<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the Quarter Ended March 31, 2000
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________ to __________
Commission File number 000-26287
Kana Communications, Inc.
(Exact Name of Registrant as Specified in Its Charter)
Delaware 77-0435679
-------- ----------
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
740 Bay Road
Redwood City, California 94063
----------------------------------------
(Address of Principal Executive Offices)
Registrant's Telephone Number, Including Area Code: (650) 298-9282
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
--- ---
On April 19, 2000, approximately 90,108,680 shares of the Registrant's Common
Stock, $0.001 par value, were outstanding.
<PAGE>
Kana Communications, Inc.
Form 10-Q
Quarter Ended March 31, 2000
Index
Part I: Financial Information
Item 1: Financial Statements
Unaudited Condensed Consolidated Balance Sheets at March 31, 3
2000 and December 31, 1999
Unaudited Condensed Consolidated Statements of Operations for the 4
three months ended March 31, 2000 and 1999
Unaudited Condensed Consolidated Statements of Cash Flows for the 5
three months ended March 31, 2000 and 1999
Notes to the Unaudited Condensed Consolidated Financial 6
Statements
Item 2: Management's Discussion and Analysis of Financial Condition and 9
Results of Operations
Item 3: Quantitative and Qualitative Disclosures About Market Risk 27
Part II: Other Information
Item 1. Legal Proceedings 28
Item 2. Changes in Securities and Use of Proceeds 28
Item 6. Exhibits and Reports on Form 8-K 29
Signatures
Exhibit Index
2
<PAGE>
PART I: FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
KANA COMMUNICATIONS, INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
March 31, December 31,
2000 1999
---- ----
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 18,414 $ 18,695
Short-term investments 17,254 34,522
Accounts receivable, net 9,595 4,655
Prepaid expenses and other current assets 2,324 2,036
----------------- ------------------
Total current assets 47,587 59,908
Property and equipment, net 12,776 8,360
Other assets 3,996 1,961
----------------- ------------------
Total assets $ 64,359 $70,229
================= ==================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of notes payable $ 1,428 $ 4,224
Accounts payable 5,301 2,766
Accrued payroll and related expenses 4,553 3,623
Accrued liabilities 2,487 4,451
Deferred revenue 12,525 6,253
----------------- ------------------
Total current liabilities 26,294 21,317
Notes payable, less current portion 362 412
----------------- ------------------
Total liabilities 26,656 21,729
----------------- ------------------
Stockholders' equity:
Common stock 61 61
Additional paid-in capital 206,013 202,473
Deferred stock-based compensation (15,082) (14,962)
Notes receivable from stockholders (6,114) (6,380)
Accumulated other comprehensive losses (110) (75)
Accumulated deficit (147,065) (132,617)
----------------- ------------------
Total stockholders' equity 37,703 48,500
----------------- ------------------
Total liabilities and stockholders' equity $ 64,359 $ 70,229
================= ==================
</TABLE>
SEE ACCOMPANYING NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
3
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KANA COMMUNICATIONS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(In thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
---------
2000 1999
----------------- --------------
<S> <C> <C>
Revenue:
License $ 7,329 $ 1,209
Service 3,359 280
----------------- ---------------
Total revenue 10,688 1,489
----------------- --------------
Cost of revenue:
License 143 34
Service (excluding stock-based compensation
of $815 and $128, respectively) 4,032 498
----------------- --------------
Total cost of revenue 4,175 532
----------------- --------------
Gross profit 6,513 957
----------------- --------------
Operating expenses:
Sales and marketing (excluding stock-based
compensation of $1,403 and $220,
respectively) 11,210 2,479
Research and development (excluding stock-
based compensation of $819 and $128,
respectively) 5,239 2,329
General and administrative (excluding stock-
based compensation of $283 and $44,
respectively) 1,835 725
Amortization of deferred stock-based
compensation 3,320 520
----------------- --------------
Total operating expenses 21,604 6,053
----------------- --------------
Operating loss (15,091) (5,096)
Other income & expense, net 680 (125)
----------------- --------------
Loss before income taxes (14,411) (5,221)
Income taxes 37 -
----------------- --------------
Net loss $ (14,448) $ (5,221)
================= ==============
Basic and diluted net loss per share $ (0.27) $ (0.92)
================= ==============
Shares used in computing basic and diluted net
loss per share 52,550 5,655
================= ==============
</TABLE>
SEE ACCOMPANYING NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
4
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KANA COMMUNICATIONS, INC.
UNAUDITED CONDENSED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
2000 1999
-------------- ----------------
<S> <C> C>
Cash flows from operating activities:
Net loss $ (14,448) $ (5,221)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation 996 163
Amortization of stock-based compensation 3,320 520
Noncash interest on warrants and bridge loans - 216
Changes in operating assets and liabilities:
Accounts receivable (4,940) (308)
Prepaid and other current assets (2,323) (154)
Accounts payable and accrued liabilities 1,502 892
Deferred revenue 6,273 682
-------------- ---------------
Net cash used in operating activities (9,620) (3,210)
-------------- ---------------
Cash flows from investing activities:
Sales (purchases) of short-term investments 17,268 (2,076)
Property and equipment purchases (5,413) (513)
-------------- ---------------
Net cash provided by (used in) investing activities 11,855 (2,589)
-------------- ---------------
Cash flows from financing activities:
Payments on notes payable (2,846) (28)
Proceeds from notes payable - 2,847
Proceeds from issuance of common stock 75 230
Proceeds from stockholders' notes receivable 266 -
-------------- ---------------
Net cash (used in) provided by financing activities (2,505) 3,049
-------------- ---------------
Effect of exchange rate changes on cash and cash equivalents (11) (19)
-------------- ---------------
(281) (2,769)
Net decrease in cash and cash equivalents
Cash and cash equivalents at beginning of period 18,695 13,875
-------------- ---------------
Cash and cash equivalents at end of period $ 18,414 $ 11,106
============== ===============
</TABLE>
SEE ACCOMPANYING NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
5
<PAGE>
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
The unaudited condensed consolidated financial statements have been
prepared by Kana Communications, Inc. ("Kana" or the "Company") and reflect all
adjustments (all of which are normal and recurring in nature) that, in the
opinion of management, are necessary for a fair presentation of the interim
financial information. The results of operations for the interim periods
presented are not necessarily indicative of the results to be expected for any
subsequent quarter or for the entire year ending December 31, 2000. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted under the Securities and Exchange Commission's rules and
regulations. These unaudited condensed consolidated financial statements and
notes included herein should be read in conjunction with Kana's audited
consolidated financial statements and notes included in Kana's annual report on
Form 10-K for the year ended December 31, 1999.
NOTE 2. STOCKHOLDERS' EQUITY
On January 10, 2000, Kana announced that its Board of Directors approved a
two-for-one stock split of its common stock. The split was effected in the form
of a stock dividend. Stockholders received one additional share for each share
held of record at the end of business on January 28, 2000. Shares resulting from
the split were distributed by the transfer agent in February 2000. The
accompanying financial statements have been retroactively restated to reflect
the effect of this stock split.
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 from
convertible securities using the as-if converted basis.
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 common share because all such securities are anti-dilutive
for all periods presented. The total number of shares excluded from the
calculation of diluted loss per share are as follows (in thousands):
Three Months Ended
March 31,
---------
2000 1999
---- ----
Stock options and warrants 3,646 435
Common stock subject to repurchase 6,803 6,541
Convertible preferred stock - 25,025
------------ ---------
10,449 32,001
============ =========
The weighted average exercise price of stock options outstanding was $12.89
and $0.33 as of March 31, 2000 and 1999, respectively.
6
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NOTE 3. COMPREHENSIVE LOSS
The components of comprehensive loss for the three months ended March 31,
2000 and 1999 were as follows (in thousands):
Three Months Ended
March 31,
--------------------
2000 1999
------------ ----------
Net loss $ (14,448) $ (5,221)
Foreign currency translation adjustments (35) (14)
------------ ----------
$ (14,483) $ (5,235)
============ ==========
Tax effects of foreign currency translation adjustments are not material.
NOTE 4. DEFERRED STOCK-BASED COMPENSATION
Kana uses the intrinsic value method of accounting for its employee
stock-based compensation plans. Accordingly, compensation cost is recognized for
stock options when the exercise price of an option is less than the fair value
of the underlying common stock as of the grant date for each stock option. Kana
recorded approximately $3.4 million of deferred stock-based compensation for the
three months ended March 31, 2000. This amount is being amortized in accordance
with Financial Accounting Standards Board (FASB) Interpretation No. 28 over the
vesting period of the individual options, generally 4 years.
NOTE 5. LEGAL PROCEEDINGS
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. Genesys alleges that Kana's Customer Messaging
System 3.0 infringes one or more claims of a Genesys patent. Genesys is seeking
relief in the forms of an injunction, damages, punitive damages, attorneys'
fees, costs and pre- and post-judgement interest. The litigation is currently in
its early stages and therefore Kana cannot fully evaluate the claim. Kana
intends to fight this claim vigorously and does not expect it to materially
impact the results from operations. Kana is not currently a party to any other
material legal proceedings.
NOTE 6. SEGMENT INFORMATION
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 three months ended
March 31, 2000 are as follows (in thousands):
7
<PAGE>
Three Months Ended
March 31,
--------------------
2000 1999
----------- ---------
United States $ 9,578 $ 1,452
International 1,110 37
----------- ---------
$10,688 $ 1,489
=========== =========
During the three months ended March 31, 2000, no customer represented more
than 10% of total revenues. During the three months ended March 31, 1999, one
customer accounted for more than 10% of total revenues.
NOTE 7. SUBSEQUENT EVENTS
On February 6, 2000, Kana, Pistol Acquisition Corp., a wholly-owned,
subsidiary of Kana, and Silknet Software, Inc. ("Silknet") entered into an
Agreement and Plan of Reorganization. On April 19, 2000, this transaction was
completed. As a result of the merger, each outstanding share of Silknet common
stock was converted into the right to acquire 1.66 shares of Kana common stock.
In addition, all outstanding options and warrants to purchase Silknet common
stock were assumed by Kana, adjusted for the exchange ratio. On a fully diluted
basis, Kana issued (or reserved) approximately 33.6 million shares of its common
stock having a value of approximately $4.2 billion. The transaction will be
accounted for as a purchase. As a result, Kana will record on its balance sheet
the fair market value of Silknet's assets and liabilities and identifiable
intangibles and goodwill of approximately $4.0 billion. Kana will amortize the
intangible assets and goodwill acquired in connection with the merger over a
three-year period, resulting in an approximate $1.3 billion charge per year that
will negatively affect Kana's results of operations during this period.
On February 11, 2000, the Company entered into an agreement to lease
approximately 62,500 square feet under a lease that expires in December 2010.
The annual base rent for this facility for the first year is approximately $2.4
million. The total lease obligation pursuant to this lease is $28.3 million.
NOTE 8. 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"). SFAS 133 establishes accounting and reporting
standards for derivative instruments and for hedging activities. This statement
becomes effective for all fiscal quarters of fiscal years beginning after June
15, 1999. In June 1999, the FASB issued Statement of Financial Accounting
Standard No. 137 "Accounting for Derivative Instruments - Deferral of the Effect
Date of SFAS Statement No. 133" ("SFAS 137"). SFAS 137 defers the effective date
of SFAS 133 until June 15, 2000. Kana will adopt SFAS 133 in 2001. Kana expects
the adoption of SFAS 133 will not affect results of operations.
In December 1998, the American Institute of Certified Public Accountants
issued Statement of Position (SOP) 98-9, Modification of SOP 97-2, Software
Revenue Recognition with Respect to Certain Transactions. SOP 98-9 amends SOP
97-2 to require the entity to recognize revenue for multiple element
arrangements by means of the "residual method" when: (1) there is
vendor-specific evidence of the fair values of all of the undelivered elements;
(2) vendor-specific evidence of fair value does not exist for one or more of the
delivered elements; and (3) the revenue recognition criteria of SOP 97-2 are
satisfied. SOP 98-9 became effective January 1, 2000. Kana adopted SOP 98-9 on
January 1, 2000 without any material effect on its results of operations,
financial position or cash flows.
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. Kana does not believe SAB 101 will have a material impact on the
financial statements.
In March 2000, the Financial Accounting Standards Board ("FASB") issued
FASB Interpretation No. 44 "Accounting for Certain Transactions Involving Stock
Compensation - an interpretation of APB Opinion No. 25". This interpretation has
provisions that are effective on staggered dates, some of which began after
December 15, 1998 and others that become effective after June 30, 2000. The
adoption of this interpretation did not and will not have a material impact on
the financial statements.
8
<PAGE>
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
EXCEPT FOR HISTORICAL INFORMATION CONTAINED OR INCORPORATED BY REFERENCE IN THIS
SECTION, THE FOLLOWING DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS THAT
INVOLVE RISKS AND UNCERTAINTIES. KANA'S ACTUAL RESULTS COULD DIFFER
SIGNIFICANTLY FROM THOSE DISCUSSED HEREIN. FACTORS THAT COULD CAUSE OR
CONTRIBUTE TO THESE DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED
HEREIN WITH THIS QUARTERLY REPORT ON FORM 10-Q, THE COMPANY'S ANNUAL REPORT ON
FORM 10-K, AND THE COMPANY'S REGISTRATION STATEMENT ON FORM S-4 FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. ANY FORWARD-LOOKING STATEMENTS SPEAK ONLY AS
OF THE DATE SUCH STATEMENTS ARE MADE.
OVERVIEW
We derive our revenues from the sale of software product licenses and from
professional services including implementation, system integration, hosting and
maintenance. License revenue is recognized when persuasive evidence of an
agreement exists, the product has been delivered, the arrangement does not
involve significant customization of the software, the license fee is fixed and
determinable and collection of the fee is probable. Service revenue includes
revenues from maintenance contracts, implementation, customization and hosting
services. Revenue from maintenance contracts is recognized ratably over the term
of the contract. Revenue from implementation, customization 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 its relative fair value.
Our cost of license revenue includes royalties due to a third party 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,
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 for the corporate office, communication charges and depreciation
expense for furniture and equipment.
In connection with the granting of stock options to our employees, we
recorded deferred stock-based compensation in the aggregate of approximately
$100.4 million through March 31, 2000. This amount represents the total
difference between the exercise prices of stock options and the deemed fair
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 Financial Accounting Standards Board (FASB) Interpretation No. 28.
The amortization of deferred stock-based compensation is classified as a
separate component of operating expenses in our consolidated statement of
operations.
Since the beginning of 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 three months
ended March 31, 2000, incurred a net loss of $14.4 million. As of March 31,
2000, we had an accumulated deficit of $147.1 million. We believe our future
success is contingent upon providing superior customer service, increasing our
customer base and developing our products. We intend to invest heavily in sales,
marketing, research and
9
<PAGE>
development, client services and infrastructure to support these activities. We
therefore expect to continue to incur substantial operating losses for the
foreseeable future.
We had 426 full-time employees as of March 31, 2000 and intend to hire a
significant number of employees in the future. This expansion places significant
demands on our management and operational resources. To manage this rapid
growth, we must invest in and implement scaleable operational systems,
procedures and controls. We expect future expansion to continue to challenge our
ability to hire, train, manage and retain employees.
We believe that period-to-period comparisons of our historical operating
results are not necessarily meaningful and should not be relied upon as being
indicative of future performance. 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. Furthermore, we may not achieve or
maintain profitability in the future.
RECENT DEVELOPMENTS
Pursuant to an Agreement and Plan of Reorganization dated as of
February 6, 2000, by and among Kana, Pistol Acquisition Corp., a Delaware
corporation and a wholly-owned subsidiary of Kana ("Merger Sub"), and Silknet
Software, Inc., a Delaware corporation ("Silknet"), Merger Sub merged with and
into Silknet, and Silknet became a wholly-owned subsidiary of Kana, effective
April 19, 2000 (the "Merger").
In connection with the Merger, each share of Silknet common stock
outstanding immediately prior to the consummation of the Merger was converted
into the right to receive 1.66 shares of Kana common stock (the "Exchange
Ratio") and Kana assumed Silknet's outstanding stock options and warrants based
on the Exchange Ratio, issuing approximately 29.2 million shares of Kana common
stock and assuming options and warrants to acquire approximately 4.4 million
shares of Kana common stock. The transaction is intended to qualify as a
tax-free reorganization under the Internal Revenue Code of 1986, as amended, and
will be accounted for using the purchase method of accounting. After giving
effect to the issuance of shares in connection with the Merger, Kana will have
approximately 90,108,680 shares of Kana common stock outstanding. The details of
the merger are described in a Registration Statement on Form S-4 that was
declared effective by the Securities and Exchange Commission ("SEC") on March
22, 2000 and a Current Report on Form 8-K filed with the SEC on May 4, 2000 and
amended on May 8, 2000.
10
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RESULTS OF OPERATIONS
The following table sets forth the results of operations for the three
months ended March 31, 2000 and 1999 expressed as a percentage of total
revenues.
Three Months Ended
March 31,
------------------
2000 1999
------ -------
Revenues:
License 68.6% 81.2%
Service 31.4 18.8
------- -------
Total revenues 100.0 100.0
------- -------
Cost of revenues:
License 1.3 2.3
Service 37.7 33.4
------- -------
Total cost of revenues 39.0 35.7
------- -------
Gross profit 61.0 64.3
Operating expenses:
Sales and marketing 104.9 166.5
Research and development 49.0 156.4
General and administrative 17.2 48.7
Amortization of deferred stock-based
compensation 31.1 34.9
------- -------
Total operating expenses 202.2 406.5
------- -------
Operating loss (141.2) (342.2)
------- -------
Other income, expense 6.0 (8.4)
Net loss (135.2)% (350.6)%
======= =======
COMPARISON OF THE THREE MONTHS ENDED MARCH 31,
2000 AND 1999
Revenues
Total revenues increased to $10.7 million for the three months ended March
31, 2000 from $1.5 million for the three months ended March 31, 1999. License
revenue increased to $7.3 million for the three months ended March 31, 2000 from
$1.2 million for the three months ended March 31, 1999. The 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. Total sales personnel increased to 124 people at March 31, 2000
from 24 people at March 31, 1999. License revenue represented 69% of total
revenues for the three months ended March 31, 2000 and 81% of total revenues for
the three months ended March 31, 1999.
Service revenue increased to $3.4 million for the three months ended March
31, 2000 from $280,000 for the three months ended March 31, 1999. This increase
in service revenue was due primarily to the increased licensing activity
described above, resulting in increased revenue from customer implementations,
system integration projects, maintenance contracts and hosted service. Service
revenue represented 31% of total revenues for the three months ended March 31,
2000 and 19% of total revenues for the three months ended March 31, 1999.
Revenue from international sales for the three months ended March 31, 2000
was 10.4%, and 2.5% for the three months ended March 31, 1999.
Cost of Revenues
Cost of license revenue includes third party software royalties, product
packaging, documentation and production. Cost of license revenue increased to
$143,000 for the three months ended March 31, 2000 from $34,000 for the three
months ended March 31, 1999. The absolute dollar increase in the cost of license
revenue was due principally to royalties. As a
11
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percentage of license revenue, cost of license revenue was 2% for the three
months ended March 31, 2000 and 3% for the three months ended March 31, 1999.
The decrease in cost of license revenue as a percent of license revenue was due
primarily to the increase in license revenue over the period. We anticipate that
the cost of license revenue will increase in absolute dollars as we license
additional technologies, but will decrease as a percentage of license revenue.
Cost of service revenue consists primarily of salaries and related expenses
for our customer support, implementations and training services organization and
allocation of facility costs and system costs incurred in providing customer
support. Cost of service revenue increased to $4.0 million for the three months
ended March 31, 2000 from $498,000 for the three months ended March 31, 1999.
The growth in cost of service revenue was attributable primarily to an increase
in personnel and related costs associated with an increased number of customers
and recruiting fees. Cost of service revenue as a percent of service revenue was
120% for the three months ended March 31, 2000 and 178% for the three months
ended March 31,1999. The decrease in cost of service revenue as a percent of
service revenue was due primarily to the increase in service revenue over the
period. We anticipate that cost of service revenue will increase in absolute
dollars, but will decrease as a percentage of service revenue.
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 to $11.2
million for the three months ended March 31, 2000 from $2.5 million for the
three months ended March 31, 1999. This increase was attributable primarily to
the addition of sales and marketing personnel, 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 105% for the three months ended March 31, 2000 and
167% for the three months ended March 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 period. We expect to continue to increase
our marketing and promotional efforts and hire additional sales personnel. We
further expect our sales and marketing expenses to increase due to our recent
mergers. Accordingly, we anticipate that sales and marketing expenses will
increase 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 engineering employees and
contractors responsible for new product development and for enhancement of
existing products and quality assurance activities. Research and development
expenses increased to $5.2 million for the three months ended March 31, 2000
from $2.3 million for the three months ended March 31, 1999. This increase was
attributable primarily to the addition of personnel associated with product
development and related benefits, consulting and recruiting costs. As a
percentage of total revenues, research and development expenses were 49% for the
three months ended March 31, 2000 and 156% for the three months ended March 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 period. We
expect to continue to make substantial investments in research and development
and anticipate that research and development expenses will continue to increase
in absolute dollars, but will vary as a percentage of total revenues from period
to period. We further expect our research and development expenses to increase
due to our recent mergers.
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 to $1.8 million for the three months ended March 31, 2000
from $725,000 for the three months ended March 31, 1999, due primarily to
increased personnel, legal and professional fees, facilities and other related
costs necessary to support our growth. As a percentage of total revenues,
general and administrative expenses were 17% for the three months ended March
31, 2000 and 49% for the three months ended March 31, 1999. This decrease in
general and administrative expenses as a percent of total revenues was due
primarily to the increase in total revenues over the period. We expect that
general and administrative expenses will increase in absolute dollars as we add
personnel and
12
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incur additional costs related to the anticipated growth of our business and
operation as a public company. However, we expect that these expenses will vary
as a percentage of total revenues from period to period.
Amortization of stock-based compensation
In connection with the granting of stock options to its employees, Kana
recorded stock-based compensation in the aggregate of approximately $100.4
million through March 31, 2000. This amount represents the total difference
between the exercise prices of stock options and the deemed fair 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.
The amortization of stock-based compensation by operating expense is
detailed as follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
------------------
2000 1999
------- --------
<S> <C> <C>
Cost of service......................................................... $815 $128
Sales and marketing..................................................... 1,403 220
Research and development................................................ 819 128
General and administrative.............................................. 283 44
------- --------
Total.............................................................. $3,320 $520
======= ========
</TABLE>
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 a note. Other
income (expense), net was $680,000 for the three months ended March 31, 2000 and
$(125,000) for the three months ended March 31, 1999. The increase in
net was due primarily to increased interest income earned on higher cash
balances offset by interest expense.
Provision for Income Taxes
We have incurred operating losses for all periods from inception through
March 31, 2000. We have recorded a provision for income taxes for the minimum
tax provisions. 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.
Net Loss
Our net loss increased to $14.4 million for the three months ended March
31, 2000 from $5.2 million for the three months ended March 31, 1999. We have
experienced substantial increases in our 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. 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 for profitability.
LIQUIDITY AND CAPITAL RESOURCES
Our operating activities used $9.6 million of cash for the three months
ended March 31, 2000, which is primarily attributable to net losses experienced
during this period as we invested in the development of our products, expanded
our sales force and expanded our infrastructure to support our growth and
increase in sales, which led to an increase in accounts receivable. Our
operating activities used $3.2 million of cash for the three months ended March
31, 1999, which is primarily attributable to net losses experienced during this
period.
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Our investing activities consisted primarily of net sales of short-term
investments, purchases of computer equipment, furniture, fixtures and leasehold
improvements to support our growing number of employees, and provided $11.9
million of cash for the three months ended March 31, 2000. Our investing
activities used $2.6 million of cash for the three months ended March 31, 1999,
which is primarily due to purchases of short-term investments and computer
equipment, furniture, fixtures and leasehold improvements.
Our financing activities used $2.5 million in cash for the three months
ended March 31, 2000, primarily due to payments on bank borrowings. Our
financing activities generated $3.0 million in cash for the three months ended
March 31, 1999, primarily from the net proceeds from bank borrowings.
At March 31, 2000, we had cash and cash equivalents aggregating $18.4
million and short-term investments totaling $17.3 million. We have two lines of
credit totaling $3.0 million, which are secured by all of our assets, bear
interest at the bank's prime rate (9.0% as of March 31, 2000), and expire in May
2000 and June 2000. Our total bank debt was $1.8 million at March 31, 2000.
Our capital requirements depend on numerous factors. We expect to devote
substantial resources to continue our research and development efforts, expand
our sales, support, marketing and product development organizations, establish
additional facilities worldwide and build the infrastructure necessary to
support our growth. We have experienced substantial increases in our
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. We believe that the net proceeds from the sale of the common stock
in our initial public offering and collections on our accounts receivable will
be sufficient to meet our working capital and operating resource expenditure
requirements for the next 18 months. However, we may need to raise additional
funds in order to fund more rapid expansion, including significant increases in
personnel and office facilities; to develop new or enhance existing services or
products; to respond to competitive pressures; or to acquire or invest in
complementary businesses, technologies, services or products. 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 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.
RISK FACTORS ASSOCIATED WITH KANA'S BUSINESS AND FUTURE OPERATING RESULTS
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.
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 THIS "RISKS ASSOCIATED WITH KANA'S BUSINESS AND FUTURE OPERATING
RESULTS" 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 STATEMENT, WHICH
REFLECT OUR MANAGEMENT'S VIEW ONLY AS OF THE DATE OF THIS REPORT.
14
<PAGE>
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.
BECAUSE KANA HAS A LIMITED OPERATING HISTORY, THERE IS LIMITED INFORMATION UPON
WHICH YOU CAN EVALUATE KANA'S BUSINESS
Kana is still in the early stages of its development, and Kana's limited
operating history makes it difficult to evaluate Kana's business and prospects.
Kana was incorporated in July 1996 and first recorded revenue in February 1998.
Thus, Kana has a limited operating history upon which you can evaluate its
business and prospects. In addition, Kana's operating results include the
results of operations of Connectify, Inc., netDialog, Inc. and Business
Evolution, Inc., three companies acquired by Kana and accounted for as poolings
of interests. Due to Kana's limited operating history, it is difficult or
impossible to predict future results of operations. For example, Kana cannot
forecast operating expenses based on its historical results because they are
limited, and Kana is required to forecast expenses in part on future revenue
projections. Moreover, due to Kana's limited operating history, any evaluation
of its 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
Kana's ability to:
o attract more customers;
o implement its sales, marketing and after-sales service initiatives,
both domestically and internationally;
o execute its product development activities;
o anticipate and adapt to the changing Internet market;
o attract, retain and motivate qualified personnel;
o respond to actions taken by its competitors;
o continue to build an infrastructure to effectively manage growth and
handle any future increased usage; and
o integrate acquired businesses, technologies, products and services.
If Kana is unsuccessful in addressing these risks or in executing its
business strategy, its business, results of operations and financial condition
would be materially and adversely affected.
KANA'S QUARTERLY REVENUES AND OPERATING RESULTS MAY FLUCTUATE IN FUTURE PERIODS
AND KANA MAY FAIL TO MEET EXPECTATIONS, WHICH MAY CAUSE THE PRICE OF KANA'S
COMMON STOCK TO DECLINE
Kana's quarterly revenues and operating results are difficult to predict
and may fluctuate significantly from quarter to quarter particularly because
Kana's products and services are relatively new and Kana's prospects uncertain.
If quarterly revenues or operating results fall below the expectations of
investors or public market analysts, the price of Kana's common stock could
decline substantially. Factors that might cause quarterly fluctuations in Kana's
operating results include the factors described in the subheadings below as well
as:
o the evolving and varying demand for customer communication software
products and services for e-Businesses, particularly Kana's products
and services;
o costs associated with integrating Kana's recent acquisitions, and
costs associated with any future acquisitions;
o the timing of new releases of Kana's products;
o the discretionary nature of Kana's customers' purchasing and budgetary
cycles;
15
<PAGE>
o changes in Kana's pricing policies or those of Kana's competitors;
o the timing of execution of large contracts that materially affect
Kana's operating results;
o the mix of sales channels through which Kana's products and services
are sold;
o the mix of Kana's domestic and international sales;
o costs related to the customization of Kana's products;
o Kana's ability to expand its operations, and the amount and timing of
expenditures related to this expansion; and
o global economic conditions, as well as those specific to large
enterprises with high e-mail volume.
Kana also often offers volume-based pricing, which may affect operating
margins. Most of Kana's expenses, such as employee compensation and rent, are
relatively fixed in the short term. Moreover, Kana's expense levels are based,
in part, on its expectations regarding future revenue levels. As a result, if
total revenues for a particular quarter are below expectations, Kana could not
proportionately reduce operating expenses for that quarter. Therefore, this
revenue shortfall would have a disproportionate effect on Kana's expected
operating results for that quarter. In addition, because Kana's service revenue
is largely correlated with its license revenue, a decline in license revenue
could also cause a decline in service revenue in the same quarter or in
subsequent quarters.
Due to the foregoing factors, Kana believes that quarter-to-quarter
comparisons of its operating results are not a good indication of its future
performance.
KANA HAS A HISTORY OF LOSSES AND MAY NOT BE PROFITABLE IN THE FUTURE, WHICH MAY
REDUCE THE TRADING PRICE OF KANA COMMON STOCK
Since Kana began operations in 1997, it has incurred substantial operating
losses in every quarter. At March 31, 2000, Kana had an accumulated deficit of
approximately $147 million. For the three months ended March 31, 2000, Kana had
a net loss of approximately $14.4 million, or 135% of revenues for that period.
Since inception, Kana has funded its business primarily through selling its
stock, not from cash generated by its business. Kana's growth in recent periods
has been from a limited base of customers, and Kana may not be able to sustain
these growth rates. Kana expects to continue to increase its operating expenses.
As a result, Kana expects to continue to experience losses and negative cash
flows, even if sales of its products and services continue to grow, and Kana may
not generate sufficient revenues to achieve profitability in the future.
In addition, as a result of its mergers with Connectify, netDialog,
Business Evolution, and Silknet, Kana expects that its losses will increase even
more significantly because of additional costs and expenses related to:
o an increase in the number of employees;
o an increase in research and development activities;
o an increase in sales and marketing activities; and
o assimilation of operations and personnel.
If Kana does achieve profitability, it may not be able to sustain or
increase any profitability on a quarterly or annual basis in the future. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations ".
KANA FACES SUBSTANTIAL COMPETITION AND MAY NOT BE ABLE TO COMPETE EFFECTIVELY
16
<PAGE>
The market for Kana's products and services is intensely competitive,
evolving and subject to rapid technological change. Kana expects the intensity
of competition to increase in the future. Increased competition may result in
price reductions, reduced gross margins and loss of market share.
Kana currently faces competition for its products from systems designed by
in-house and third-party development efforts. Kana expects that these systems
will continue to be a principal source of competition for the foreseeable
future. Kana's competitors include a number of companies offering one or more
products for the e-Business communications market, some of which compete
directly with Kana's products. For example, Kana's competitors include companies
providing stand-alone point solutions, including Annuncio, Inc., AskJeeves,
Inc., Brightware, Inc., Digital Impact, Inc., eGain Communications Corp.,
Inference Corp., Marketfirst, Inc., Live Person, Inc., Mustang Software, Inc.,
Responsys.com and Servicesoft, Inc. In addition, Kana may compete with companies
providing customer management and communications solutions, such as Broadbase,
Inc., Clarify Inc. (which was recently acquired by Northern Telecom), E.piphany,
Inc., Genesys Telecommunications Laboratories, Inc. (which was recently acquired
by Alcatel), Cisco Systems, Inc., Lucent Technologies, Inc., Message Media,
Inc., Oracle Corporation, Pivotal Corporation, Siebel Systems, Inc., and Vantive
Corporation (which was recently acquired by PeopleSoft, Inc.). Furthermore, Kana
may face increased competition should it expand its product line, through
acquisition of complementary businesses or otherwise.
Many of Kana's 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 Kana has.
In addition, many of Kana's competitors have well-established relationships with
Kana's current and potential customers and have extensive knowledge of Kana's
industry. Kana may lose potential customers to competitors for various reasons,
including the ability or willingness of competitors to offer lower prices and
other incentives that Kana cannot match. Accordingly, it is possible that new
competitors or alliances among competitors may emerge and rapidly acquire
significant market share. Kana also expects that competition will increase as a
result of recently-announced industry consolidations, as well as future
consolidations.
Kana may not be able to compete successfully against current and future
competitors, and competitive pressures may seriously harm its business.
KANA'S FAILURE TO CONSUMMATE ITS EXPECTED SALES IN ANY GIVEN QUARTER COULD
DRAMATICALLY HARM ITS OPERATING RESULTS BECAUSE OF THE LARGE SIZE OF TYPICAL
ORDERS
Kana's sales cycle is subject to a number of significant risks, including
customers' budgetary constraints and internal acceptance reviews, over which
Kana has little or no control. Consequently, if sales expected from a specific
customer in a particular quarter are not realized in that quarter, Kana is
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.
KANA MAY NOT BE ABLE TO FORECAST ITS REVENUES ACCURATELY BECAUSE ITS PRODUCTS
HAVE A LONG AND VARIABLE SALES CYCLE
The long sales cycle for Kana's products may cause license revenue and
operating results to vary significantly from period to period. To date, the
sales cycle for Kana's products has taken three to 12 months in the United
States and longer in foreign countries. Kana's sales cycle has required
pre-purchase evaluation by a significant number of individuals in its customers'
organizations. Along with third parties that often jointly market Kana's
software with Kana, Kana invests significant amounts of time and resources
educating and providing information to prospective customers regarding the use
and benefits of Kana's products. Many of Kana's customers evaluate Kana's
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 Kana's products.
17
<PAGE>
KANA'S STOCK PRICE MAY BE HIGHLY VOLATILE AND COULD DROP, PARTICULARLY BECAUSE
ITS BUSINESS DEPENDS ON THE INTERNET
The trading price of Kana's common stock has in the past and is expected to
continue in the future to fluctuate widely as a result of a number of factors,
many of which are outside Kana's 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 which have often been unrelated or
disproportionate to the operating performance of these companies. These broad
market fluctuations could adversely affect the market price of Kana common
stock.
DIFFICULTIES IN IMPLEMENTING KANA'S PRODUCTS COULD HARM KANA'S REVENUES AND
MARGINS
Forecasting Kana's revenues depends upon the timing of implementation of
its products. This implementation typically involves working with sophisticated
software, computing and communications systems. If Kana experiences difficulties
with implementation or does not meet project milestones in a timely manner, Kana
could be obligated to devote more customer support, engineering and other
resources to a particular project. Some customers may also require Kana to
develop customized features or capabilities. If new or existing customers have
difficulty deploying Kana's products or require significant amounts of Kana's
professional services support or customized features, Kana's revenue recognition
could be further delayed and Kana's costs could increase, causing increased
variability in Kana's operating results.
KANA'S BUSINESS DEPENDS ON THE ACCEPTANCE OF ITS PRODUCTS AND SERVICES, AND IT
IS UNCERTAIN WHETHER THE MARKET WILL ACCEPT KANA'S PRODUCTS AND SERVICES
Of Kana's total revenue of $10.7 million for the three months ended March
31, 2000, $7.3 million was derived from licenses of products and $3.4 million
from related services. Kana is not certain that its target customers will widely
adopt and deploy its products and services. Kana's future financial performance
will depend on the successful development, introduction and customer acceptance
of new and enhanced versions of Kana's products and services. In the future,
Kana may not be successful in marketing its products and services or any new or
enhanced products.
KANA MAY BE UNABLE TO HIRE AND RETAIN THE SKILLED PERSONNEL NECESSARY TO DEVELOP
ITS ENGINEERING, PROFESSIONAL SERVICES AND SUPPORT CAPABILITIES IN ORDER TO
CONTINUE TO GROW
Kana intends to increase its sales, marketing, engineering, professional
services and product management personnel over the next 12 months. Competition
for these individuals is intense, and Kana may not be able to attract,
assimilate or retain highly qualified personnel in the future. Kana's business
cannot continue to grow if it cannot attract qualified personnel. Kana's failure
to attract and retain the highly trained personnel that are integral to its
product development and professional services group, which is the group
responsible for implementation and customization of, and technical support for,
Kana's products and services, may limit the rate at which Kana can develop and
install new products or product enhancements, which would harm its business.
Kana will need to increase its staff to support new customers and the expanding
needs of its existing customers, without compromising the quality of Kana's
customer service. Since Kana's inception, a number of employees have left or
have been terminated, and Kana expects to lose more employees in the future.
Hiring qualified professional services personnel, as well as sales, marketing,
administrative and research and development personnel, is very competitive in
Kana's industry, particularly in the San Francisco Bay Area, where Kana is
headquartered, due to the limited number of people available with the necessary
technical skills. Kana faces greater difficulty attracting these personnel with
equity incentives as a public company than it did as a privately held company.
KANA MAY FACE DIFFICULTIES IN HIRING AND RETAINING QUALIFIED SALES PERSONNEL TO
SELL ITS PRODUCTS AND SERVICES, WHICH COULD HARM KANA'S ABILITY TO INCREASE ITS
REVENUES IN THE FUTURE
18
<PAGE>
Kana's financial success depends to a large degree on the ability of its
direct sales force to increase sales to a level required to adequately fund
marketing and product development activities. Therefore, Kana's ability to
increase revenues in the future depends considerably upon its 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 Kana's sales force.
Kana's business will be harmed if it fails 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 Kana anticipates.
LOSS OF KANA'S CHIEF EXECUTIVE OFFICER OR ANY OF KANA'S EXECUTIVE OFFICERS COULD
HARM KANA'S BUSINESS
Kana's future success depends to a significant degree on the skills,
experience and efforts of Kana's senior management. In particular, Kana depends
upon the continued services of Michael J. McCloskey, its Chief Executive
Officer. The loss of the services of Mr. McCloskey or any of Kana's executive
officers could harm Kana's business and operations. In addition, Kana has not
obtained life insurance benefiting Kana on any of its key employees or entered
into employment agreements with its key employees. If any of Kana's key
employees left or was seriously injured and unable to work and Kana was unable
to find a qualified replacement, Kana's business could be harmed.
A FAILURE TO MANAGE KANA'S INTERNAL OPERATING AND FINANCIAL FUNCTIONS COULD LEAD
TO INEFFICIENCIES IN CONDUCTING ITS BUSINESS AND SUBJECT KANA TO INCREASED
EXPENSES
Kana's ability to offer its products and services successfully in a rapidly
evolving market requires an effective planning and management process. Kana has
limited experience in managing rapid growth. Kana is experiencing a period of
growth that is placing a significant strain on its managerial, financial and
personnel resources. Kana's business will suffer if this growth continues and
Kana fails to manage it successfully. On March 31, 2000, Kana had a total of 426
full-time employees compared to 135 on March 31, 1999. Kana expects to continue
to hire new employees at a rapid pace. Recent completion of the merger with
Silknet is expected to result in approximately 300 new employees joining Kana.
Moreover, Kana will need to assimilate substantially all of these companies'
operations into its operations. The rate of Kana's recent growth has made
management of that growth more difficult. Any additional growth will further
strain Kana's management, financial, personnel, internal training and other
resources. To manage any future growth effectively, Kana must improve its
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 Kana's products, Kana's ability to
respond to its customers and retain key personnel, and Kana's business in
general.
THE INTEGRATION OF KANA'S NEW PRESIDENT, VICE PRESIDENT OF PRODUCT DEVELOPMENT,
VICE PRESIDENT OF MARKETING, CHIEF FINANCIAL OFFICER, VICE PRESIDENT OF HUMAN
RESOURCES, VICE PRESIDENT FOR KANA ON-LINE, VICE PRESIDENT OF EBUSINESS SERVICES
AND VICE PRESIDENT OF REALTIME INTO ITS MANAGEMENT TEAM MAY INTERFERE WITH ITS
OPERATIONS
The Recent completion of the merger with Silknet has resulted in the
addition of a new President, Vice President of Development, and Vice President
of Marketing. In addition, Kana has recently hired a Chief Financial Officer,
Vice President of Human Resources, Vice President for Kana On-Line, Vice
President of eBusiness Services and Vice President of Realtime, each of whom has
been with Kana for less than six months. To integrate into Kana, these
individuals must spend a significant amount of time learning Kana's business
model and management system, in addition to performing their regular duties.
Accordingly, the integration of new personnel has resulted and will continue to
result in some disruption to Kana's ongoing operations.
KANA HAS COMPLETED FOUR MERGERS IN THE PAST TEN MONTHS, AND THOSE MERGERS MAY
RESULT IN DISRUPTIONS TO ITS BUSINESS AND MANAGEMENT DUE TO DIFFICULTIES IN
ASSIMILATING PERSONNEL AND OPERATIONS
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Kana may not realize the benefits from the significant mergers it has
completed. In August 1999, Kana acquired Connectify, and in December 1999, Kana
acquired netDialog and Business Evolution. On April 19, 2000, Kana completed its
merger with Silknet. Kana may not be able to successfully assimilate the
additional personnel, operations, acquired technology and products into its
business. In particular, Kana 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 Kana is 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 Kana. In
addition, products of these companies will have to be integrated into Kana's
products, and it is uncertain whether Kana may accomplish this easily or at all.
These difficulties could disrupt Kana's ongoing business, distract management
and employees or increase expenses. Acquisitions are inherently risky and Kana
may also face unexpected costs, which may adversely affect operating results in
any quarter.
THE MERGER OF SILKNET SOFTWARE, INC. INTO KANA COULD ADVERSELY AFFECT COMBINED
FINANCIAL RESULTS
If the benefits of the merger of Silknet into Kana do not exceed the costs
associated with the merger, including any dilution to Kana's stockholders
resulting from the issuance of shares in connection with the merger, Kana's
financial results, including earnings per share, could be adversely affected. In
addition, Kana expects to record goodwill and intangible assets of approximately
$4.0 billion, which will be amortized over a period of three years.
THE MARKET PRICE OF KANA COMMON STOCK MAY DECLINE AS A RESULT OF THE MERGER OF
SILKNET SOFTWARE, INC. INTO KANA
The market price of Kana common stock may decline as a result of the merger
if:
o the integration of Kana and Silknet is unsuccessful;
o Kana does not achieve the perceived benefits of the merger as rapidly
or to the extent anticipated by financial or industry analysts or
investors; or
o the effect of the merger on Kana's financial results is not consistent
with the expectations of financial or industry analysts or investors.
The market price of the Kana common stock could also decline as a result of
factors related to the merger which may currently be unforeseen. A decline in
the market price of the Kana common stock could materially and adversely affect
Kana's operating results.
IF KANA ACQUIRES ADDITIONAL COMPANIES, PRODUCTS OR TECHNOLOGIES, IT MAY FACE
RISKS SIMILAR TO THOSE FACED IN ITS OTHER MERGERS
If Kana is presented with appropriate opportunities, Kana intends to make
other investments in complementary companies, products or technologies. Kana may
not realize the anticipated benefits of any other acquisition or investment. If
Kana acquires another company, it will likely face the same risks, uncertainties
and disruptions as discussed above with respect to its other mergers.
Furthermore, Kana 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 Kana or Kana's existing stockholders. In addition, Kana's
profitability may suffer because of acquisition-related costs or amortization
costs for acquired goodwill and other intangible assets.
DELAYS IN THE DEVELOPMENT OF NEW PRODUCTS OR ENHANCEMENTS TO EXISTING PRODUCTS
WOULD HURT KANA'S SALES AND DAMAGE ITS REPUTATION
To be competitive, Kana must develop and introduce on a timely basis new
products and product enhancements for companies with significant e-Business
customer interactions needs. Any failure to do so could harm Kana's business. If
Kana experiences product delays in the future, it may face:
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o customer dissatisfaction;
o cancellation of orders and license agreements;
o negative publicity;
o loss of revenues;
o slower market acceptance; and
o legal action by customers.
In the future, Kana's efforts to remedy this situation may not be
successful and Kana 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 Kana's competitors. If Kana were to
lose market share as a result of lapses in its product management, Kana's
business would suffer.
TECHNICAL PROBLEMS WITH EITHER KANA'S INTERNAL OR OUTSOURCED COMPUTER AND
COMMUNICATIONS SYSTEMS COULD INTERRUPT KANA'S KANA ON-LINE SERVICE
The success of the Kana On-Line service depends on the efficient and
uninterrupted operation of its 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. Kana has entered into an Internet-hosting agreement
with Exodus Communications, Inc. to maintain all of the Kana On-Line servers at
Exodus' data center in Santa Clara, California. Kana's operations depend on
Exodus' ability to protect its and Kana's systems in Exodus' data center against
damage or interruption. Exodus does not guarantee that Kana's Internet access
will be uninterrupted, error-free or secure. Kana has no formal disaster
recovery plan in the event of damage or interruption, and its insurance policies
may not adequately compensate Kana for any losses that it may incur. Any system
failure that causes an interruption in Kana's service or a decrease in
responsiveness could harm Kana's relationships with customers and result in
reduced revenues.
IF KANA FAILS TO BUILD SKILLS NECESSARY TO SELL ITS KANA ON-LINE SERVICE, KANA
WILL LOSE REVENUE OPPORTUNITIES AND ITS SALES WILL SUFFER
The skills necessary to market and sell Kana On-Line are different from
those relating to Kana's software products. Kana licenses its software products
for a fixed fee based on the number of concurrent users and the optional
applications purchased. Kana licenses Kana On-Line based on a fixed fee for
installation, configuration and training, and a variable monthly component
depending on actual customer usage. Kana's sales force sells both Kana's
software products and Kana On-Line. Because different skills are necessary to
sell Kana On-Line as compared to selling software products, Kana's sales and
marketing groups may not be able to maintain or increase the level of sales of
either Kana On-Line or Kana's software products.
KANA'S PENDING PATENTS MAY NEVER BE ISSUED AND, EVEN IF ISSUED, MAY PROVIDE
LITTLE PROTECTION
Kana's success and ability to compete depend to a significant degree upon
the protection of its software and other proprietary technology rights. Kana
regards the protection of patentable inventions as important to its future
opportunities. Kana currently has seven U.S. patent applications pending
relating to its software. However, none of Kana's technology is patented outside
of the United States, although Kana has filed three international patent
applications corresponding to three of Kana's U.S. patent applications. It is
possible that:
o Kana's pending patent applications may not result in the issuance of
patents;
o any patents issued may not be broad enough to protect Kana's
proprietary rights;
21
<PAGE>
o any issued patent could be successfully challenged by one or more
third parties, which could result in Kana's loss of the right to
prevent others from exploiting the inventions claimed in those
patents;
o current and future competitors may independently develop similar
technology, duplicate Kana's products or design around any of Kana's
patents; and
o effective patent protection may not be available in every country in
which Kana does business.
KANA RELIES UPON TRADEMARKS, COPYRIGHTS AND TRADE SECRETS TO PROTECT ITS
PROPRIETARY RIGHTS, WHICH MAY NOT BE SUFFICIENT TO PROTECT ITS INTELLECTUAL
PROPERTY
Kana also relies 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 its proprietary rights. In the
United States, Kana currently has a registered trademark, "Kana", and seven
pending trademark applications, including trademark applications for its logo
and "KANA COMMUNICATIONS and Design". Although none of its trademarks is
registered outside of the United States, Kana has trademark applications pending
in Australia, Canada, the European Union, India, Japan, South Korea and Taiwan.
Moreover, despite the precautions that Kana has taken:
o laws and contractual restrictions may not be sufficient to prevent
misappropriation of its technology or deter others from developing
similar technologies;
o 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;
o other companies may claim common law trademark rights based upon state
or foreign laws that precede the federal registration of Kana's marks;
and
o policing unauthorized use of Kana's products and trademarks is
difficult, expensive and time-consuming, and Kana may be unable to
determine the extent of this unauthorized use.
Also, the laws of other countries in which Kana markets its products may
offer little or no effective protection of Kana's proprietary technology.
Reverse engineering, unauthorized copying or other misappropriation of Kana's
proprietary technology could enable third parties to benefit from Kana's
technology without paying Kana for it, which would significantly harm Kana's
business.
KANA MAY BECOME INVOLVED IN LITIGATION OVER PROPRIETARY RIGHTS, WHICH COULD BE
COSTLY AND TIME CONSUMING, AND GENESYS TELECOMMUNICATIONS LABORATORIES, INC. HAS
FILED AN INFRINGEMENT SUIT AGAINST KANA
Substantial litigation regarding intellectual property rights exists in
Kana's industry. Kana expects that software in its 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
Kana's products or technology infringe. Any of these third parties might make a
claim of infringement against Kana. Many of Kana's software license agreements
require Kana to indemnify its customers from any claim or finding of
intellectual property infringement. Any litigation, brought by Kana 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
Kana is accused of infringement might cause product shipment delays, require
Kana to develop non-infringing technology or require Kana 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 Kana and it could
not develop non-infringing technology or license the infringed or similar
technology on a timely and cost-effective basis, Kana's business could be
significantly harmed.
22
<PAGE>
On October 8, 1999, Genesys Telecommunications Laboratories, Inc. filed a
complaint against Kana in the United States District Court for the District of
Delaware. Genesys has amended its complaint to allege that Kana's Customer
Messaging System 3.0 infringes one or more claims of two Genesys patents.
Genesys is seeking relief in the forms of an injunction, damages, punitive
damages, attorneys' fees, costs and pre- and post-judgment interest. The
litigation is currently in its early stages and Kana has not received material
information or documentation. Kana intends to fight this claim vigorously and
does not expect it to materially impact its results from operations. Kana is not
currently a party to any other material legal proceedings.
KANA MAY FACE HIGHER COSTS AND LOST SALES IF ITS SOFTWARE CONTAINS ERRORS
Kana faces the possibility of higher costs as a result of the complexity of
its products and the potential for undetected errors. Due to the mission-
critical nature of Kana's products and services, undetected errors are of
particular concern. Kana has only a few "beta" customers that test new features
and functionality of its software before Kana makes these features and
functionalities generally available to its customers. If Kana's software
contains undetected errors or Kana fails to meet customers' expectations in a
timely manner, Kana could experience:
o loss of or delay in revenues expected from the new product and an
immediate and significant loss of market share;
o loss of existing customers that upgrade to the new product and of new
customers;
o failure to achieve market acceptance;
o diversion of development resources;
o injury to its reputation;
o increased service and warranty costs;
o legal actions by customers; and
o increased insurance costs.
KANA MAY FACE LIABILITY CLAIMS THAT COULD RESULT IN UNEXPECTED COSTS AND DAMAGE
TO ITS REPUTATION
Kana's licenses with customers generally contain provisions designed to
limit Kana's exposure to potential product liability claims, such as disclaimers
of warranties and limitations on liability for special, consequential and
incidental damages. In addition, Kana's license agreements generally cap the
amounts recoverable for damages to the amounts paid by the licensee to Kana for
the product or service giving rise to the damages. However, these contractual
limitations on liability may not be enforceable and Kana may be subject to
claims based on errors in its software or mistakes in performing its services
including claims relating to damages to its customers' internal systems. A
product liability claim, whether or not successful, could harm Kana's business
by increasing its costs, damaging its reputation and distracting its management.
KANA INTENDS TO EXPAND ITS INTERNATIONAL OPERATIONS, WHICH COULD DIVERT
MANAGEMENT ATTENTION AND PRESENT FINANCIAL ISSUES
Kana's international operations are located in the United Kingdom,
Australia, Holland, Germany and Japan and, to date, have been limited. Kana
plans to expand its existing international operations and establish additional
facilities in other parts of the world. Kana may face difficulties in
accomplishing this expansion, including finding adequate staffing and management
resources for its international operations. The expansion of Kana's existing
international operations and entry into additional international markets will
require significant management attention and financial resources. In addition,
in order to expand its international sales operations, Kana will need to, among
other things:
23
<PAGE>
o expand its international sales channel management and support
organizations;
o customize its products for local markets; and
o develop relationships with international service providers and
additional distributors and system integrators.
Kana's investments in establishing facilities in other countries may not
produce desired levels of revenues. Even if Kana is able to expand its
international operations successfully, Kana may not be able to maintain or
increase international market demand for its products. In addition, Kana has
only licensed its products internationally since January 1999 and has limited
experience in developing localized versions of its software and marketing and
distributing them internationally. Localizing Kana's products may take longer
than Kana anticipates due to difficulties in translation and delays Kana may
experience in recruiting and training international staff.
KANA'S GROWTH COULD BE LIMITED IF IT FAILS TO EXECUTE ITS PLAN TO EXPAND
INTERNATIONALLY
For the three month periods ended March 31, 2000 and March 31, 1999, Kana
derived approximately 10.4% and 2.5%, respectively, of its total revenues from
sales outside North America. Kana has established offices in the United Kingdom,
Australia and Germany. As of December 31, 1999 Kana had 7 sales persons in its
international offices. As a result, Kana faces risks from doing business on an
international basis, any of which could impair its internal revenues. Kana
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, Kana's international operations could cause its
average tax rate to increase. Any of these events could harm Kana's
international sales and results of operations.
INTERNATIONAL LAWS AND REGULATIONS MAY EXPOSE KANA TO POTENTIAL COSTS AND
LITIGATION
Kana's international operations will increase its exposure to international
laws and regulations. If Kana cannot comply with foreign laws and regulations,
which are often complex and subject to variation and unexpected changes, it
could incur unexpected costs and potential litigation. For example, the
governments of foreign countries might attempt to regulate Kana's products and
services or levy sales or other taxes relating to Kana's 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 Kana to conduct its 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 Kana's products
and services, could negatively impact Kana's results of operations.
KANA MAY SUFFER FOREIGN EXCHANGE RATE LOSSES
Kana's international revenues are denominated in local currency. Therefore,
a weakening of other currencies versus the U.S. dollar could make Kana's
products less competitive in foreign markets. Kana does not currently engage in
currency hedging activities. Kana has not yet but may in the future experience
foreign currency translation losses, especially to the extent that it does not
engage in hedging.
KANA'S PROSPECTS FOR OBTAINING ADDITIONAL FINANCING, IF REQUIRED, ARE UNCERTAIN
AND FAILURE TO OBTAIN NEEDED FINANCING COULD AFFECT ITS ABILITY TO PURSUE FUTURE
GROWTH
Kana may need to raise additional funds to develop or enhance its products
or services, to fund expansion, to respond to competitive pressures or to
acquire complementary products, businesses or technologies. Kana does not have a
long enough operating history to know with certainty whether its existing cash
and expected revenues will be sufficient to finance its anticipated growth.
Additional financing may not be available on terms that are acceptable to Kana.
If Kana raises additional funds through the issuance of equity or convertible
debt securities, the percentage ownership of its stockholders would be reduced
and these securities might have
24
<PAGE>
rights, preferences and privileges senior to those of Kana's current
stockholders. If adequate funds are not available on acceptable terms, Kana's
ability to fund its expansion, take advantage of unanticipated opportunities,
develop or enhance products or services, or otherwise respond to competitive
pressures would be significantly limited.
KANA'S EXECUTIVE OFFICERS AND DIRECTORS CAN EXERCISE SIGNIFICANT INFLUENCE OVER
STOCKHOLDER VOTING MATTERS
After the closing of the merger, Kana's executive officers and directors,
and their affiliates together control approximately 37% of Kana's outstanding
common stock. As a result, these stockholders, if they act together, will have a
significant impact on all matters requiring approval of Kana's stockholders,
including the election of directors and significant corporate transactions. This
concentration of ownership may delay, prevent or deter a change in control of
Kana, could deprive Kana's stockholders of an opportunity to receive a premium
for their common stock as part of a sale of Kana or its assets and might affect
the market price of Kana common stock.
KANA HAS ADOPTED ANTI-TAKEOVER DEFENSES THAT COULD DELAY OR PREVENT AN
ACQUISITION OF KANA
Kana's 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 Kana 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 Kana's outstanding voting stock. Kana currently
has no plans to issue preferred stock.
Kana's certificate of incorporation, bylaws and equity compensation plans
include provisions that may deter an unsolicited offer to purchase Kana. These
provisions, coupled with the provisions of the Delaware General Corporation Law,
may delay or impede a merger, tender offer or proxy contest involving Kana.
Furthermore, Kana's 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 Kana.
KANA'S FAILURE TO MANAGE MULTIPLE TECHNOLOGIES AND TECHNOLOGICAL CHANGE COULD
HARM ITS FUTURE PRODUCT DEMAND
Future versions of hardware and software platforms embodying new
technologies and the emergence of new industry standards could render Kana's
products obsolete. The market for e-Business customer communication software is
characterized by:
o rapid technological change;
o frequent new product introductions;
o changes in customer requirements; and
o evolving industry standards.
Kana's products are designed to work on a variety of hardware and software
platforms used by Kana's customers. However, Kana's software may not operate
correctly on evolving versions of hardware and software platforms, programming
languages, database environments and other systems that its customers use. For
example, the server component of the current version of Kana's products runs on
the Windows NT operating system from Microsoft, and Kana must develop products
and services that are compatible with UNIX and other operating systems to meet
the demands of its customers. If Kana cannot successfully develop these products
in response to customer demands, Kana's business could suffer. Also, Kana must
constantly modify and improve its products to keep pace with changes made to
these platforms and to database
25
<PAGE>
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 Kana's business. If Kana fails to modify or improve its products
in response to evolving industry standards, its products could rapidly become
obsolete, which would harm its business.
IF KANA FAILS TO RESPOND TO CHANGING CUSTOMER PREFERENCES IN ITS MARKET, DEMAND
FOR ITS PRODUCTS AND KANA'S ABILITY TO ENHANCE ITS REVENUES WILL SUFFER
Kana must continually improve the performance, features and reliability of
its products, particularly in response to competitive offerings. Kana's success
depends, in part, on Kana's ability to enhance its existing software and to
develop new services, functionality and technology that address the increasingly
sophisticated and varied needs of Kana's prospective customers. If Kana does not
properly identify the feature preferences of prospective customers, or if Kana
fails to deliver features that meet the requirements of these customers, Kana's
ability to market its products successfully and to increase its 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 E-MAIL FAIL TO GROW AND BE ACCEPTED AS MEDIA OF
COMMUNICATION, DEMAND FOR KANA'S PRODUCTS AND SERVICES WILL DECLINE
Kana sells its products and services primarily to organizations that
receive large volumes of e-mail and Web-based communications. Many of Kana's
customers have business models that are based on the continued growth of the
Internet. Consequently, Kana's 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 Kana's 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, Kana's business will suffer.
FUTURE REGULATION OF THE INTERNET MAY SLOW ITS GROWTH, RESULTING IN DECREASED
DEMAND FOR KANA'S 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 Kana's 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
Kana's products and services and increase Kana's costs of doing business, or
otherwise harm its business. Kana's costs could increase and its 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 its
business, or the application of existing laws and regulations to the Internet
and other online services.
YEAR 2000 ISSUES COULD CONTINUE TO PRESENT TECHNOLOGICAL RISKS, COULD CAUSE
DISRUPTION TO KANA'S BUSINESS AND COULD HARM SALES OF ITS PRODUCTS AND SERVICES
26
<PAGE>
Many currently installed computer systems and software products are coded
to accept or recognize only two digit entries in the date code field. These
systems and software products need to accept four digit entries to distinguish
21st century dates from 20th century dates. As a result, computer systems and/or
software used by many companies and governmental agencies may need to be
upgraded to comply with these Year 2000 requirements or risk system failure or
miscalculations causing disruptions of normal business activities.
Any failure of Kana's material systems, Kana's customers' material systems
or the Internet to be Year 2000 compliant would have material adverse
consequences for Kana. Kana is unable to predict to what extent its business may
be affected if its software, the systems that operate in conjunction with its
software or its internal systems experience a material failure due to residual
Year 2000 problems. Residual Year 2000 issues may disrupt Kana's operations,
subject Kana to liabilities and costs and lower net income.
KANA'S SECURITY COULD BE BREACHED, WHICH COULD DAMAGE ITS REPUTATION AND DETER
CUSTOMERS FROM USING ITS SERVICES
Kana must protect its 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 Kana's computer systems and network, which could
adversely affect Kana's ability to retain or attract customers, damage Kana's
reputation and subject Kana to litigation. Kana has in the past, and could in
the future, be subject to denial of service, vandalism and other attacks on its
systems by Internet hackers. Although Kana intends to continue to implement
security technology and establish operational procedures to prevent break-ins,
damage and failures, these security measures may fail. Kana's insurance coverage
in certain circumstances may be insufficient to cover issues that may result
from such events.
FUTURE SALES OF STOCK COULD AFFECT KANA'S STOCK PRICE
If Kana's stockholders sell substantial amounts of Kana common stock,
including shares issued upon the exercise of outstanding options and warrants,
in the public market, the market price of Kana common stock could fall. These
sales also might make it more difficult for Kana to sell equity or
equity-related securities in the future at a time and price that Kana deems
appropriate.
Item 3: Quantitative and Qualitative Disclosures About Market Risk
We develop products in the United States and sell these products in North
America, Europe, Asia and Australia. Generally, our sales are made in local
currency. As a result, our financial results 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 our
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
commercial paper, which have an average fixed yield rate of 6%. These all mature
within three months. Kana does not consider its cash equivalents to be subject
to interest rate risk due to their short maturities.
27
<PAGE>
PART II: OTHER INFORMATION
Item 1. Legal Proceedings
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. Genesys alleges that Kana's Customer Messaging
System 3.0 infringes one or more claims of a Genesys patent. Genesys is seeking
relief in the forms of an injunction, damages, punitive damages, attorneys'
fees, costs and pre- and post-judgement interest. The litigation is currently in
its early stages and therefore we cannot fully evaluate the claim. We intend to
fight this claim vigorously and do not expect it to impact results. 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 and Genesys Telecommunications Laboratories, Inc. has
filed an infringement suit against us."
Item 2. Changes in Securities and Use of Proceeds
On September 21, 1999, we consummated our initial public offering of common
stock, $0.001 par value. The managing underwriters in the offering were Goldman
Sachs & Co, Hambrecht & Quist LLC and Wit Capital Corporation. The shares of
common stock sold in the offering were registered under the Securities Act of
1933, as amended, on a registration statement on Form S-1 (Reg. No. 333-82587)
that was declared effective by the SEC on September 21, 1999. All 7,590,000
shares of common stock registered under the registration statement, including
shares covered by an over-allotment option that was exercised, were sold at a
price to the public of $7.50 per share. The aggregate offering amount registered
was $56,925,000. In connection with the offering, Kana paid an aggregate of
$3,985,000 in underwriting discounts to the underwriters. In addition, the
following table sets forth an approximation of all expenses incurred in
connection with the offering, other than underwriting discounts. All amounts
shown are approximations except for the registration fees of the SEC and the
National Association of Securities Dealers, Inc.
SEC Registration Fee........................................ $ 28,130
NASD Filing Fee............................................. 5,500
Nasdaq National Market Listing Fee.......................... 91,000
Printing and Engraving Expenses............................. 440,000
Legal Fees and Expenses..................................... 700,000
Accounting Fees and Expenses................................ 360,000
Blue Sky Fees and Expenses.................................. 15,000
Transfer Agent Fees......................................... 30,000
Miscellaneous............................................... 276,370
Total Expenses:............................................. $1,946,000
All of such expenses were direct or indirect payments to others.
The net offering proceeds to us after deducting the total expenses above
were approximately $51,066,000. From September 21, 1999 to December 31, 1999, we
used such net offering proceeds from our initial public offering of common stock
to invest in short-term, interest bearing, investment grade securities and used
proceeds for working capital and other corporate purposes. This use of proceeds
does not represent a material change in the use of proceeds described in the
prospectus of the registration statement. We used its existing cash balances to
fund Kana's general operations.
We currently estimate that we will use the remaining net proceeds as
follows: 45% for marketing and distribution activities; 20% for various product
development initiatives; 10% for capital expenditures; and 25% for working
capital and other general corporate purposes.
28
<PAGE>
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
27 Financial Data Schedule
(b) Reports on Form 8-K:
(1) Amended Form 8-K filed March 30, 2000; Change in
Registrant's certifying accountants.
(2) Form 8-K filed March 29, 2000; Change in Registrant's
certifying accountants.
(3) Amended Form 8-K filed February 14, 2000; Acquisition of BEI
and netDialog.
(4) Form 8-K filed February 7, 2000; Kana, Pistol Acquisition
Corp. and Silknet Software, Inc. entered into an Agreement
of Plan of Reorganization
29
<PAGE>
SIGNATURES
Pursuant to the requirements 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.
May 12, 2000 Kana Communications, Inc.
/s/ MICHAEL J. MCCLOSKEY
-------------------------
Michael J. McCloskey
Chief Executive Officer and Director
/s/ BRIAN K. ALLEN
-------------------------
Brian K. Allen
Chief Financial Officer
(Principal Financial and Accounting Officer)
30
<PAGE>
EXHIBIT INDEX TO KANA COMMUNICATIONS, INC.
Quarterly Report on Form 10-Q
For the Quarter Ended March 31, 2000
Exhibit Number Description
- -------------------- -------------------
27 Financial Data Schedule
31
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
KANA COMMUNICATIONS, INC'S QUARTERLY REPORT ON FORM 10-Q FOR THE PERIOD ENDED
MARCH 31, 2000 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-2000
<PERIOD-START> JAN-01-2000
<PERIOD-END> MAR-31-2000
<CASH> 18,414
<SECURITIES> 17,254
<RECEIVABLES> 9,595
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 47,587
<PP&E> 12,776
<DEPRECIATION> 0
<TOTAL-ASSETS> 64,359
<CURRENT-LIABILITIES> 26,294
<BONDS> 0
0
0
<COMMON> 61
<OTHER-SE> 37,642
<TOTAL-LIABILITY-AND-EQUITY> 64,359
<SALES> 7,329
<TOTAL-REVENUES> 10,688
<CGS> 143
<TOTAL-COSTS> 4,175
<OTHER-EXPENSES> 21,604
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (14,411)
<INCOME-TAX> 37
<INCOME-CONTINUING> (14,448)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (14,448)
<EPS-BASIC> (0.27)
<EPS-DILUTED> (0.27)
</TABLE>
