser of either $50,000 or 10% of the total
annual salary and bonus of each of the Named Executive Officers in 2000 is
excluded. The option grants reflected in the table below for 2000 were made
under our 1999 Stock Option Issuance Plan.
Long-Term
Compensation
Awards
Annual Compensation Securities
----------------------- Underlying
Name and Principal Position Year Salary($) Bonus($) Options (#)
--------------------------- ---- --------- -------- ------------
James C. Wood....................... 2000 200,000 75,000 100
Chief Executive Officer (1) 1999 186,122 100,000 41,499(2)
1998 140,881 -- --
Michael J. McCloskey (3)............ 2000 150,000 -- 375,100(4)
Former Chief Executive Officer 1999 81,250 -- 1,866,666
Nigel K. Donovan.................... 2000 180,000 100,000 200,100
Chief Operations Officer 1999 158,290 100,000 45,000(2)
1998 120,750 -- 74,700(2)
Paul R. Holland (5)................. 2000 156,250 393,098 195,100(6)
Former Vice President, Worldwide
Sales 1999 75,000 721,600 --
1998 75,000 139,022
William R. Phelps................... 2000 200,000 60,000 195,100(7)
Vice President, Professional
Services 1999 130,000 56,000 413,330
1998 8,917 -- --
Alexander E. Evans.................. 2000 149,886 250,979 65,100
Vice President, International (8) 1999 63,115 53,928 400,000
- --------
(1) Mr. Wood joined us as a director in April 2000 in connection with our
acquisition of Silknet Software, Inc. and served as our President from May
2000 to January 2001. In January 2001, Mr. Wood became our Chief Executive
Officer.
44
(2) Options granted to Messr.'s Wood and Donovan prior to our fiscal year 2000
were granted pursuant to the stock incentive plans for Silknet Software,
Inc. that have been assumed by us.
(3) Mr. McCloskey served as our Chief Executive Officer from June 1999 through
January 2001.
(4) A 375,000 share option granted to Mr. McCloskey on April 19, 2000 was
cancelled on October 25, 2000.
(5) Mr. Holland served as our Vice President, Worldwide Sales from December
1997 through December 2000.
(6) A 150,000 share option granted to Mr. Holland on February 22, 2000 was
cancelled on October 25, 2000.
(7) A 150,000 share option granted to Mr. Phelps on February 22, 2000 was
cancelled on October 25, 2000.
(8) Mr. Evans joined us in July 1999. Mr. Evan's cash compensation was
converted from U.K. currency to U.S. currency based upon an average
exchange rate of 1.51703 for 2000 and 1.6178 for 1999.
Option Grants in Last Fiscal Year
The following table sets forth information with respect to stock options
granted to each of the Named Executive Officers in 2000. We granted options to
purchase up to a total of approximately 21,787,000 shares to employees during
the year (including grants made by Silknet Software, Inc. in 2000), and the
table's percentage column shows how much of that total was granted to the Named
Executive Officers. No stock appreciation rights were granted to the Named
Executive Officers during 2000.
The table includes the potential realizable value over the 10-year term of
the options, based on assumed rates of stock price appreciation of 5% and 10%,
compounded annually. The potential realizable value is calculated based on the
initial public offering price of the common stock, assuming that price
appreciates at the indicated rate for the entire term of the option and that
the option is exercised and sold on the last day of its term at the appreciated
price. All options listed have a term of 10 years. The stock price appreciation
rates of 5% and 10% are assumed pursuant to the rules of the Securities and
Exchange Commission. We can give no assurance that the actual stock price will
appreciate over the 10-year option term at the assumed 5% and 10% levels or at
any other defined level. Actual gains, if any, on stock option exercises will
be dependent on the future performance of our common stock. Unless the market
price of the common stock appreciates over the option term, no value will be
realized from the option grants made to the Named Executive Officers.
The option grants to the Named Executive Officers were made under our 1999
Stock Option/Stock Issuance Plan. The exercise price for each option grant is
equal to the fair market value of our common stock on the date of grant, as
determined in good faith by the board of directors. See "Employment
Arrangements, Termination of Employment Arrangements and Change in Control
Arrangements."
45
Option Grants in 2000
Potential Realizable
Value at Assumed
Annual Rates of Stock
Number of % of Total Price Appreciation
Securities Options Individual Grant for Option Term (1)
Underlying Granted to ------------------------- ---------------------
Options Employees in Exercise Price Expiration
Name Granted (#) Fiscal Year ($/Sh) Date 5% ($) 10% ($)
---- ---------- ------------ -------------- ---------- ---------- ----------
James C. Wood........... 100 * 10.00 04/19/10 5,404 9,197
Michael J. McCloskey.... 375,000(2) 1.7 39.3125 04/19/10 9,271,282 23,495,250
100 * 10.00 04/19/10 5,404 9,197
Nigel K. Donovan........ 200,000 * 39.3125 04/19/10 4,944,684 2,530,800
100 * 10.00 04/19/10 5,404 9,197
100,000 * 15.25 10/18/10
Paul R. Holland......... 150,000(2) * 129.6875 2/22/10 12,233,966 31,003,271
45,000 * 39.3125 04/19/10 1,112,554 2,819,430
100 * 10.00 04/19/10 5,404 9,197
William R. Phelps....... 150,000(2) * 129.6875 2/22/10 12,233,966 31,003,271
45,000 * 39.3125 04/19/10 1,112,554 2,819,430
100 * 10.00 04/19/10 5,404 9,197
Alexander E. Evans...... 50,000 * 129.6875 2/22/10 4,077,989 10,334,424
15,000 * 39.3125 04/19/10 370,851 39,810
100 * 10.00 04/19/10 5,404 9,197
- --------
* denotes, less than one percent (1%).
(1) The exercise prices of all options granted in fiscal year 2000 are well
above the last close price of the Company's common stock of $3.0625 on
February 28, 2001.
(2) This option was cancelled by the optionholder on October 25, 2000.
Aggregated Option Exercises and Fiscal Year-End Values
The following table sets forth the number of shares underlying exercisable
and unexercisable options held by the Named Executive Officers at the end of
2000, and the value of such options. None of the Executive Officers exercised
any options during 2000, other than Mr. Donovan. None of them exercised any
stock appreciation rights during 2000, and none held any stock appreciation
rights at the end of the year.
The value realized is based on the fair market value of our common stock on
the date of exercise, minus the exercise price payable for the shares, except
in the event of a same day sale transaction, in which case the actual sale
price is used. With the exception of an option to purchase 100 shares granted
to all of our employees on April 19, 2000, the exercise price for each grant
equaled the fair market value on the date of exercise. None of such 100 share
option was exercised by any of the Named Executive Officer, so the Named
Executive Officers did not realize any value on the exercise of any stock
option in 2000.
# of Securities
Number of Underlying Unexercised Value of Unexercised in-
Shares Options/SARs at Fiscal the-Money Options/SARs at
Acquired on Year-End (#) Fiscal Year-End ($)
Exercise Value ------------------------- -------------------------
Name (#) Realized ($) Exercisable Unexercisable Exercisable Unexercisable
---- ----------- ------------ ----------- ------------- ----------- -------------
James C. Wood........... 0 0 24,309 17,290 150 0
Michael J. McCloskey.... 0 0 100 0 150 0
Nigel K. Donovan........ 100,000 3,772,100 482,319 329,739 5,619,697 129,978
Paul R. Holland......... 0 0 100 45,000 150 0
William R. Phelps....... 0 0 100 45,000 150 0
Alexander E. Evans...... 0 0 400,100 65,000 3,700,150 0
46
EMPLOYMENT ARRANGEMENTS, TERMINATION OF EMPLOYMENT ARRANGEMENTS AND CHANGE IN
CONTROL ARRANGEMENTS
In February 1997, Dr. Holloway, one of our directors, exercised an option to
purchase 106,666 shares of common stock and entered into a stock purchase
agreement for the purchase of those shares. At the time of this report, these
shares were fully vested.
In April 1998, Mr. Holland, our former Vice President, Worldwide Sales,
exercised an option to purchase 811,406 shares of common stock and entered into
a stock purchase agreement for the purchase of those shares. To the extent the
shares are unvested at the time of his termination of service, we will have the
right to repurchase those shares at the exercise price paid per share. Under
the stock purchase agreement, if we are acquired by merger or asset sale, our
right to repurchase the unvested shares will automatically lapse in its
entirety, and the shares will vest in full, unless the repurchase right is
assigned to the successor entity. In addition, if we are acquired by merger or
asset sale and Mr. Holland is not offered comparable employment by the
successor entity, our right to repurchase the unvested shares will
automatically lapse and the shares will vest in full.
In July 1998, Mr. Hahn, one of our directors, exercised an option to
purchase 150,064 shares of common stock and entered into a stock purchase
agreement for the purchase of those shares. To the extent the shares are
unvested at the time of his termination of service, we will have the right to
repurchase those shares at the exercise price paid per share. Under the stock
purchase agreement, if we are acquired by merger or asset sale, our right to
repurchase the unvested shares will automatically lapse in its entirety and the
shares will vest in full.
Also in July 1998, Dr. Holloway, one of our directors exercised an option to
purchase 53,332 shares of common stock and entered into a stock purchase
agreement for the purchase of those shares. To the extent the shares are
unvested at the time of his termination of service, we will have the right to
repurchase those shares at the exercise price paid per share. Under the stock
purchase agreement, if we are acquired by merger or asset sale, our right to
repurchase all of the unvested shares will automatically lapse in its entirety,
and the shares will vest in full, unless the repurchase right is assigned to
the successor entity. In addition, if we are acquired by merger or asset sale
and Dr. Holloway does not provide services to the successor entity, 25% of the
unvested shares will vest and no longer be subject to repurchase.
In February and June 1999, Mr. Phelps, our Vice President, Professional
Services, exercised options to purchase a total of 413,330 shares of common
stock and entered into a stock purchase agreement for the purchase of those
shares. To the extent the shares are unvested at the time of his termination of
service, we will have the right to repurchase those shares at the exercise
price paid per share. Under the stock purchase agreement, if we are acquired by
merger or asset sale, our right to repurchase the unvested shares will
automatically lapse in its entirety, and the shares will vest in full, unless
the repurchase right is assigned to the successor entity. In addition, if we
are acquired by merger or asset sale and Mr. Phelps is not offered employment
by the successor entity, 25% of the unvested shares will vest and no longer be
subject to repurchase.
In June 1999, we entered into an employment arrangement with Mr. McCloskey,
our former Chief Executive Officer. In connection with this arrangement, we
granted Mr. McCloskey an option to purchase 1,866,666 shares of common stock,
which Mr. McCloskey exercised in June 1999. Of these shares, 1,119,999 are
subject to a right of repurchase granted to us which will allow us to
repurchase those shares at the option exercise price paid per share, to the
extent those shares are unvested at the time of his termination of service.
Under the stock purchase agreement and the terms of Mr. McCloskey's employment
arrangement, the unvested shares will vest in a series of 48 successive equal
monthly installments upon his completion of each month of service over the 48-
month period measured from June 17, 1999. However, all or part of the shares
will vest on an accelerated basis, following a change of control of our
company, under the various circumstances. Michael McCloskey resigned as CEO in
January 2001 due to the discovery of a medical condition that prevented him
from continuing to serve in such capacity. In March 2001, Mr. McCloskey
resigned as an employee of the Company. In addition, the Board of Directors
approved the acceleration of the 871,111 shares that remained unvested under
such option grant.
47
In August 1999, we granted an option to purchase 66,666 fully vested shares
of common stock to Mr. Frick, one of our directors, at an exercise price of
$4.50 per share, which he exercised in full in September 1999.
Generally, our option grants to employees, other than those under the 1999
Special Stock Option Plan, provide that if we are acquired by merger or asset
sale and the employee is not offered employment by the successor entity, then
25% of any unvested shares held by that individual will vest and no longer be
subject to repurchase.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The table below sets forth information regarding the beneficial ownership of
our common stock as of February 28, 2001, by the following individuals or
groups:
. each person or entity who is known by us to own beneficially more than
five percent of our outstanding stock;
. each of the Named Executive Officers;
. each of our directors; and
. all current directors and executive officers as a group.
Applicable percentage ownership in the following table is based on
94,345,305 shares of common stock outstanding as of February 28, 2001, as
adjusted to include all options exercisable within 60 days of February 28, 2001
held by the particular stockholder and that are included in the first column.
Unless otherwise indicated, the principal address of each of the
stockholders below is c/o Kana Communications, Inc., 740 Bay Road, Redwood
City, CA 94063. Except as otherwise indicated, and subject to applicable
community property laws, the persons named in the table have sole voting and
investment power with respect to all shares of common stock held by them.
Number of Percentage
Shares of Shares
Beneficially Beneficially
Name and Address of Beneficial Owner Owned (#) Owned (%)
------------------------------------ ------------ ------------
Entities affiliated with Draper Fisher
Jurvetson(1)....................................... 7,875,162 8.3
Entities affiliated with Benchmark Capital Partners
L.P.(2)............................................ 6,927,511 7.3
Entities affiliated with CMG @Ventures II LLC....... 4,700,759 5.0
Michael J. McCloskey................................ 1,870,604 2.0
James C. Wood....................................... 2,471,646 2.6
Paul R. Holland(3).................................. 759,844 *
William R. Phelps(4)................................ 379,768 *
Alexander E. Evans.................................. 426,021 *
Nigel K. Donovan.................................... 585,161 *
Steven T. Jurvetson(1).............................. 8,215,331 8.7
David M. Beirne(2)(5)............................... 7,309,190 7.7
Eric A. Hahn(6)..................................... 397,705 *
Dr. Charles A. Holloway............................. 103,748 *
Robert W. Frick..................................... 157,034 *
All current directors and executive officers as a
group (10 persons)................................. 19,373,634 20.5
- --------
* Less than one percent.
(1) Principal address is 400 Seaport Court, Suite 250, Redwood City, CA 94063.
Includes 7,335,461 shares of common stock held by Draper Fisher Associates
Fund IV, L.P., 506,821 shares of common stock held by Draper Fisher
Partners IV, LLC and 32,880 shares of common stock held by Draper Richards
L.P. Mr. Jurvetson disclaims beneficial ownership of these shares, except
to the extent of his pecuniary interest in the Draper Fisher Jurvetson
Funds.
48
(2) Principal address is 2480 Sand Hill Road, Suite 200, Menlo Park, CA 94025.
Represents 6,436,773 shares of common stock held by Benchmark Capital
Partners, L.P., and 490,738 shares of common stock held by Benchmark
Founders' Fund L.P. Mr. Beirne, one of our directors, is a Managing Member
of Benchmark Capital Management Co., LLC. Mr. Beirne disclaims beneficial
ownership of these shares, except to the extent of his pecuniary interest
in the Benchmark funds.
(3) Includes 26,666 shares of common stock held by The Paul Holland Grantor
Retained Annuity Trust, 26,666 shares of common stock held by The Linda
Yates Holland Grantor Retained Annuity Trust, 53,332 shares of common stock
held by the Yates/Holland 1999 Irrevocable Trust, 513,910 shares of common
stock held by The Yates/Holland Family Trust and 133,332 shares of common
stock held by Paul Holland and Linda Yates as community property. Includes
135,235 shares of common stock subject to our right of repurchase. This
repurchase right lapses with respect to 16,904 shares per month.
(4) Includes 26,278 shares of common stock held by The William Phelps Grantor
Retained Annuity Trust, 27,478 shares of common stock held by The Margaret
Phelps Grantor Retained Annuity Trust and 322,074 shares of common stock
held by The Phelps Family Trust. Includes 152,778 shares of common stock
subject to our right of repurchase. This repurchase right lapses with
respect to 7,638 shares per month. Also includes 25,278 shares of common
stock subject to our right of repurchase, which lapses with respect to 972
shares per month.
(5) Includes 192,000 shares of common stock held by Ramsey/Beirne Investment
Pool II, LLC. Mr. Beirne, one of our directors, was Chief Executive Officer
of Ramsey/Beirne Associates until June 1997. Mr. Beirne disclaims
beneficial ownership of these shares, except to the extent of his pecuniary
interest in the Ramsey/Beirne Investment Pool II, LLC.
(6) Includes 43,769 shares of common stock subject to our right of repurchase.
This repurchase right lapses with respect to 3,126 shares per month.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Sales of Securities
Since January 2000, we have been a party to several transactions in which
the amount involved exceeded $60,000 and in which any of our directors or
executive officers, any holder of more than 5% of our outstanding capital stock
or any member of their immediate families had a direct or indirect material
interest.
These transactions include:
On April 19, 2000, we closed a merger with Silknet Software, Inc., pursuant
to which Silknet became our wholly-owned subsidiary. In connection with the
acquisition of Silknet, approximately 33 million shares of common stock, valued
at approximately $4.2 billion, were issued or reserved for issuance for all
outstanding shares, warrants and options of Silknet. In connection with the
acquisition, Mr. Wood, a founder and the Chairman of the Board, President and
Chief Executive Officer of Silknet, became one of our directors.
49
Loans to and Other Arrangements with Officers and Directors
In connection with the option exercises described under "Employment
Arrangements, Termination of Employment Arrangements and Change of Control
Arrangements," the following officers and directors delivered five-year full
recourse promissory notes, bearing interest at an annual rate of 5.7%, except
in the case of Mr. Frick whose note bears interest at an annual rate of 6.0%,
in amounts and with the balances indicated:
Original Amount
Amount of Outstanding at
Promissory December 31,
Officer or Director Note 2000
------------------- ---------- --------------
Michael J. McCloskey(1)............................ $630,000 $686,500
Robert W. Frick.................................... 299,997 323,489
William R. Phelps(2)............................... 79,000 17,155
Ian P. Cavanagh.................................... 900,000 974,772
- --------
(1) $304,500 remained outstanding as of March 8, 2001.
(2) This loan had been paid in full as of March 8, 2001.
We entered into an employment arrangement with Mr. McCloskey, our former
Chief Executive Officer. See "Employment Arrangements, Termination of
Employment Arrangements and Change in Control Arrangements."
We have granted options to our executive officers and directors. See
"Management--Director Compensation" and "--Executive Compensation."
We have entered into an indemnification agreement with each of our executive
officers and directors containing provisions that may require us, among other
things, to indemnify our executive officers and directors against liabilities
that may arise by reason of our status or service as executive officers or
directors (other than liabilities arising from willful misconduct of a culpable
nature) and to advance expenses incurred as a result of any proceeding against
them as to which they could be indemnified.
50
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Report:
1. Financial Statements.
Page
----
Report of Independent Accountants........................................ 54
Independent Auditors' Report............................................. 55
Consolidated Balance Sheets as of December 31, 2000 and 1999............. 56
Consolidated Statements of Operations and Comprehensive Loss for the
Years ended December 31, 2000, 1999 and 1998............................ 57
Consolidated Statements of Stockholders' Equity for the Years ended
December 31, 2000, 1999 and 1998........................................ 58
Consolidated Statements of Cash Flows for the Years ended December 31,
2000, 1999 and 1998..................................................... 61
Notes to Consolidated Financial Statements............................... 62
2. Financial Statement Schedules.
Schedule Title Page
-------- ----- ----
Report of Independent Accountants on Financial Statement
Schedule...................................................... 79
Independent Auditors Report on Schedule....................... 80
II Valuation and Qualifying Accounts............................. 81
Schedules not listed above have been omitted because they are not
applicable, not required, or the information required to be set forth therein
is included in the consolidated financial statements or notes thereto.
3. Exhibits.
Exhibit
Number Description of Document
------- -----------------------
2.1(1) Agreement and Plan of Reorganization, dated August 13, 1999, by and
among Kana Communications, Inc., KCI Acquisition, Inc. and
Connectify, Inc.
2.2(3) Agreement and Plan of Reorganization, dated December 3, 1999, by and
among Kana Communications, Inc., King Acquisition Corp. and Business
Evolution, Inc.
2.3(3) Agreement and Plan of Reorganization, dated December 3, 1999, by and
among Kana Communications, Inc., Kong Acquisition Corp. and
netDialog.
2.4(6) Agreement and Plan of Reorganization, dated February 6, 2000, by and
among Kana Communications, Inc., Pistol Acquisition Corp. and
Silknet Software, Inc.
3.1(11) Second Amended and Restated Certificate of Incorporation, as amended
by the Certificate of Amendment dated April 18, 2000.
3.2(1) Amended and Restated Bylaws.
4.1(1) Form of Registrant's Specimen Common Stock Certificate
4.2(1) Fourth Amended and Restated Investors' Rights Agreement dated August
13, 1999 by and among Kana Communications, Inc. and parties listed
on Schedule A therein.
4.3(7) Form of amendment to Fourth Amended and Restated Investors' Rights
Agreement.
4.4(12) Registration Rights Agreement, dated June 7, 2000, by and among Kana
Communications, Inc. and the parties listed on Exhibit A thereto.
4.5(14) Stock and Warrant Purchase Agreement, dated September 6, 2000 by and
among Kana Communications, Inc. and Andersen Consulting LLP.
51
Exhibit
Number Description of Document
------- -----------------------
4.6(14)* Warrant to purchase Common Stock, dated September 6, 2000 between
Kana Communications, Inc. and Andersen Consulting LLP.
10.1(1) Registrant's 1997 Stock Option/Stock Issuance Plan.
10.2(1) Registrant's 1999 Stock Incentive Plan.
10.3(1) Registrant's 1999 Employee Stock Purchase Plan.
10.4(8) Registrant's 1999 Special Stock Option Plan.
10.5(8) Registrant's 1999 Special Stock Option Plan--Form of Nonstatutory
Stock Option Agreement-- 4-year vesting.
10.6(8) Registrant's 1999 Special Stock Option Plan--Form of Nonstatutory
Stock Option Agreement--30-month vesting.
10.7(1) Form of Registrant's Directors' and Officers' Indemnification
Agreement.
10.8(1) Form of Registrant's License Agreement.
10.9(1) Letter of Credit, dated July 9, 1999, with Silicon Valley Bank and
the Registrant.
10.10(1) Lease, dated May 1998, by and between Encina Properties and the
Registrant.
10.11(1) Office/R&D Lease, dated June 18, 1999, by and between Chestnut Bay
LLC and the Registrant.
10.12(1) Form of Registrant's Kana Online Service Agreement.
10.13(1) Form of Registrant's Restricted Stock Purchase Agreement.
10.14(1) QuickStart Loan and Security Agreement, dated November 6, 1998, with
Silicon Valley Bank and Connectify, Inc.
10.15(7) Lease, dated February 11, 2000, by and between Veterans Self-
Storage, LLC and the Registrant.
10.16(7) Amended and Restated 1999 Stock Incentive Plan of Kana
Communications, Inc.
10.17(12) Stock Purchase Agreement, dated June 7, 2000, by and among Kana
Communications, Inc. and the parties listed on Exhibit A thereto.
10.18(13) Lease, dated November 15, 1999, by and between 1848 Associates and
Silknet, Inc.
16.1(9) Letter from KPMG LLP, dated March 30, 2000.
23.1 Consent of KPMG LLP, Independent Auditors.
23.2 Consent of PricewaterhouseCoopers LLP, Independent Accountants.
24.1 Power of Attorney (See Signature Page).
99.1(6) Connectify, Inc. 1998 Stock Plan.
99.2(6) Connectify, Inc. 1998 Stock Plan Form of Incentive Stock Option
Agreement.
99.3(6) Connectify, Inc. 1998 Stock Plan Form of Nonstatutory Stock Option
Agreement.
99.4(6) Form of Option Assumption Agreement.
99.5(4) Business Evolution, Inc. 1999 Stock Plan.
99.6(4) Business Evolution, Inc. Form of Stock Option Agreement.
99.7(4) Form of Option Assumption Agreement--12 Months Acceleration
(Business Evolution Option Shares).
99.8(4) Form of Option Assumption Agreement--24 Months Acceleration
(Business Evolution Option Shares).
99.9(4) netDialog, Inc. 1997 Stock Plan.
99.10(4) netDialog, Inc. Form of Stock Option Agreement.
99.11(4) Form of Option Assumption Agreement (netDialog Option Shares).
99.12(10) Silknet Software, Inc. 1999 Employee Stock Purchase Plan.
52
Exhibit
Number Description of Document
------- -----------------------
99.13(10) Silknet Software, Inc. 1999 Stock Option and Stock Incentive Plan.
99.14(10) Silknet Software, Inc. 1999 Non-Employee Director Stock Option Plan.
99.15(10) Silknet Software, Inc. Employee Stock Option Plan.
99.16(10) Insite Marketing Technology, Inc. 1997 Stock Option Plan.
99.17(10) Form of Option Assumption Agreement (Silknet Option Shares).
99.18(10) Form of Option Assumption Agreement--Acceleration (Silknet Option
Shares).
99.19(3) Press Release, dated December 6, 1999, announcing the closing of the
Registrant's acquisitions of Business Evolution, Inc. and
netDialog.
99.20(3) Press Release, dated December 6, 1999, announcing the release of two
new products.
99.21(5) Joint Press Release with Silknet Software, Inc., dated February 7,
2000.
99.22(12) Press Release, dated June 7, 2000.
99.23(12) Press Release, dated June 14, 2000.
- --------
* Confidential treatment has been granted with respect to certain portions
of this exhibit.
(1) Previously filed as an exhibit to the registration statement on Form S-1,
File No. 333-82587, originally filed with the Commission by the Registrant
on July 9, 1999, as subsequently amended, and incorporated herein by
reference.
(2) Previously filed as an exhibit to the Form S-8 filed with the Commission
by the Registrant on December 6, 1999 and incorporated herein by
reference.
(3) Previously filed as an exhibit to the Form 8-K filed with the Commission
by the Registrant on December 14, 1999, and incorporated herein by
reference.
(4) Previously filed as an exhibit to the Form S-8 filed with the Commission
by the Registrant on December 23, 1999 and incorporated herein by
reference.
(5) Previously filed as an exhibit to the Form 8-K filed with the Commission
by the Registrant on February 7, 2000, and incorporated herein by
reference.
(6) Previously filed as an exhibit to the Form 13D filed with the Commission
by the Registrant on February 16, 2000, and incorporated herein by
reference.
(7) Previously filed as an exhibit to the registration statement on Form S-4,
File No. 333-32428, originally filed with the Commission by the Registrant
on March 14, 2000, as subsequently amended, and incorporated herein by
reference.
(8) Previously filed as an exhibit to the Form S-8 filed with the Commission
by the Registrant on March 14, 2000 and incorporated herein by reference.
(9) Previously filed as an exhibit to the Form 10-K filed with the Commission
by the Registrant on March 30, 2000 and incorporated herein by reference.
(10) Previously filed as an exhibit to the Form S-8 filed with the Commission
by the Registrant on April 27, 2000 and incorporated herein by reference.
(11) Previously filed as an exhibit to the Form 8-K filed with the Commission
by the Registrant on May 4, 2000, and incorporated herein by reference.
(12) Previously filed as an exhibit to the Form 8-K filed with the Commission
by the Registrant on June 15, 2000, and incorporated herein by reference.
(13) Previously filed as an exhibit to the registration statement on Form S-1,
File No. 333-40338, originally filed with the Commission by the Registrant
on June 28, 2000, as subsequently amended, and incorporated herein by
reference.
(14) Previously filed as an exhibit to the registration statement on Form S-3,
File No. 333-46624, originally filed with the Commission by the Registrant
on September 26, 2000, as subsequently amended, and incorporated herein by
reference.
(b) Reports on Form 8-K.
None.
53
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
Kana Communications, Inc.
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of operations and comprehensive loss, of stockholders'
equity and of cash flows present fairly, in all material respects, the
financial position of Kana Communications, Inc. and its subsidiaries at
December 31, 2000, and the results of their operations and their cash flows for
the year then ended in conformity with accounting principles generally accepted
in the United States of America. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audit. We conducted our
audit of these statements in accordance with auditing standards generally
accepted in the United States of America, which require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As discussed in
Note 1 to the financial statements, the Company has suffered recurring losses
and negative cash flows from operations and has a significant accumulated
deficit. These matters raise substantial doubt about the Company's ability to
continue as a going concern. Management's plans in regard to these matters are
also described in Note 1. The consolidated financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
/s/ PRICEWATERHOUSECOOPERS LLP
San Jose, California
January 23, 2001, except for Note 9, which is as of February 28, 2001
54
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Kana Communications, Inc.:
We have audited the accompanying consolidated balance sheet of Kana
Communications, Inc. and subsidiary as of December 31, 1999 and the related
consolidated statements of operations and comprehensive loss, stockholders'
equity, and cash flows for each of the years in the two-year period ended
December 31, 1999. The consolidated financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Kana
Communications, Inc. and subsidiary as of December 31, 1999 and the results of
their operations and their cash flows for each of the years in the two-year
period ended December 31, 1999 in conformity with accounting principles
generally accepted in the United States of America.
/s/ KPMG LLP
Mountain View, California
January 20, 2000
55
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
December 31,
----------------------
2000 1999
----------- ---------
ASSETS
Current assets:
Cash and cash equivalents............................. $ 76,202 $ 18,695
Short-term investments................................ 297 34,522
Accounts receivable, less allowance for doubtful
accounts of $1,966 in 2000 and $366 in 1999.......... 43,393 4,655
Prepaid expenses and other current assets............. 14,866 2,036
----------- ---------
Total current assets.................................. 134,758 59,908
Property and equipment, net............................ 40,095 8,360
Intangible assets, principally goodwill................ 800,000 --
Other assets........................................... 5,271 1,961
----------- ---------
Total assets......................................... $ 980,124 $ 70,229
=========== =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of notes payable...................... $ 1,456 $ 4,224
Accounts payable...................................... 17,980 2,766
Accrued liabilities................................... 35,846 8,074
Deferred revenue...................................... 25,242 6,253
----------- ---------
Total current liabilities............................ 80,524 21,317
Notes payable, less current portion.................... 148 412
----------- ---------
Total liabilities.................................... 80,672 21,729
----------- ---------
Commitments and contingencies (Note 7)
Stockholders' equity:
Convertible preferred stock, $0.001 par value;
5,000,000 shares authorized; no shares issued and
outstanding.......................................... -- --
Common stock, $0.001 par value; 1,000,000,000 and
100,000,000 shares authorized; 94,051,837 and
60,766,650 shares issued and outstanding............. 94 61
Additional paid-in capital............................ 4,130,231 202,473
Deferred stock-based compensation..................... (21,639) (14,962)
Notes receivable from stockholders.................... (5,367) (6,380)
Accumulated other comprehensive losses................ (377) (75)
Accumulated deficit................................... (3,203,490) (132,617)
----------- ---------
Total stockholders' equity........................... 899,452 48,500
----------- ---------
Total liabilities and stockholders' equity........... $ 980,124 $ 70,229
=========== =========
The accompanying notes are an integral part of these consolidated financial
statements.
56
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(In thousands, except per share data)
Years Ended December 31,
--------------------------------
2000 1999 1998
----------- --------- --------
Revenues:
License..................................... $ 75,360 $ 10,536 $ 2,014
Service..................................... 43,887 3,528 333
----------- --------- --------
Total revenues............................ 119,247 14,064 2,347
----------- --------- --------
Cost of revenues:
License..................................... 2,856 271 54
Service, excluding amortization of stock-
based compensation of $2,816, $19,752 and
$143....................................... 56,201 6,610 666
----------- --------- --------
Total cost of revenues.................... 59,057 6,881 720
----------- --------- --------
Gross profit................................. 60,190 7,183 1,627
----------- --------- --------
Operating expenses:
Sales and marketing, excluding amortization
of stock-based compensation of $8,078,
$34,000 and $564........................... 88,186 21,199 5,504
Research and development, excluding
amortization of stock-based compensation of
$2,831, $19,864 and $438................... 42,724 12,854 5,669
General and administrative, excluding
amortization of stock-based compensation of
$990, $6,860 and $311...................... 18,945 5,018 1,826
Amortization of stock-based compensation.... 14,715 80,476 1,456
Amortization of goodwill and identifiable
intangibles................................ 873,022 -- --
In-process research and development......... 6,900 -- --
Acquisition related costs................... 6,564 5,635 --
Goodwill impairment......................... 2,084,841 -- --
----------- --------- --------
Total operating expenses.................. 3,135,897 125,182 14,455
----------- --------- --------
Operating loss............................... (3,075,707) (117,999) (12,828)
Other income (expense), net.................. 4,834 (744) 227
----------- --------- --------
Net loss.................................. (3,070,873) (118,743) (12,601)
----------- --------- --------
Other comprehensive loss:
Net unrealized gain (loss) on available for
sale securities............................ (26) 26 --
Foreign currency translation adjustments.... (276) (96) (5)
----------- --------- --------
Total other comprehensive loss............ (302) (70) (5)
----------- --------- --------
Comprehensive loss........................ $(3,071,175) $(118,813) $(12,606)
=========== ========= ========
Basic and diluted net loss per share......... $ (39.57) $ (4.61) $ (2.01)
=========== ========= ========
Shares used in computing basic and diluted
net loss per share.......................... 77,610 25,772 6,258
=========== ========= ========
The accompanying notes are an integral part of these consolidated financial
statements.
57
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except share data)
Convertible Notes Accumulated
Preferred Stock Common Stock Additional Deferred Receivable Other Total
----------------- ----------------- Paid-in Stock-based From Comprehensive Accumulated Stockholders'
Shares Amount Shares Amount Capital Compensation Stockholders Losses Deficit Equity
---------- ------ ---------- ------ ---------- ------------ ------------ ------------- ----------- -------------
Balances,
December 31,
1997............ 8,917,855 $ 9 6,486,558 $7 $ 7,725 $ (784) $ -- $ -- $ (1,273) $ 5,684
Issuance of
common stock to
Connectify and
BEI founders.... -- -- 3,954,940 4 61 -- -- -- -- 65
Issuance of
stock upon
exercise of
stock options
and warrants,
net of
repurchases..... 68,139 -- 5,314,624 5 174 -- (164) -- -- 15
Issuance of
common stock of
pooled
companies....... -- -- 3,442,704 3 6,573 -- -- -- -- 6,576
Issuance of
Series B and C
convertible
preferred stock,
net............. 3,526,647 4 -- -- 11,624 -- -- -- -- 11,628
Issuance of
common stock and
warrants in
exchange for
services and
intellectual
property........ -- -- 75,690 -- 133 -- -- -- -- 133
Deferred stock-
based
compensation.... -- -- -- -- 2,956 (2,956) -- -- -- --
Amortization of
deferred stock-
based
compensation.... -- -- -- -- -- 1,456 -- -- -- 1,456
Other
comprehensive
loss............ -- -- -- -- -- -- -- (5) -- (5)
Net loss........ -- -- -- -- -- -- -- -- (12,601) (12,601)
---------- --- ---------- --- ------- ------- ----- ----- -------- --------
Balances,
December 31,
1998............ 12,512,641 13 19,274,516 19 29,246 (2,284) (164) (5) (13,874) 12,951
The accompanying notes are an integral part of these consolidated financial
statements.
58
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY--(Continued)
(In thousands, except share data)
Convertible Notes Accumulated
Preferred Stock Common Stock Additional Deferred Receivable Other
------------------- ----------------- Paid-in Stock-based From Comprehensive Accumulated
Shares Amount Shares Amount Capital Compensation Stockholders Losses Deficit
----------- ------ ---------- ------ ---------- ------------ ------------ ------------- -----------
Balances,
December 31,
1998............ 12,512,641 13 19,274,516 19 29,246 (2,284) (164) (5) (13,874)
Issuance of
common stock
upon exercise of
stock options
and warrants,
net of
repurchases..... -- -- 5,749,356 6 6,393 -- (6,544) -- --
Issuance of
Series D
convertible
preferred
stock........... 838,466 -- -- -- 10,169 -- -- -- --
Conversion of
convertible
preferred stock
to common
stock........... (13,351,107) (13) 26,702,214 27 (14) -- -- -- --
Issuance of
common stock of
pooled
companies....... -- -- 964,964 1 5,790 -- -- -- --
Issuance of
common stock in
exchange for
services........ -- -- 5,306 -- 60 -- -- -- --
Issuance of
common stock in
conjunction with
initial public
offering, net... -- -- 7,590,000 8 51,058 -- -- -- --
Conversion of
debt, accrued
interest, and
warrants to
common stock.... -- -- 480,294 -- 5,058 -- -- -- --
Payments on
notes receivable
from
stockholders.... -- -- -- -- -- -- 501 -- --
Interest
receivable from
notes receivable
from
stockholders.... -- -- -- -- -- -- (173) -- --
Interest expense
from warrants
issued in
connection with
bridge loans.... -- -- -- -- 1,559 -- -- -- --
Deferred stock-
based
compensation.... -- -- -- -- 93,154 (93,154) -- -- --
Amortization of
deferred stock--
based
compensation.... -- -- -- -- -- 80,476 -- -- --
Other
comprehensive
loss............ -- -- -- -- -- -- -- (70) --
Net loss........ -- -- -- -- -- -- -- -- (118,743)
----------- --- ---------- --- ------- ------- ------ --- --------
Balances,
December 31,
1999............ -- -- 60,766,650 61 202,473 (14,962) (6,380) (75) (132,617)
Total
Stockholders'
Equity
-------------
Balances,
December 31,
1998............ 12,951
Issuance of
common stock
upon exercise of
stock options
and warrants,
net of
repurchases..... (145)
Issuance of
Series D
convertible
preferred
stock........... 10,169
Conversion of
convertible
preferred stock
to common
stock........... --
Issuance of
common stock of
pooled
companies....... 5,791
Issuance of
common stock in
exchange for
services........ 60
Issuance of
common stock in
conjunction with
initial public
offering, net... 51,066
Conversion of
debt, accrued
interest, and
warrants to
common stock.... 5,058
Payments on
notes receivable
from
stockholders.... 501
Interest
receivable from
notes receivable
from
stockholders.... (173)
Interest expense
from warrants
issued in
connection with
bridge loans.... 1,559
Deferred stock-
based
compensation.... --
Amortization of
deferred stock--
based
compensation.... 80,476
Other
comprehensive
loss............ (70)
Net loss........ (118,743)
-------------
Balances,
December 31,
1999............ 48,500
The accompanying notes are an integral part of these consolidated financial
statements.
59
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY--(Continued)
(In thousands, except share data)
Convertible Notes Accumulated
Preferred Stock Common Stock Additional Deferred Receivable Other
----------------- ----------------- Paid-in Stock-based From Comprehensive Accumulated
Shares Amount Shares Amount Capital Compensation Stockholders Losses Deficit
------- -------- ---------- ------ ---------- ------------ ------------ ------------- -----------
Balances,
December 31,
1999............ -- -- 60,766,650 61 202,473 (14,962) (6,380) (75) (132,617)
Issuance of
common stock
upon exercise of
stock options
and warrants,
net of
repurchases..... -- -- 696,318 -- 3,462 408 320 -- --
Issuance of
common stock for
Employee Stock
Purchase Plan... -- -- 502,133 1 4,606 -- -- -- --
Issuance of
common stock
related to
Silknet
Software, Inc.
acquisition..... -- -- 29,186,736 29 3,778,318 -- -- -- --
Issuance of
common stock and
warrants related
to Accenture
agreement....... -- -- 400,000 1 16,778 (16,779) -- -- --
Issuance of
common stock
related to
private
placement, net.. -- -- 2,500,000 2 119,573 -- -- -- --
Deferred stock-
based
compensation.... -- -- -- -- 5,021 (5,021) -- -- --
Amortization of
deferred stock-
based
compensation.... -- -- -- -- -- 14,715 -- -- --
Payments on
notes receivable
from
stockholders.... -- -- -- -- -- -- 945 -- --
Other
comprehensive
loss............ -- -- -- -- -- -- -- (302) --
Interest on
notes receivable
from
stockholders.... -- -- -- -- -- -- (252) -- --
Net loss........ -- -- -- -- -- -- -- -- (3,070,873)
------- -------- ---------- --- ---------- -------- ------- ----- -----------
Balances,
December 31,
2000............ -- $ -- 94,051,837 $94 $4,130,231 $(21,639) $(5,367) $(377) $(3,203,490)
======= ======== ========== === ========== ======== ======= ===== ===========
Total
Stockholders'
Equity
-------------
Balances,
December 31,
1999............ 48,500
Issuance of
common stock
upon exercise of
stock options
and warrants,
net of
repurchases..... 4,190
Issuance of
common stock for
Employee Stock
Purchase Plan... 4,607
Issuance of
common stock
related to
Silknet
Software, Inc.
acquisition..... 3,778,347
Issuance of
common stock and
warrants related
to Accenture
agreement....... --
Issuance of
common stock
related to
private
placement, net.. 119,575
Deferred stock-
based
compensation.... --
Amortization of
deferred stock-
based
compensation.... 14,715
Payments on
notes receivable
from
stockholders.... 945
Other
comprehensive
loss............ (302)
Interest on
notes receivable
from
stockholders.... (252)
Net loss........ (3,070,873)
-------------
Balances,
December 31,
2000............ $ 899,452
=============
The accompanying notes are an integral part of these consolidated financial
statements.
60
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Years Ended December 31,
--------------------------------
2000 1999 1998
----------- --------- --------
Cash flows from operating activities:
Net loss.................................... $(3,070,873) $(118,743) $(12,601)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization.............. 882,032 1,531 328
In process research and development........ 6,900 -- --
Goodwill impairment........................ 2,084,841 -- --
Amortization of stock-based compensation
and other stock-based items............... 14,715 80,536 1,589
Noncash interest (income) expense.......... (252) 1,644 --
Changes in operating assets and
liabilities, net of effects from purchase
of Silknet:
Accounts receivable........................ (30,691) (3,807) (690)
Prepaid expenses and other assets.......... (13,706) (1,831) (469)
Accounts payable and accrued liabilities... 19,014 9,274 1,177
Deferred revenue........................... 17,273 5,691 562
----------- --------- --------
Net cash used in operating activities...... (90,747) (25,705) (10,104)
----------- --------- --------
Cash flows from investing activities:
Sales (purchases) of short-term investments,
net........................................ 34,225 (35,981) 50
Purchases of property and equipment......... (35,637) (8,418) (1,446)
Cash acquired from acquisition.............. 23,806 -- --
----------- --------- --------
Net cash provided by (used in) investing
activities................................ 22,394 (44,399) (1,396)
----------- --------- --------
Cash flows from financing activities:
Proceeds from notes payable and convertible
notes payable.............................. -- 9,790 1,834
Payments on notes payable................... (3,155) (2,151) (122)
Net proceeds from issuance of convertible
preferred stock............................ -- 10,169 11,628
Net proceeds from issuance of common stock
and warrants............................... 128,372 56,711 6,656
Payments on stockholders' notes receivable.. 945 501 --
----------- --------- --------
Net cash provided by financing activities.. 126,162 75,020 19,996
----------- --------- --------
Effect of exchange rate changes on cash and
cash equivalents............................ (302) (96) (5)
----------- --------- --------
Net change in cash and cash equivalents...... 57,507 4,820 8,491
Cash and cash equivalents at beginning of
year........................................ 18,695 13,875 5,384
----------- --------- --------
Cash and cash equivalents at end of year..... $ 76,202 $ 18,695 $ 13,875
=========== ========= ========
Supplemental disclosure of cash flow
information:
Cash paid during the year for interest...... $ 242 $ 131 $ 36
=========== ========= ========
Noncash activities:
Issuance of common stock upon conversion of
convertible note payable.................. $ -- $ 4,800 $ 300
=========== ========= ========
Issuance (repurchase) of common stock in
exchange for notes receivable from
stockholders.............................. $ (320) $ 6,544 $ 155
=========== ========= ========
Grant of options to purchase common stock
with an exercise price below fair market
value..................................... $ 5,021 $ 93,154 $ 2,273
=========== ========= ========
Issuance of common stock related to Silknet
Software, Inc. acquisition................ $ 3,778,347 $ -- $ --
=========== ========= ========
The accompanying notes are an integral part of these consolidated financial
statements.
61
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2000, 1999, and 1998
1. Description of Business and Summary of Significant Accounting Policies
(a) Description of Business
Kana Communications, Inc. and its subsidiaries (the Company or Kana)
develop, market and support customer communications software products and
services for e-Businesses. The Company sells its products primarily in the
United States and, to a lesser extent, in Europe primarily through its direct
sales force.
(b) Principles of Consolidation
The consolidated financial statements include the financial statements of
Kana Communications, Inc. and its wholly-owned subsidiaries. All significant
intercompany balances and transactions have been eliminated in consolidation.
(c) Basis of Presentation and Liquidity
The Company's consolidated financial statements have been presented on a
going concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. The Company has
incurred a consolidated net loss of approximately $3.1 billion for the year
ended December 31, 2000. Included in the aggregate net loss is approximately
$2.1 billion related to the long-lived asset impairment in 2000.
In February 2000, the Company restructured its operations and reduced its
workforce by 25% of its employee base. The Company continues to face
significant risks associated with successful execution of its strategy. These
risks include, but are not limited to technology and product development,
introduction and market acceptance of new products and services, changes in the
marketplace, liquidity, competition from existing and new competitors which may
enter the marketplace and retention of key personnel.
The Company may need additional funds for promoting new products and
services and working capital required to support increased sales and support
any investments.
There can be no assurance, however, that such financing would be available
when needed, if at all, or on favorable terms and conditions. If results of
operations for 2001 do not meet management's expectations, or additional
capital is not available, management believes it has the ability to reduce
certain expenditures. The precise amount and timing of the funding needs cannot
be determined accurately at this time, and will depend on a number of factors,
including the market demand for the Company's services and products, the
quality of product development efforts, management of working capital, and
continuation of normal payment terms and conditions for purchase of services.
The Company is uncertain whether its cash balances and cash flow from
operations will be sufficient to fund its operations for the next twelve
months. If the Company is unable to substantially increase revenues, reduce
expenditures, or otherwise generate cash flows for operations, then the Company
will need to raise additional funding to continue as a going concern.
(d) Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
(e) Foreign Currency Translation
The functional currency for the Company's international subsidiaries is the
local currency of the country in which it operates. Assets and liabilities are
translated using the exchange rate at the balance sheet date. Revenues,
expenses, gains, and losses are translated at the average exchange rates
prevailing during the year. Any translation adjustments are included in other
comprehensive loss.
62
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(f) Cash Equivalents and Short-Term Investments
The Company considers all highly liquid investments with an original
maturity or reset date of three months or less to be cash equivalents. The
Company has classified its cash equivalents and short-term investments as
"available for sale." These items are carried at fair value, based on the
quoted market prices, and unrealized gains and losses, are reported as a
separate component of accumulated other comprehensive losses in stockholders'
equity. All short- term investments mature in less than one year. To date,
realized gains or losses have not been material.
(g) Fair value of Financial Instruments
The carrying values of the Company's financial instruments, including cash
and cash equivalents, accounts receivable, accounts payable, accrued
liabilities and notes payable approximates their fair values due to their
relatively short maturities.
(h) Concentration of Credit Risk
Financial instruments subjecting the Company to concentrations of credit
risk consist primarily of cash and cash equivalents, short-term investments and
trade accounts receivable. The Company maintains cash and cash equivalents with
four domestic financial institutions. From time to time, the Company's cash
balances with its financial institutions may exceed Federal Deposit Insurance
Corporation insurance limits.
The Company's customers are currently concentrated in the United States. The
Company performs ongoing credit evaluations, generally does not require
collateral and establishes an allowance for doubtful accounts based upon
factors surrounding the credit risk of customers, historical trends and other
information. As of December 31, 2000 and 1999, no customer represented more
than 10% of total accounts receivable.
(i) Property and Equipment
Property and equipment are stated at cost, less accumulated depreciation and
amortization. Depreciation is computed using the straight-line method over the
estimated useful lives of the respective assets, generally three to five years.
Leasehold improvements are amortized over the lesser of the related lease term
or the life of the improvement. Depreciation expense for the years ended
December 31, 2000, 1999 and 1998 was $9,010,000, $1,531,000 and $328,000,
respectively.
(j) Intangible assets and impairment
Goodwill and identifiable intangibles are carried at cost less accumulated
amortization. The Company amortizes goodwill and other identifiable intangibles
on a straight-line basis over their estimated useful lives, which is three
years for the acquisition of Silknet.
The Company assesses the impairment of long-lived assets periodically 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 assesses the impairment of enterprise level goodwill periodically in
accordance with the provision of Accounting Principles Board (APB) Opinion No.
17, Intangible Assets. An impairment review is performed whenever events or
changes in circumstances indicate that the carrying value may not be
recoverable. Factors the Company considers important which could trigger an
impairment review include, but are not limited to, significant underperformance
relative to expected historical or projected future operating results,
significant changes in the manner of use of the acquired assets or the strategy
for our overall business, significant negative industry or economic trends, a
significant decline in its stock price for a sustained period,
63
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
and its market capitalization relative to net book value. When the Company
determines that the carrying value of goodwill may not be recoverable based
upon the existence of one or more of the above indicators of impairment, the
Company measures any impairment based on a projected discounted cash flow
method using a discount rate commensurate with the risk inherent in our current
business model.
The Company has performed an impairment assessment of the identifiable
intangibles and goodwill recorded in connection with the acquisition of
Silknet. The assessment was performed primarily due to the significant
sustained decline in the Company's stock price since the valuation date of the
shares issued in the Silknet acquisition resulting in the Company's net book
value of its assets prior to the impairment charge significantly exceeding the
Company's market capitalization, the overall decline in the industry growth
rates, and the Company's lower fourth quarter of 2000 actual and projected
operating results. As a result, the Company recorded a $2.1 billion impairment
charge to reduce goodwill. The charge was based upon the estimated discounted
cash flows over the remaining useful life of the goodwill using a discount rate
of 20%. The assumptions supporting the cash flows, including the discount rate,
were determined using the Company's best estimates as of such date. The
remaining goodwill balance of approximately $800 million will be amortized over
its remaining useful life.
(k) Revenue Recognition
The Company generally recognizes revenue in accordance with Statement of
Position ("SOP") 97-2, Software Revenue Recognition and SOP 98-9, Modification
of SOP 97-2, Software Revenue Recognition, with Respect to Certain
Transactions. Revenue recognized from software arrangements is allocated to
each element of the arrangement based on the relative fair values of the
elements, such as software products, upgrades, enhancements, post contract
customer support, installation, or training. The determination of fair value is
based on objective evidence that is specific to the vendor. If evidence of fair
value for the undelivered elements of the arrangement does not exist, all
revenue from the arrangement is deferred until such time as evidence of fair
value does exist or until all elements of the arrangement are delivered.
License revenue is recognized when there is persuasive evidence of an
arrangement and delivery to the customer has occurred provided the arrangement
does not require significant customization of the software, the fee is fixed
and determinable and collectibility is considered probable. If the arrangement
involves significant customization of the software, the fees, excluding the
portion attributable to maintenance, are recognized using the percentage-of-
completion method. Revenue from maintenance contracts is recognized ratably
over the term of the maintenance contract on a straight-line basis. Service
revenue, consisting primarily of consulting, implementation, and hosting, is
generally recognized at the time the service is performed.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 ("SAB 101"), Revenue Recognition in Financial
Statements. SAB 101 provides guidance for revenue recognition under certain
circumstances. SAB 101 was effective in the quarter beginning October 1, 2000.
The adoption of SAB 101 did not have a material impact on the financial
statements.
(l) Software Development Costs
Software development costs are expensed as incurred until technological
feasibility of the underlying software product is achieved. After technological
feasibility is established, software development costs are capitalized.
Capitalized costs are then amortized on a straight-line basis over the
estimated product life, or based on the ratio of current revenue to total
projected product revenue, whichever is greater. To date, technological
feasibility and general availability of such software have occurred
simultaneously and software development costs qualifying for capitalization
have been insignificant. Accordingly, the Company has not capitalized any
software development costs.
64
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company accounts for the costs of computer software developed or
obtained for internal use in accordance with SOP 98-1, Accounting for the Costs
of Computer Software Developed or Obtained for Internal Use. This SOP requires
that certain costs incurred during a software development project be
capitalized. These costs generally include external direct costs of materials
and services consumed in the project, and internal costs such as payroll and
benefits of those employees directly associated with the development of the
software. To date, this SOP has not had a material impact on the Company's
financial position or results of operations.
(m) Advertising Costs
The Company expenses advertising costs as incurred. Advertising expense was
$7,386,000, $2,579,000, $852,000, for the years ended December 31, 2000, 1999
and 1998, respectively.
(n) Stock-Based Compensation
The Company accounts for its stock-based compensation arrangements with
employees using the intrinsic-value method. Deferred stock-based compensation
is recorded on the date of grant when the deemed fair value of the underlying
common stock exceeds the exercise price for stock options or the purchase price
for the shares of common stock.
Deferred stock-based compensation resulting from option grants is amortized
on an accelerated basis over the vesting period of the individual options,
generally four years, in accordance with Financial Accounting Standards Board
Interpretation No. 28.
(o) Income Taxes
Deferred tax assets and liabilities are recognized for the estimated future
tax consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. A valuation allowance is recorded to reduce deferred tax assets to an
amount whose realization is more likely than not.
(p) Comprehensive Loss
Other comprehensive loss recorded by the Company for the years ended
December 31, 2000 and 1999 was primarily attributable to foreign currency
translation adjustments.
(q) Net Loss Per Share
Basic net loss per share is computed using the weighted-average number of
outstanding shares of common stock, excluding common stock subject to
repurchase. Diluted net loss per share is computed using the weighted-average
number of outstanding shares of common stock and, when dilutive, potential
common shares from options and warrants to purchase common stock and common
stock subject to repurchase using the treasury stock method, and convertible
securities using the as-if converted basis. The following table presents the
calculation of basic and diluted net loss per share:
65
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Years Ended December 31,
--------------------------------
2000 1999 1998
----------- --------- --------
(in thousands, except per
share amounts)
Numerator:
Net loss................................ $(3,070,873) $(118,743) $(12,601)
----------- --------- --------
Denominator:
Weighted-average shares of common stock
outstanding............................ 83,055 34,873 15,184
Less weighted-average shares subject to
repurchase............................. (5,445) (9,101) (8,926)
----------- --------- --------
Denominator for basic and diluted
calculation............................ 77,610 25,772 6,258
=========== ========= ========
Basic and diluted net loss per common
share................................... $ (39.57) $ (4.61) $ (2.01)
=========== ========= ========
All convertible preferred stock, warrants, outstanding stock options and
shares subject to repurchase by Kana have been excluded from the calculation of
diluted net loss per share because all such securities are anti-dilutive for
all periods presented. The total number of shares excluded from the calculation
of diluted net loss per share are as follows (in thousands):
Years Ended December
31,
--------------------
2000 1999 1998
------ ------ ------
Stock options and warrants............................. 25,547 3,771 825
Common stock subject to repurchase..................... 3,886 9,101 8,926
Convertible preferred stock (as if converted basis).... -- -- 25,025
------ ------ ------
29,433 12,872 34,776
====== ====== ======
(q) Segment Reporting
Kana's chief operating decision maker reviews financial information
presented on a consolidated basis, accompanied by disaggregated information
about revenues by geographic region for purposes of making operating decisions
and assessing financial performance. Accordingly, Kana considers itself to be
in a single industry segment, specifically the license, implementation and
support of its software applications. Kana's long-lived assets are primarily in
the United States. Geographic information on revenue for the years ended
December 31, 2000, 1999 and 1998 are as follows (in thousands):
Years Ended December
31,
-----------------------
2000 1999 1998
-------- ------- ------
United States........................................ $ 99,753 $12,679 $2,347
International........................................ 19,494 1,385 --
-------- ------- ------
$119,247 $14,064 $2,347
======== ======= ======
During the years ended December 31, 2000, 1999 and 1998, no customer
represented more than 10% of total revenues. As of December 31, 2000, revenue
from the United Kingdom accounted for approximately $12,860,000 or 11% of total
revenue. Revenue to any one foreign country did not exceed 10% of total revenue
in 1999 and 1998.
(r) Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133
"Accounting for Derivative Instruments and Hedging Activities". SFAS 133
establishes accounting and reporting standards for derivative instruments and
for hedging activities which is effective in the first quarter of 2001. The
adoption of SFAS 133 did not have any material effect on its results of
operations.
66
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
2. Business Combinations
On April 19, 2000, the Company acquired Silknet Software, Inc. ("Silknet").
In connection with the merger, each share of Silknet common stock was converted
into the right to receive 1.66 shares of the Company's common stock (the
"Exchange Ratio") and the Company assumed Silknet's outstanding stock options
and warrants based on the Exchange Ratio, issuing approximately 29,000,000
shares of common stock and assuming options and warrants to acquire
approximately 4,000,000 shares of the Company's common stock. The transaction
was accounted for using the purchase method of accounting.
As of the acquisition date, the Company recorded the fair market value of
Silknet's assets and liabilities. The resulting goodwill and intangible assets
acquired in connection with the merger are being amortized over a three-year
period. The allocation of the purchase price to assets acquired and liabilities
assumed is as follows (in thousands):
Tangible assets acquired......................................... $ 60,074
Identifiable intangibles acquired:
In process research and development............................. 6,900
Existing technology............................................. 14,400
In-place workforce.............................................. 6,600
Goodwill........................................................ 3,736,835
Liabilities assumed.............................................. (13,562)
----------
Net assets acquired............................................. $3,811,247
==========
The purchase price was determined using the average fair market value of the
Company's common stock from January 31, 2000 to February 14, 2000, five trading
days before and after the merger agreement was announced. The purchase price is
summarized as follows (in thousands):
Fair market value of common stock................................ $3,373,425
Fair market value of options and warrants assumed................ 404,922
Acquisition-related costs........................................ 32,900
----------
Total............................................................ $3,811,247
==========
As of December 31, 2000, the Company had approximately $13,500,000 remaining
in accrued acquisition-related costs, which it expects to pay during fiscal
2001.
In connection with the merger of Silknet, $6,900,000 was allocated to in-
process research and development. The fair value allocation to in-process
research and development was determined by identifying the research projects
for which technological feasibility has not been achieved and which have no
alternative future use at the merger date, assessing the stage and expected
date of completion of the research and development effort at the merger date,
and calculating the net present value of the cash flows expected to result from
the successful deployment of the new technology resulting from the in-process
research and development effort.
The stages of completion were determined by estimating the costs and time
incurred to date relative to the costs and time incurred to develop the in-
process technology into a commercially viable technology or product, while
considering the relative difficulty of completing the various tasks and
obstacles necessary to attain technological feasibility. As of the date of the
acquisition, Silknet had two projects in process that were 90% complete.
The estimated net present value of cash flows was based on incremental
future cash flows from revenues expected to be generated by the technologies in
the process of development, taking into account the characteristics and
applications of the technologies, the size and growth rate of existing and
future markets and
67
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
an evaluation of past and anticipated technology and product life cycles.
Estimated net future cash flows included allocations of operating expenses and
income taxes but excluded the expected completion costs of the in-process
projects, and were discounted at a rate of 20% to arrive at a net present
value. The discount rate included a factor that took into account the
uncertainty surrounding the successful deployment of in-process technology
projects. This net present value was allocated to in-process research and
development based on the percentage of completion at the merger date.
In connection with the Silknet merger, the Company recorded $6,600,000 of
transaction costs and merger-related integration expenses. These amounts
consisted primarily of merger-related advertising and announcements of
$4,500,000 and duplicate facility costs of $1,000,000.
The following unaudited pro forma net revenues, net loss and net loss per
share data for the years ended December 31, 2000 and 1999 are based on the
respective historical financial statements of the Company and Silknet. The pro
forma data reflects the consolidated results of operations as if the merger
with Silknet occurred at the beginning of each of the periods indicated and
includes the amortization of the resulting goodwill and other intangible
assets. The pro forma financial data presented are not necessarily indicative
of the Company's results of operations that might have occurred had the
transaction been completed at the beginning of the periods specified, and do
not purport to represent what the Company's consolidated results of operations
might be for any future period.
Years Ended December
31,
------------------------
2000 1999
----------- -----------
(In thousands, except
per share data)
(unaudited)
Net revenues..................................... $ 132,571 $ 36,594
Net loss......................................... $(3,415,192) $(1,385,313)
Basic and diluted net loss per share............. $ (39.56) $ (30.52)
Shares used in basic and diluted net loss per
share calculation............................... 86,326 45,392
As discussed in Note 1, the Company recorded a $2.1 billion impairment
charge to reduce the value of goodwill resulting from the Silknet acquisition.
Such amount is not included in the above unaudited pro forma information.
On August 13, 1999, the Company issued 6,982,542 shares of its common stock
to the shareholders of Connectify in exchange for all of the outstanding
capital stock of Connectify. Prior to the consummation of the merger, 5,095,819
shares of the outstanding Kana preferred stock were converted to 10,191,638
shares of Kana common stock. As a result of the conversion, the Company created
a controlling class of common stock.
On December 3, 1999, in connection with the acquisition of Business
Evolution, Inc. ("BEI"), 1,935,206 shares of Kana common stock were issued or
reserved for issuance for all outstanding shares, warrants and options of BEI.
On the same date, in connection with the acquisition of netDialog, Inc.
("netDialog"), 1,244,062 shares of Kana common stock were issued or reserved
for issuance for all outstanding shares, warrants, convertible notes and
options of netDialog.
The mergers in 1999 have been accounted for as poolings of interests, and,
accordingly, the Company's consolidated financial statements have been restated
for all periods prior to the merger to include the results of operations,
financial position, and cash flows of the acquired companies. No significant
adjustments were required to conform the accounting policies of the Company and
the acquired companies.
In connection with the merger with Connectify, Kana recorded a charge for
merger integration costs of $1.2 million consisting primarily of transaction
fees of approximately $390,000 and employee severance benefits and facility
related costs of $780,000. As of December 31, 2000, these costs were paid in
their entirety.
68
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In connection with the mergers with BEI and netDialog, the Company recorded
a nonrecurring charge for merger integration costs of $4.5 million, consisting
primarily of transaction fees of approximately $1.5 million, merger-related
advertising and announcements of $1.7 million charges for the elimination of
duplicate facilities of approximately $840,000 and severance costs and certain
other related costs of approximately $433,000. As of December 31, 2000, these
costs were paid in their entirety.
Certain results of operations data for the separate companies and the
combined amounts presented in the consolidated financial statements were as
follows (in thousands):
Nine Months
Ended Year Ended
September 30, December 31,
1999 1998
------------- ------------
(Unaudited)
Revenues:
Kana............................................ $ 7,174 $ 2,049
Connectify(1)................................... -- --
BEI............................................. 361 298
NetDialog....................................... 72 --
-------- --------
$ 7,607 $ 2,347
======== ========
Nine Months
Ended Year Ended
September 30, December 31,
1999 1998
------------- ------------
(Unaudited)
Net Loss:
Kana............................................ $(16,828) $ (6,337)
Connectify(1)................................... (2,627) (1,041)
BEI............................................. (2,404) (1,360)
NetDialog....................................... (6,288) (3,863)
-------- --------
$(28,147) $(12,601)
======== ========
- --------
(1) Connectify figures included in the nine months ended 1999 are stated for
the six months ended June 30, 1999.
3. Financial Statement Detail
Cash equivalents consisted of the following (in thousands):
December 31,
----------------
2000 1999
-------- -------
Money market funds......................................... $ 7,225 $ 3,553
Commercial paper........................................... 25,722 7,949
Municipal securities....................................... 31,901 4,014
Certificates of deposit.................................... -- 283
-------- -------
$ 64,848 $15,799
======== =======
69
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Short-term investments consisted of the following (in thousands):
December 31,
------------
2000 1999
---- -------
Commercial paper............................................... $-- $ 9,307
Municipal securities........................................... -- 18,450
Corporate notes/bonds.......................................... -- 5,118
Certificates of deposit........................................ 297 1,647
---- -------
$297 $34,522
==== =======
Unrealized gains and losses on available-for-sale securities at December 31,
2000 and 1999 were immaterial.
Property and equipment, net consisted of the following (in thousands):
December 31,
-----------------
2000 1999
-------- -------
Computer equipment........................................ $ 38,582 $ 6,688
Furniture and fixtures.................................... 5,743 1,972
Leasehold improvements.................................... 6,611 1,531
-------- -------
50,936 10,191
Less accumulated depreciation and amortization............ (10,841) (1,831)
-------- -------
$ 40,095 $ 8,360
======== =======
Accrued liabilities consisted of the following (in thousands):
December 31,
-----------------
2000 1999
-------- -------
Accrued payroll and related expenses...................... $ 8,470 $ 1,639
Accrued commissions....................................... 2,372 1,984
Accrued acquisition related costs......................... 13,547 3,148
Other accrued liabilities................................. 11,457 1,303
-------- -------
$ 35,846 $ 8,074
======== =======
Other income (expense), net consisted of the following (in thousands):
Year Ended December
31,
---------------------
2000 1999 1998
------ ------- ----
Interest income..................................... $5,991 $ 1,419 $324
Interest expense.................................... (242) (520) (53)
Interest expense from warrants issued in connection
with bridge loans.................................. -- (1,559) (35)
Other............................................... (915) (84) (9)
------ ------- ----
$4,834 $ (744) $227
====== ======= ====
70
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
4. Notes Payable
The Company maintained a line of credit providing for borrowings of up to
$10,000,000 as of December 31, 2000, to be used for qualified equipment
purchases or working capital needs. Borrowings under the line of credit are
collateralized by all of the Company's assets and bear interest at the bank's
prime rate (9.50% as of December 31, 2000). The line of credit contains certain
financial covenants including: a quick asset ratio of at least 1.75 and a
tangible net worth of at least $60,000,000. The Company was in compliance with
all debt covenants as of December 31, 2000. Total borrowings as of December 31,
2000 and 1999 were $1,187,000. The entire balance under this line of credit is
due on the expiration date, July 31, 2001.
On May 18, 1999, the Company entered into two term loan obligations totaling
$685,000 of which $417,000 and $649,000 was outstanding at December 31, 2000
and 1999, respectively. The loans bear interest at a fixed rate of
approximately 14.5% and mature in June 2002. The aggregate principal payments
due under these obligations are as follows (in thousands):
Year Ending December 31,
------------------------
2001.................................................................. $269
2002.................................................................. 148
----
$417
====
On October 22, 1999, the Company issued subordinated promissory notes in the
aggregate principal amount of $2,800,000. Such notes bore interest at an annual
rate of 10%. These notes were paid in January 2000.
5. Stockholders' Equity
(a) Reincorporation and Stock Splits
On April 18, 2000, the Board of Directors of the Company approved an
increase to the authorized number of shares of common stock from 100,000,000 to
1,000,000,000.
The Board of Directors approved a two-for-one stock split of the common
stock for stockholders of record on January 28, 2000. The accompanying
financial statements have been retroactively restated to reflect the effect of
this stock split.
In September 1999, Kana reincorporated into the State of Delaware, effected
a two-for-three reverse stock split of Kana's common stock and preferred stock
and increased Kana's authorized common stock to 100,000,000 shares. The
accompanying financial statements have been retroactively restated to reflect
the effect of this reincorporation and reverse stock split.
(b) Private Placement and Initial Public Offering
On June 12, 2000, the Company sold 2,500,000 shares of common stock at
$50.00 per share in a private placement transaction. Kana received
approximately $120 million in net proceeds.
On September 21, 1999, Kana consummated its initial public offering in which
it sold 7,590,000 shares of common stock at $7.50 per share. Kana received
approximately $51 million in cash, net of underwriting discounts, commissions
and other offering costs.
71
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(c) Convertible Preferred Stock
Since inception, Kana issued 13,351,107 shares of convertible preferred
stock. During 1999, 11,581,379 shares were converted to common stock at the
time of the Connectify merger and 1,769,728 shares were converted to common
stock at the initial public offering at a ratio of 1 share of preferred stock
for 2 shares of common stock.
(d) Common Stock
The Company has issued to founders 10,994,398 shares of common stock, which
are subject to repurchase on termination of employment. Such repurchase rights
lapse in a series of equal monthly installments over a four year period ending
in June 2000. As of December 31, 2000, all shares were vested.
Certain option holders have exercised options to purchase shares of
restricted common stock in exchange for five-year full recourse promissory
notes. The notes bear interest at 5.7% and expire on various dates through
2004. The Company has the right to repurchase all unvested shares purchased by
the notes at the original exercise price in the event of employee termination.
The number of shares subject to this repurchase right decreases as the shares
vest under the original option terms, generally over four years. As of
December 31, 2000, there were 3,886,100 shares subject to repurchase. These
options were exercised at prices ranging from $0.02 to $4.50 with a weighted-
average exercise price of $3.29 per share.
(e) Stock Compensation Plans
The Company's 1999 Stock Incentive Plan (the "1999 Plan"), as successor to
the 1997 Stock Option/Stock Issuance Plan (the "1997 Plan"), provides for a
total of 35,819,474 shares of the Company's common stock to be granted to
employees, independent contractors, officers, and directors. Options are
generally granted at an exercise price equivalent to the estimated fair market
value per share at the date of grant, as determined by the Company's Board of
Directors. All options are granted at the discretion of the Company's Board of
Directors and have a term not greater than 10 years from the date of grant.
Options are immediately exercisable and generally vest over four years, 25% one
year after the grant date and the remainder at a rate of 1/36 per month
thereafter. Plans of acquired companies have similar terms as those of the 1999
Plan. Outstanding options under all these plans were assumed in the respective
merger or acquisition.
The 1999 Employee Stock Purchase Plan ("1999 ESPP") allows eligible
employees to purchase common stock through payroll deductions of up to 15% of
an employee's compensation. The 1999 ESPP currently has a two-year offering
period that ends in October 2001. The purchase price of the common stock will
be equal to 85% of the fair market value per share on the participant's entry
date into the offering period, or, if lower, 85% of fair market value per share
on each semi-annual purchase date. The 1999 ESPP qualifies as an employee stock
purchase plan under Section 423 of the Internal Revenue Code of 1986, as
amended. As of December 31, 2000, 502,133 shares were issued from the 1999
ESPP.
In December 1999, the board of directors approved the 1999 Special Stock
Option Plan and 1,000,000 shares of common stock were reserved for issuance
under this plan. The Special Stock Option Plan has similar terms as those of
the 1999 Plan, except that options may be granted with an exercise price less
than, equal to, or greater than the fair market value of the option shares on
the grant date. As of December 31, 2000, 904,014 shares have been granted.
72
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
A summary of stock option activity follows:
Options Outstanding
--------------------
Weighted
Shares Average
Available Number of Exercise
for Grant Shares Price
----------- ---------- --------
Balances, December 31, 1997................... 3,930,412 3,397,144 $ 0.03
Additional shares authorized................ 3,825,842 -- --
Options granted............................. (3,004,420) 3,004,420 0.13
Options exercised........................... -- (5,394,478) 0.04
Options canceled............................ 230,770 (230,770) 0.12
----------- ----------
Balances, December 31, 1998................... 4,982,604 776,316 0.19
Additional shares authorized................ 11,976,310 -- --
Options granted............................. (9,394,740) 9,394,740 6.24
Options exercised........................... -- (6,096,242) 1.01
Options canceled............................ 303,698 (303,698) 14.88
----------- ----------
Balances, December 31, 1999................... 7,867,872 3,771,116 12.71
Additional shares authorized................ 12,583,100 -- --
Options assumed............................. -- 3,421,990 16.87
Options granted............................. (21,512,998) 21,512,998 52.13
Options exercised........................... -- (1,036,371) 4.12
Options canceled and retired................ 2,792,347 (2,848,000) 78.88
----------- ----------
Balances, December 31, 2000................... 1,730,321 24,821,733 39.78
=========== ==========
The following table summarizes information about fixed stock options
outstanding at December 31, 2000:
Options
Options Outstanding Exercisable
------------------------------- ------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Number of Contractual Exercise Number of Exercise
shares Life Price Shares Price
---------- ----------- -------- --------- --------
$0.02--$1.06................. 1,124,585 6.6 $ 0.59 1,006,830 $ 0.54
$1.81--$9.04................. 2,515,770 7.5 $ 5.53 1,557,142 $ 4.70
$10.00--$14.46............... 1,402,942 9.2 $ 14.16 68,683 $ 10.61
$15.00--$22.25............... 7,149,508 9.7 $ 16.77 408,340 $ 15.83
$23.50--$25.38............... 339,826 9.3 $ 23.73 84,703 $ 23.34
$27.04--$29.67............... 294,093 8.8 $ 29.35 160,357 $ 29.36
$33.66--$56.63............... 8,347,311 9.4 $ 46.12 332,699 $ 49.02
$73.50--$85.24............... 822,626 9.5 $ 80.24 97,398 $ 78.59
$129.69--$164.46............. 2,825,072 9.1 $129.36 32,879 $114.31
---------- ---------
24,821,733 9.1 $ 39.78 3,749,031 $ 13.19
========== =========
The weighted average exercise price of stock options outstanding was $12.71
as of December 31, 1999.
The Company uses the intrinsic-value method in accounting for its stock-
based compensation plans. Accordingly, compensation cost has been recognized
in the financial statements for those options issued with exercise prices at
less than fair value at date of grant. With respect to the stock options
granted from inception through December 31, 2000, the Company recorded
deferred stock-based compensation of $101.0 million for
73
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
the difference at the grant date between the exercise price and the fair value
of the common stock underlying the options. Subsequent to the consummation of
the BEI and netDialog acquisitions, the Company granted 698,264 under the 1999
Special Stock Option Plan options to certain employees hired from the acquired
companies for an exercise price below the fair market value of the common
stock. These options were immediately vested on the date of grant and 50% of
the options can be exercised 15 months after the grant date and the remaining
50% of the options can be exercised 30 months after the grant date, provided
the individual remains an employee of the Company. If the employee is
terminated prior to these dates, the options can be exercised after 9.5 years.
The difference between the fair market value of the underlying common stock and
the exercise price of the options was recorded as compensation expense in the
fourth quarter of 1999 in the amount of approximately $60,372,000.
On September 6, 2000, the Company issued to Accenture 400,000 shares of
common stock and a warrant to purchase up to 725,000 shares of common stock
pursuant to a stock and warrant purchase agreement in connection with our
global strategic alliance. The shares of common stock issued were fully vested
and the Company has recorded a charge of approximately $14.8 million to be
amortized over the four-year term of the agreement. The portion of the warrant
to purchase 125,000 shares of common stock is fully vested with the remainder
becoming vested upon the achievement of certain performance goals. The vested
warrants were valued using the Black-Scholes model resulting in a charge of
$1.0 million to be amortized over the four-year term of the agreement. The
Company will incur a charge to stock-based compensation for the unvested
portion of the warrant when performance goals are achieved.
On December 31, 2000, Accenture earned and vested in a portion of the
warrant to purchase 121,628 shares of common stock. This vesting of shares
resulted in a charge to operations of $968,000 during the quarter ended
December 31, 2000. As of December 31, 2000, shares of common stock under the
warrant which are unvested had a fair value of approximately $5.0 million based
upon the fair market value of our common stock at such date.
Had compensation costs been determined in accordance with SFAS No. 123 for
all of the Company's stock-based compensation plans, net loss and basic and
diluted net loss per share would not have been materially impacted for the year
ended December 31, 1998. Had compensation cost for the Company's plans been
determined consistent with the fair value approach in SFAS No. 123, the
Company's net loss and net loss per share would have been as indicated below
(in thousands, except per share amounts):
Year Ended December
31,
----------------------
2000 1999
----------- ---------
Net loss:
As reported....................................... $(3,070,873) $(118,743)
Pro forma......................................... $(3,190,035) $(124,603)
Basic and diluted net loss per share:
As reported....................................... $ (39.57) $ (4.61)
Pro forma......................................... $ (41.10) $ (4.83)
74
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The fair value of the Company's stock-based awards was estimated assuming no
expected dividends and the following weighted average assumptions:
Options ESPP
------------------------- --------------------------
Interest Interest
Rate Term Volatility Rate Term Volatility
-------- ----- ---------- -------- ------ ----------
2000.................... 6.16% 3 yrs 100% 5.30% 9 mths 100%
1999--Post IPO.......... 5.45% 3 yrs 100% 5.14% 6 mths 100%
1999--Pre IPO........... 5.30% 3 yrs -- -- -- --
1998.................... 5.15% 3 yrs -- -- -- --
The weighted average fair value of the employee stock purchase rights
granted under the 1999 ESPP during 2000 and 1999 was $4.99 and $6.55,
respectively. The weighted average fair value and exercise price of the options
granted in 1998, 1999, and 2000 are as follows:
Weighted Average Weighted Average
Exercise Price Fair Value
------------------- -------------------
2000 1999 1998 2000 1999 1998
------ ------ ----- ------ ------ -----
Exercise price equals fair value on
grant date........................ $51.22 $24.67 $ -- $33.49 $15.94 $ --
Exercise price exceeds fair value
on grant date..................... $81.12 $ 2.71 $0.13 $52.69 $12.83 $0.13
Total options...................... $52.13 $ 6.24 $0.13 $34.20 $13.39 $0.13
(f) Warrants
In connection with the Series A preferred stock issuance, the Company issued
a warrant to two investors to purchase 89,744 shares of Series A preferred
stock with an exercise price of $0.20 per share. The warrants were exercisable
any time prior to April 7, 1998. The fair value of the warrants computed using
the Black-Scholes option pricing model on the date of grant was not material.
In lieu of paying cash upon exercise of the warrants in 1998, the warrant
holders surrendered 43,209 shares of Series A preferred stock back to the
Company.
In connection with the issuance of convertible notes payable of $300,000,
Connectify issued warrants to purchase 48,314 shares of common stock for $1.25
per share in August 1998. Such warrants were exercised at the time of the
initial public offering. Using the Black-Scholes pricing model, the Company
determined that the fair value of the warrants was $35,000 at the date of
grant. Accordingly, following the conversion of the convertible notes payable
in 1998, the Company recorded $35,000 of interest expense associated with the
warrants.
In connection with its convertible debt offerings, netDialog issued warrants
to purchase preferred stock. The warrants were initially exercisable into an
amount of preferred stock equal to 10% of the value of the convertible debt
outstanding. As long as the convertible debt remained outstanding, the amount
of preferred stock into which the warrants could be exercised increased in
tranches of 3.33% of the value of the debt every two or three months following
the initial grant date up to a maximum of an additional 10% of the debt value.
The fair value of each tranche of warrants was measured at each date the
exercise terms of the warrants changed. The fair value of the warrants was
treated as a discount on the convertible debt and recorded as interest expense.
In connection with the acquisition of netDialog, all warrants issued under the
arrangement were converted into approximately 74,000 shares of Kana common
stock at an exercise price of $12.13 per share, of which, approximately 10,000
shares of Kana common stock were surrendered back to the Company in lieu of
paying cash. The full value of the warrants of approximately $1.6 million was
expensed during the year ended December 31, 1999.
75
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
6. Retirement Plan
The Company has a 401(k) retirement plan, which covers substantially all
employees. Eligible employees may make salary deferral (before tax)
contributions up to a specified amount. The Company, at its discretion, may
make additional matching contributions on behalf of the participants of the
retirement plan. No contributions were made by the Company for the years ended
December 31, 2000, 1999 and 1998.
7. Commitments and Contingencies
(a) Lease Obligations
The Company leases its facilities under noncancelable operating leases with
various expiration dates through October 2006. In connection with its existing
leases, the Company entered into three letters for credit totaling $1,645,000
which expire in 2000 and 2001. The letters of credit are supported by the
Company's line of credit.
Future minimum lease payments under noncancelable operating leases are as
follows (in thousands):
Operating
Year ending December 31, Leases
------------------------ ---------
2001............................................................. $ 11,662
2002............................................................. 10,723
2003............................................................. 9,959
2004............................................................. 9,548
2005............................................................. 8,712
Thereafter....................................................... 50,803
---------
$ 101,407
=========
Rent expense, net of sublease payments, was approximately $8,012,000,
$1,620,000 and $604,000 for the years ended December 31, 2000, 1999 and 1998,
respectively. Sublease payments were approximately $324,000, $212,000 and
$140,000 in the years ended December 31, 2000, 1999 and 1998, respectively. The
Company's sublease and the underlying lease arrangements expired in December
2000.
(b) Litigation
On October 8, 1999, Genesys Telecommunications Laboratories, Inc. (Genesys)
filed a complaint against Kana in the United States District Court for the
District of Delaware alleging patent infringement. On December 29, 2000, the
Company entered into a License Agreement and a Worldwide Bilateral Reseller
Agreement with Genesys Telecommunications Laboratories, Inc. Under the terms of
the License Agreement, the Company received a license to use or distribute
products which make use of technology which may be covered by certain patents
owned by Genesys. Under the terms of the Reseller Agreement, Genesys granted to
the Company the right to use or resell to third parties Genesys products, and
the Company granted to Genesys the right to use or resell to third parties our
products. In connection with the Reseller Agreement and the License Agreement,
the litigation between the Company and Genesys has been dismissed with
prejudice and the Company recognized a $2,000,000 charge to operations. The
Company is not currently a party to any other material legal proceedings.
76
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
8. Income Taxes
The 2000, 1999 and 1998 income tax benefit differed from the amounts
computed by applying the U.S. federal income tax rate of 34% to pretax loss as
a result of the following (in thousands):
Years Ended December 31,
------------------------------
2000 1999 1998
----------- -------- -------
Federal tax benefit at statutory rate...... $(1,040,940) $(40,372) $(4,284)
Stock compensation expense................. 3,861 27,222 432
Merger costs............................... 7,564 726 --
Foreign losses............................. (3,157) 486 --
Net operating losses and temporary
differences, no tax benefit recognized.... 29,674 11,896 3,172
Goodwill amortization and impairment....... 1,005,673 -- --
Other permanent differences................ (2,675) 42 680
----------- -------- -------
Total .................................... $ -- $ -- $ --
=========== ======== =======
The types of temporary differences that give rise to significant portions of
the Company's deferred tax assets and liabilities are set as follows (in
thousands):
Years Ended
December 31,
------------------
2000 1999
-------- --------
Deferred tax assets (liabilities):
Accruals and reserves................................. $ 3,017 $ 2,489
Plant and equipment................................... 1,131 (40)
Credit carryforwards.................................. 1,126 1,063
Net operating loss.................................... 44,869 16,957
-------- --------
Gross deferred tax assets............................... 50,143 20,469
Valuation allowance..................................... (50,143) (20,469)
-------- --------
Net deferred tax assets (liabilities)................. $ -- $ --
======== ========
The net change in the valuation allowance for the year ended December 31,
2000 was an increase of approximately $29,664,000. Management believes that
sufficient uncertainty exists as to whether the deferred tax assets will be
realized, and accordingly, a valuation allowance is required.
As of December 31, 2000, the Company had net operating loss carryforwards
for federal and state income tax purposes of approximately $122,767,000 and
$53,619,000, respectively. The federal net operating loss carryforwards, if not
offset against future taxable income, will expire from 2011 through 2020. The
state net operating loss carryforwards, if not offset against future taxable
income, expire from 2003 through 2005.
As of December 31, 2000, unused research and development tax credits of
approximately $914,000 and $321,000 were available to reduce future federal and
state income taxes, respectively. Federal credit carryforwards expire from 2011
through 2020.
Under the Tax Reform Act of 1986, the amounts of and benefits from net
operating loss carryforwards may be impaired or limited in certain
circumstances. Events which cause limitations in the amount of net operating
losses that the Company may utilize in any one year include, but are not
limited to, a cumulative ownership change of more than 50%, as defined, over a
three year period.
77
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
9. Subsequent Events
On February 28, 2001, the Company filed a tender offer statement on Schedule
TO announcing its offer to exchange certain eligible options outstanding under
the stock option plans for new options to purchase shares of common stock and
for restricted shares of common stock. The new options will be granted on or
after six months and one day after the date the tendered options are accepted
and cancelled. There are options to purchase approximately 18,000,000 shares of
common stock that could be exchanged if all the options eligible under stock
option plans were tendered by the employees. The Company will incur a charge to
compensation expense in connection with the issuance of the restricted shares
of common stock. Such charge is based on the fair market value of the common
stock at the time of the exchange. The charge to compensation expense will be
amortized over the six month vesting term of the restricted stock. Had the
compensation cost related to the maximum number of restricted shares issuable
under the offer been determined based upon the fair market value of $3.0625 per
share at the date of the tender offer, the total compensation charge would have
approximated $6,900,000.
On February 28, 2001, the Company announced a restructuring which included a
reduction of employees across all departments, representing approximately 25%
of its employees and other measures to reduce operating costs. As part of the
restructuring, the Company expects to record a charge to earnings of
approximately $17.0 million in the first fiscal quarter of 2001. The charge is
based on estimates of termination benefits, the cost to terminate certain
leases and other related costs.
78
REPORT OF INDEPENDENT ACCOUNTANTS ON
FINANCIAL STATEMENT SCHEDULE
To the Board of Directors and Stockholders
of Kana Communications, Inc.:
Our audit of the consolidated financial statements referred to in our report
dated January 23, 2001, except for Note 9, which is as of February 28, 2001,
appearing in the 2000 Annual Report on Form 10-K of Kana Communications, Inc.
also included an audit of the financial statement schedule for the year ended
December 31, 2000 listed in Item 14(a)(2) of this Form 10-K. In our opinion,
this financial statement schedule for the year ended December 31, 2000 presents
fairly, in all material respects, the information set forth therein when read
in conjunction with the related consolidated financial statements.
/s/ PRICEWATERHOUSECOOPERS LLP
San Jose, CA
January 23, 2001
79
INDEPENDENT AUDITORS REPORT ON SCHEDULE
The Board of Directors and Stockholders
Kana Communications, Inc.:
The audits referred to in our report included herein dated January 20, 2000
included the accompanying financial statement schedule for each of the years in
the two-year period ended December 31, 1999. The financial statement schedule
is the responsibility of the Company's management. Our responsibility is to
express an opinion on the financial statement schedule based on our audits. In
our opinion, the accompanying financial statement schedule, when considered in
relation to the basic financial statements taken as a whole, presents fairly in
all material respects the information set forth therein.
/s/ KPMG LLP
Mountain View, California
January 20, 2000
80
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
KANA COMMUNICATIONS, INC.
Charged
Balance at To Cost Balance
Beginning and at End
of Period Expense Deductions of Year
---------- ------- ---------- -------
Allowance for Doubtful Accounts:
Year ended December 31, 2000............. $366 1,962 (362) $1,966
Year ended December 31, 1999............. 110 256 -- 366
Year ended December 31, 1998............. -- 110 -- 110
81
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized, in the City of
Redwood City, State of California, on this 2nd day of April, 2001.
KANA COMMUNICATIONS, INC.
/s/ James C. Wood
By: _________________________________
James C. Wood
Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints James C. Wood, David B. Fowler and Franklin P.
Huang, and each of them, as such person's true and lawful attorneys-in-fact and
agents, with full power of substitution and resubstitution, for such person and
in such person's name, place and stead, in any and all capacities, to sign any
and all amendments to this report on Form 10-K, and to file same, with all
exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents, and each of them, full power and authority to do and perform each and
every act and thing requisite and necessary to be done in connection therewith,
as fully to all intents and purposes as such person might or could do in
person, hereby ratifying and confirming all that said attorneys-in-fact and
agents, or any of them, or their or his or her substitute or substitutes, may
lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ James C. Wood Chief Executive Officer April 2, 2001
____________________________________ and Chairman of the
James C. Wood Board of Directors
(Principal Executive
Officer)
/s/ Art M. Rodriguez Interim Chief Financial April 2, 2001
____________________________________ Officer (Principal
Art M. Rodriguez Financial and
Accounting Officer)
/s/ David B. Fowler President April 2, 2001
____________________________________
David B. Fowler
/s/ David M. Beirne Director April 2, 2001
____________________________________
David M. Beirne
/s/ Robert W. Frick Director April 2, 2001
____________________________________
Robert W. Frick
/s/ Eric A. Hahn Director April 2, 2001
____________________________________
Eric A. Hahn
/s/ Charles A. Holloway Director April 2, 2001
____________________________________
Dr. Charles A. Holloway
/s/ Steven T. Jurvetson Director April 2, 2001
____________________________________
Steven T. Jurvetson
82