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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K/A
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/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999,
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE TRANSITION PERIOD FROM ___________ TO ___________
000-26287
(COMMISSION FILE NUMBER)
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KANA COMMUNICATIONS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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DELAWARE 77-0435679
(State or other jurisdiction (I.R.S. Employer
of incorporation or Organization Identification No.)
740 BAY ROAD, REDWOOD CITY, CA 94063
(Address of principal executive offices) (Zip Code)
(650) 298-9282
(Registrant's telephone number, including area code)
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SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $0.001 PAR VALUE
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form. / /
As of July 17, 2000, the aggregate market value of the voting stock held by
non-affiliates of the Registrant was approximately $4,281,390,639 based upon the
closing sales price of the Common Stock as reported on the Nasdaq Stock
Market(R) on such date. Shares of Common Stock held by officers, directors and
holders of more than ten percent of the outstanding Common Stock have been
excluded from this calculation because such persons may be deemed to be
affiliates. The determination of affiliate status is not necessarily a
conclusive determination for other purposes.
As of August 18, 2000, the Registrant had outstanding 93,308,145 shares of
Common Stock.
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This Report on Form 10-K/A includes 78 pages with the Index to Exhibits
located on page 56.
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KANA COMMUNICATIONS, INC.
TABLE OF CONTENTS
ANNUAL REPORT ON FORM 10-K/A
FOR YEAR ENDED DECEMBER 31, 1999
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PART I
PAGE
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Item 1 Business.............................................................................. 3
Item 2 Properties............................................................................ 15
Item 3 Legal Proceedings..................................................................... 16
Item 4 Submission of Matters to a Vote of Security Holders................................... 16
PART II
Item 5 Market for the Registrant's Common Equity and Related Stockholder Matters............. 17
Item 6 Selected Consolidated Financial Data.................................................. 19
Item 7 Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................................ 20
Item 7A Quantitative and Qualitative Disclosures About Market Risk............................ 42
Item 8 Financial Statements and Supplementary Data........................................... 43
Item 9 Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure............................................................................ 43
PART III
Item 10 Directors and Executive Officers of the Registrant.................................... 44
Item 11 Executive Compensation................................................................ 48
Item 12 Security Ownership of Certain Beneficial Owners and Management........................ 52
Item 13 Certain Relationships and Related Transactions........................................ 54
PART IV
Item 14 Exhibits, Financial Statement Schedules, and Reports on Form 8-K...................... 56
Signatures ...................................................................................... 78
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PART I
THE FOLLOWING CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF
SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934. OUR ACTUAL RESULTS AND
TIMING OF CERTAIN EVENTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE
FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS, INCLUDING, BUT NOT
LIMITED TO, THOSE SET FORTH UNDER "RISK FACTORS", ELSEWHERE IN THIS REPORT AND
IN OUR OTHER PUBLIC FILINGS.
ITEM 1. BUSINESS
OVERVIEW
We are a leading provider of integrated e-business solutions that deliver
a Web-architected e-business platform and a comprehensive suite of
customer-facing applications for marketing, sales and service. We define
e-businesses as companies that leverage the reach and efficiency of the Internet
to enhance their competitive market position, from Internet start-ups to the
largest 2,000 companies in the world, commonly known as the "Global 2000." Our
products and services allow companies to offer customers, business partners and
businesses alike, the ability to collaborate with the company and each other to
efficiently resolve their problems and to receive timely, easy to access,
relevant information. By using our software products and services, e-businesses
can, among other things:
o offer a Web-based point of entry (or portals) for customers, business
partners and the enterprise to give all relevant parties within an
e-business their own global view of their communications and
relationships;
o deliver a managed and integrated set of communication channels, such
as e-mail, Web, chat, instant messaging, voice over the Internet,
phone and person-to-person;
o provide a broad range of interaction applications that empower
customers and partners to choose where, when, and how to interact
with the company. These applications offer four methods of operation:
assisted service, virtual assisted service, self-service and
proactive service;
o provide a suite of e-business and communications applications that
integrate marketing, sales and service functions, helping
e-businesses provide complete customer lifecycle solutions that
engage, acquire and grow the customer base; and
o establish an open, scaleable platform that can be easily deployed and
integrated into existing applications and data sources.
As a result, we enable e-businesses to increase sales, reduce costs and
build greater customer loyalty. Our software, which consists of applications
built upon our technology platform, is designed with a Web-based architecture.
By Web-based, we mean that our software design is based on the unique
characteristics of Internet technologies and uses Internet industry open
standards, such as the Java programming language, Hypertext Mark-Up Language
(HTML), and Extensible Mark-up Language (XML). This Web-based architecture
enhances the scalability of our software and enables the rapid integration of
our platform with other e-business and legacy application and data systems. By
integrating with databases and other enterprise systems, our technology platform
functions as the software infrastructure for rapidly deploying and changing an
e-business solution.
We offer our products on both a license and a hosted basis. We also offer
implementation, consulting and maintenance services to support our customers.
Kana Online, our hosted application service, allows e-businesses to rapidly and
efficiently deploy our integrated e-business solutions while minimizing their
up-front investment in hardware, software and services.
Our objective is to become the leading provider of mission critical
Web-architected communications and relationship management software products and
services for e-businesses. To achieve our objective, we intend to expand our
products to enter new markets, increase our global distribution capabilities and
alliances, leverage our hosted application service and continue to emphasize
customer advocacy and satisfaction.
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Our customers range from Global 2000 companies pursuing an e-business
strategy to rapidly growing Internet companies. The following is a
representative list of our customers:
o eBay o eToys o E*Trade
o American Airlines o Ameritrade o Kodak
o The Gap o barnesandnoble.com o Sprint PCS
No customer accounted for 10% or more of our total revenues in 1998 or
1999.
RECENT DEVELOPMENTS
On June 12, 2000, we sold 2,500,000 shares of our common stock for gross
proceeds of $125.0 million (net proceeds of approximately $120.0 million) in a
private placement transaction with entities affiliated with Putnam Investment
Management, Inc. and The Putnam Advisory Company, Inc., entities affiliated with
The Galleon Group, DWS Investments and Metzler Investments. On June 28, 2000, we
registered with the Securities and Exchange Commission our common stock for
resale by these selling stockholders.
On April 19, 2000, we completed a merger with Silknet Software, Inc.
under which Silknet became our wholly-owned subsidiary. Silknet provides
electronic relationship management software, or eRM software, that allows
companies to offer marketing, sales, e-commerce and support services through a
single Web site interface personalized for individual customers. Silknet's
products enable a company to deliver these services to its customers over the
Web through customer self-service, assisted service or immediate, direct
collaboration among that company and its customers, partners, employees and
suppliers. These users can choose from a variety of communications media, such
as the Web, e-mail and the telephone, to do business with that company.
Silknet's software can capture and consolidate data derived from all of these
sources and distribute it throughout a company and to its partners to provide a
single view of the customer's interaction with that company.
In connection with the merger, each share of Silknet common stock
outstanding immediately prior to the completion of the Merger was converted into
the right to receive 1.66 shares of our common stock and we assumed Silknet's
outstanding stock options and warrants based on the exchange ratio, issuing
approximately 29.2 million shares of our common stock and reserving
approximately 4.0 million shares of our common stock for Silknet options and
warrants assumed by us. The transaction is intended to qualify as a tax-free
reorganization under the Internal Revenue Code of 1986, as amended, and was
accounted for using the purchase method of accounting.
INDUSTRY BACKGROUND
With the widespread adoption of the Internet, new businesses can enter
and disrupt established markets virtually overnight. In this environment, most
companies and customers have a variety of purchasing options and are only a
click away from being able to defect to the competition. Whether a company is a
Global 2000 enterprise, or a newly established Internet-based business, the
ability to provide a high quality interaction and experience, and thus to
establish long-term relationships and loyalty, is critical to business survival.
Until recently, the relationships with customers and partners were based
on interactions in-person, by telephone or by letter. In order to respond to
these types of inquiries more effectively, many companies invested substantial
resources in expensive call centers and traditional direct marketing
initiatives. Call centers typically served a customer service function, employed
costly technology and did not scale effectively. Traditional direct marketing is
typically expensive and not highly effective in terms of conversion and response
rates. With the advent of the Internet and the proliferation of e-mail, the
manner through which businesses communicate has undergone a fundamental change:
customers and partners are now demanding that businesses be accessible anytime
and through a variety of channels, including the Web, e-mail, telephone and
storefront.
Given the emerging shift to online customer and partner interaction,
traditional solutions are not addressing the fundamental changes required by
e-businesses. Datamonitor reported that U.S. online businesses lost over $6.1
billion in potential e-commerce sales in 1999 alone due to lack of customer
service at their Web sites. And as of October 1999, Gartner Group estimated that
more than 90 percent of enterprises are not adequately prepared to handle online
customer service inquiries.
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There can be negative consequences for a business if it fails to manage
customer interactions effectively. These consequences can include loss of
customers, increased difficulty in acquiring new customers and a deterioration
of competitive position. In a recent Harris Interactive study, leading Web sites
were consistently found to generate more revenue from the customers that sought
and received service with the company over those customers who did not. In
addition, businesses face higher operating and information technology costs
without efficient and reliable management of customer and partner interactions.
Perhaps most significantly, businesses may lose the opportunity to take
advantage of new revenue-generating opportunities by failing to capitalize upon
the wealth of information conveyed through these communications. While
addressing these challenges, businesses must also be able to deploy a customer
communications solution across multiple departments, to integrate the solution
with existing business and legacy systems and databases and to scale the
solution as volumes grow.
As a result, businesses need to build an infrastructure so that
customers, the enterprise and partners can interact effectively and efficiently.
A business will then be able to enhance the customer experience by not only
better servicing the customer, but by also providing communications mechanisms
so its partners and the enterprise can better collaborate with each other.
We believe that in order for companies to compete effectively in today's
rapidly changing business environment, they must differentiate themselves by
providing the highest quality experience for their customers and partners. To
accomplish this, businesses require an integrated set of e-business solutions
that:
o allow the customer, the partner and the enterprise each a global view
of its communications and relationships with the other parties;
o empower customers to choose how, when and where to interact with the
e-business;
o establish an open, scaleable platform that can be easily deployed and
integrated into existing applications and data sources;
o broaden the opportunities for revenue generation through the
extraction, analysis and management of valuable information contained
within online interactions; and
o reduce operating and information technology costs while integrating
with existing e-business and legacy systems.
THE KANA SOLUTION
Our products and services enable e-businesses to manage their e-business
interactions and relationships in order to generate additional revenue
opportunities, enhance customer and partner loyalty, and reduce operating and
information technology costs. For those companies unwilling or unable to
implement the solution themselves, Kana Online, our Web-based service, offers
certain of our solution on a hosted basis.
We believe our products and services provide the following business
benefits:
INCREASED REVENUE OPPORTUNITIES. Our software enables e-businesses to
track and manage customer and business partner interactions and integrate the
resulting information with relevant data contained within existing corporate
databases and systems. By integrating and using information in this way,
e-businesses can identify and create additional revenue-generating
opportunities. For example, e-businesses can convert marketing interactions into
sales by attaching highly personalized and targeted communications in electronic
direct marketing campaigns, decrease shopping cart abandonment with proactive
customer service and optimize the abilities of the best sales representative by
automating those skills online to create highly sophisticated automated sales
assistants.
ENHANCED CUSTOMER RELATIONSHIPS. Our products and services were developed
to meet the needs of both the customer and the e-business. Through personalized,
Web-based points of entry for the customer and business partners, we provide a
complete overview of all facets of the customer's and partner's relationship
with the e-business. This unique viewpoint allows the customer to interact with
the e-business on the customer's terms, whether shopping, managing his or her
account or learning about products and services. This ability to collaborate
seamlessly across the enterprise facilitates the generation of comprehensive,
accurate and timely interactions.
Our software also provides e-businesses with the ability to track and
manage online customer interactions. E-businesses can analyze and report on this
information and launch customized initiatives in response to the gathered
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information. We believe that the resulting improvements in the overall customer
experience will enable e-businesses to significantly enhance customer retention
and loyalty.
REDUCED OPERATING AND INFORMATION TECHNOLOGY COSTS. Our products and
services reduce the operating and information technology costs of e-businesses
by increasing the efficiency and effectiveness of online customer and partner
interactions and transactions. For instance, an e-business using our software
will be able to integrate Web operations with other business computing systems,
such as fulfillment, call center and supply chain systems, thereby increasing
efficiency and productivity, and reducing costs. Costs may be further reduced as
a result of integrating expensive telephony-based environments with the more
cost-effective channels of e-mail and the Web.
Our products use a combination of automation, business rules, artificial
intelligence, workflow, analytics and advanced messaging analysis technologies
to allow e-businesses to deliver information and respond to customer requests
rapidly and accurately. Our open, scaleable Web-based architecture is designed
to be integrated readily with e-businesses' legacy systems, extending these
systems' useful lives and allowing e-businesses to avoid expensive upgrades. In
addition, our hosted, Web-based service, Kana Online, allows e-businesses to
utilize certain of our product while minimizing information technology
infrastructure costs.
In addition to these business benefits, our products provide
e-businesses:
o WEB-ARCHITECTED PLATFORM. Our software is developed upon a Web-based
architecture that supports multiple hardware and software platforms
and browser-based interfaces. Our software runs on multiple hardware
platforms simultaneously in order to enhance scaleability and
increase reliability. In addition, our open, standards-based software
is readily deployable and integrates rapidly with existing
applications and data sources.
o PROVEN SCALABILITY AND RELIABILITY. We offer an open and scalable
platform that allows rapid configuration and deployment and allows
modular growth to handle large numbers of transactions and concurrent
users.
o OPEN AND STANDARDS-BASED. Our software supports open industry
standards such as the Java programming language, Hypertext Mark-up
Language (HTML) and Extensible Mark-up Language (XML), and integrates
easily with:
o existing enterprise software environments;
o e-mail, telephony, billing and ERP systems;
o product and other databases; and
o a broad range of other information systems.
The ability to share data across these multiple applications provides
e-businesses with a powerful tool for capitalizing on their customer
interactions.
OPTIMIZE KEY BUSINESS PROCESSES. Our software is designed to optimize
workflow, information and communications associated with e-business
communications. Our software can be configured to trigger not only a message
delivery and response but also other actions within an organization. For
example, our software can alert an e-business' engineering department if the
e-business receives repeat inquiries about a software defect or the human
resources department if a resume is attached to a communication.
ENHANCED PRODUCTIVITY. Our software is designed to automate key functions
of e-business communications process while simultaneously providing high-quality
customer communications. Users can customize the applications and access an
integrated knowledge base of corporate information to handle increased message
volume. Our software also provides one-click access to customer histories and
all previous communications so that users can accurately target customers and
provide fully informed, accurate and personalized answers that are consistent
across the organization. System administrators can set preferences, routing
rules and user permissions and establish address books and message queues, all
on a real-time basis.
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THE KANA STRATEGY
Our objective is to become the leading provider of Web-architected
communications and relationship management products and services for
e-businesses. The key elements of our strategy include:
EXTEND MARKET LEADERSHIP POSITION. Our objective is to extend our
position as a leader in the e-business software market by delivering a broad
range of world-class Web-architected e-business and interaction applications
with a modular, flexible and scaleable platform. We intend to take advantage of
our technological leadership, strategic customer base and distribution
capabilities to extend our current position as a market leader. Moreover, we
believe that, by broadening our suite of products and services that enable
companies to interact with their customers in the most cost-effective and
efficient ways possible, we can expand our market opportunities and solidify our
position as a leading provider of comprehensive e-business products and
services.
EXPAND OUR SUITE OF PRODUCTS TO ENTER NEW MARKETS. We intend to expand
our suite of products to include additional e-commerce and business applications
in order to enter new markets. In developing these applications, we are working
with our customers to identify the strategic and functional needs of
e-businesses that operate in the rapidly changing Internet environment. Our
focus is to develop applications that address those needs and integrate them
seamlessly with our existing platform to help e-businesses establish broader and
deeper customer relationships. We believe these applications will be integrated
to merge e-commerce transactions with customer communications to create further
revenue opportunities.
INCREASE DISTRIBUTION CAPABILITIES. We intend to broaden and increase our
distribution capabilities worldwide by combining the efforts of our direct sales
force and our alliances with leading e-business service and infrastructure
providers, such as Andersen Consulting, Convergys Corporation, Davox, IBM, KPMG
Consulting and Siemens. By expanding existing alliances and aggressively
developing new ones, we can leverage others' sales, marketing and deployment
capabilities to help establish us as a worldwide provider of e-business products
and services to manage online customer communications.
ESTABLISH TECHNOLOGY LEADERSHIP WITH OPEN, SCALEABLE WEB-BASED
ARCHITECTURE. Our objective is to establish our architecture as the leading
technology platform and market standard for e-business products and services. To
deliver the high performance required in the complex and rapidly changing
e-business environment, we have designed our products to be highly scaleable,
easily customizable and readily able to integrate with existing enterprise
applications and systems. Our Web-based platform enables a universal customer
history, allowing the enterprise to view all interactions from one location,
allows the enterprise to scale to millions of daily interactions and allows for
workflow and business rule adjustments in real time without disabling the entire
system.
In addition, because our Web-based architecture is based on industry
standards such as Java, HTML and XML, e-businesses and third parties are able to
develop and deploy new applications on top of our platform. We intend to
continue to develop and enhance our advanced architecture to efficiently handle
the growing volume of online customer communications while providing increased
functionality across e-businesses.
LEVERAGE HOSTED WEB-BASED APPLICATION SERVICE. We offer Kana Online, our
hosted Web-based application service, for e-businesses that want to deploy an
online customer interaction system rapidly and efficiently while minimizing
their up-front investment in hardware, software and services. Kana Online allows
us to manage important customer data and monitor realtime, hands-on customer
feedback on our software. We intend to continue developing this service because
this service allows us to target additional markets that are complementary to
our software-based solution, provide us with recurring revenue streams and may,
in the future, allow us to enter into new business opportunities. To date,
revenues received from Kana Online have not been significant. Although we intend
to develop and support this service, as a result of many factors, including the
relative success of sales of our products and our services, we cannot accurately
predict when revenues from Kana Online will become significant.
EMPHASIZE CUSTOMER ADVOCACY AND SATISFACTION. We believe that delivering
complete customer satisfaction is vital to growing our business. Our emphasis on
customer advocacy and satisfaction has provided us with a strong base of
referenceable customers. This strategy provides many benefits, including
potentially shortened sales cycles, incremental sales opportunities to our
installed-base of customers and new and improved products resulting from
customer feedback. We intend to remain focused on providing the highest level of
satisfaction to our customers and to continue to design our solutions to address
their online customer communications needs. In addition, we intend to
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continue to build our professional services group, which maintains customer
relationships beyond the implementation phase and is responsible for providing a
superior customer experience.
PRODUCTS AND SERVICES
OUR PLATFORM AND SUITE OF APPLICATIONS Our products are comprised of a
flexible solutions platform and applications for marketing, sales and service.
Together the platform and the applications create an advanced and scaleable
customer-centric e-business solution. The suite of software applications
consists of the Kana eBusiness Platform, Kana Service, Kana Commerce, Kana
Connect, Kana I-Mail, Kana Voice, Kana Assist, Kana Advisor, Kana Phone, Kana
Classify and Kana Response.
KANA EBUSINESS PLATFORM. The Kana eBusiness Platform is an expandable
platform for building, deploying and adapting software applications. The
platform can service additional users by adding more hardware, allowing a
company to service a growing customer base. Our platform can also be tailored
and extended to add features and functionality to accommodate and integrate the
way a customer requires services and the way a company does business as that
company's business evolves. The Kana eBusiness Platform integrates personalized
interactions, collaborations and transactions over the Web among a company and
that company's customers, partners, employees and suppliers.
KANA SERVICE. Kana Service is a customer services application that
enables a company to unify all touch points with a customer into a single view
that can be provided to both the customer services agent as well as the
customer. Kana Service includes a case management function that enables case
creation and resolution, workload management and user-defined workflows to
support a company's internal customer services process.
KANA COMMERCE. Kana Commerce application combines the Kana eBusiness
Platform and Microsoft's Site Server engine and enables a company to create and
manage an electronic storefront over the Web. In addition, the Kana eCommerce
application integrates Kana Service with third-party e-commerce products,
enabling personalized shopping, service and support through a single Web site
interface for both business to consumer and business to business commerce. Kana
eCommerce creates a single, unified view of the customer relationship and
transactions across departments, such as marketing, sales, customer service,
billing, purchasing and product development, and also among partners, employees
and suppliers.
KANA CONNECT. Kana Connect is our electronic direct marketing application
that enables e-businesses to proactively deliver individually targeted messages
to increase the lifetime value of customers. The application enables marketers
to profile, target and engage customers in one-to-one conversations through
permission-based, e-mail communication.
KANA I-MAIL. Kana I-Mail lets e-businesses engage in one-to-one realtime
communications with customers. The solution's two-way Web-based instant
messaging between the company and customer provides immediate online assistance
to the customer. Kana I-Mail delivers different service levels to customers
based on a number of contextual factors such as the Web page the customer is
browsing, the value of the items in the customer's shopping cart and the nature
of the customer's question to determine the appropriate service level for that
individual.
KANA VOICE. Kana Voice allows customers to have a voice conversation with
a company agent over the Internet. Customers simply click on a button and are
connected with a live agent online. When a customer requests a voice
conversation, a secure connection is made between the customer and the company
representative using a robust communications network. Kana Voice also takes
advantage of collaborative Web browsing, Web history tracking, prioritization,
escalation, knowledgebase and agent and administrator features.
KANA ADVISOR. Kana Advisor is a Web-based application that provides an
electronic, or virtual, personal sales assistant who helps a customer through
the online purchasing process and builds a higher level of trust and interaction
between a company and its customers. This makes it possible for a company to
provide consultative and expert sales assistance in a manner that can be far
more cost-effective than human-assisted sales.
KANA ASSIST. Kana Assist is an online self-service application that
improves the customer experience by delivering context-sensitive answers to
customer questions directly on the Web site, allowing customers to quickly and
conveniently obtain answers to their questions without the intervention of a
customer service representative.
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KANA PHONE. Kana Phone integrates to third-party computer telephone
software applications, providing customer service representatives with a single
interface to customer inquiries received over various media, including the Web,
e-mail and the telephone.
KANA CLASSIFY. Kana Classify is our advanced message classification
technology that drives automated actions. Kana Classify categorizes customer
messages and can automatically respond to customers, suggest responses for user
review or route messages to skill-based queues.
KANA RESPONSE. Kana Response is our e-mail and Web communications
management application that assists e-businesses in responding to large numbers
of inbound customer communications. Kana Response provides rule-based
automation, intelligent workflow, message queuing, specialized user tools and a
centralized knowledge base of issues and responses.
KANA ONLINE
Kana Online is a Web-based application service that offers our software on
a hosted basis. Kana Online provides e-businesses with access to a customized
version of our software without the need to purchase, install or maintain their
own server or database infrastructure. With Kana Online, we host the back-end
infrastructure and the customer accesses our powerful functionality through a
Web browser or by deploying Kana's Power Client.
The hardware and core technology supporting Kana Online is pre-installed
and managed at Exodus Communications, Inc., a leading provider of Internet
server hosting and management solutions. We believe that Exodus is equipped to
provide the security, reliability and performance required for hosting our
solution through its nationwide network operating centers and high-speed wide
area network backbone.
Kana Online offers several key benefits to e-businesses:
O LOW INITIAL INVESTMENT. E-businesses gain the benefits of the core
components of our software with limited hardware and software
infrastructure costs.
O LOW COST OF USE. Because we host the back-end infrastructure for Kana
Online, e-businesses keep IT administration and overhead costs low
while achieving the benefits of our software.
O SCALABILITY. Kana Online is scaleable and, because of the Kana Online
fee structure, an e-business' costs will increase only as its usage
increases.
O RELIABILITY AND SECURITY. A team of dedicated professionals monitors
and maintains the customer business applications in a secure
environment. We actively work to promote the security of e-business
data and the reliability of the Kana Online service.
O RAPID DEPLOYMENT. Since e-businesses run our software locally, they
are not responsible for purchasing and configuring the appropriate
hardware and the system can often be set up in a matter of days. A
Kana Online representative works with the e-business to ensure that
the system is configured to meet its specific needs.
O EASY MIGRATION. Because we offer both a hosted and licensed version of
our software, e-businesses can start by using our hosted applications
and convert to a premise license without disruption of their service
or additional training for system users.
SERVICES
PROFESSIONAL SERVICES. Our professional services group consists of
consulting services, customer advocacy, technical support and education
services.
CONSULTING SERVICES. Our consulting services group provides a wide range of
business and technical expertise to support our customers and partners during
the implementation of solutions. This group brings deep functional and industry
knowledge to the market as well as the technical capabilities to deliver premium
consulting services for our customers and partners.
CUSTOMER ADVOCACY. Our customer advocacy group ensures ongoing customer
satisfaction with our solution. This includes providing experienced account
planning to develop a long-term relationship and ensure business needs
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are being met as our customers evolve and grow. The group develops a
satisfaction plan with our customers to ensure the successful delivery of
services and resources.
TECHNICAL SUPPORT. Our technical support group provides global support for
our customers through a number of channels, including phone and e-mail, as well
as access to the Kana Support Website.
EDUCATION SERVICES. Our education services group delivers a full set of
training programs for our customers and partners, including a comprehensive set
of learning tracks for end users, business consultants, and developers through
instructor-led, Web-based, and onsite delivery. The group also provides
up-to-date information to our customers and partners through monthly
newsletters, Web site FAQ's, and regional user groups.
TECHNOLOGY
Our software incorporates industry standards, such as Java, HTML, XML, and
the J2EE framework, in order to facilitate customization and to enable efficient
development cycles. Our software offers both Web and Windows-based interfaces
and relies on commercial application servers and database platforms to provide
scalability and redundancy.
OPEN, STANDARDS-BASED ARCHITECTURE. The architecture of our software is
"open" because it relies upon industry standards that facilitate integration
with customers' e-business and legacy databases and systems and the development
of applications on our platform. These industry standards include:
o Java;
o JDBC (Java DataBase Connectivity);
o Standard relational databases from Oracle, Microsoft, and IBM;
o JSP (Java Server Pages);
o The J2EE framework; and
o XML, for presentation layers, metadata, and integration.
The use of industry standards also permits our platform to be readily
customized to users' preferences.
SCALEABLE WEB-BASED ARCHITECTURE. Our software relies on a scaleable
Web-based architecture. This architecture separates the different system
components into logical layers, supports multiple hardware and software
platforms, supports browser-based interfaces and enables the system to run on
multiple hardware platforms simultaneously in order to enhance scaleability. The
tiers are the presentation, user interface, workflow, business object, mail
delivery, tracking and data layers.
ADVANCED MESSAGE CLASSIFICATION TECHNOLOGIES. We have focused our research
and development of advanced message classification technologies on Bayesian
Network technology. Bayesian Network technology is a classification technology
approach that combines machine learning with human expertise to infer
conclusions about new data. Using machine learning, the system automatically
builds a classification model from existing customer messages, thereby reducing
the cost and time of installation and maintenance and allowing the system to
improve as new issues arise. With human expertise, the system enables managers
to add their knowledge selectively to the system in order to improve accuracy
and adjust the model to anticipate new issues or react to them in real time.
Bayesian Network technology underlies Kana Classify, which categorizes customer
messages and drives system automation.
EASE OF PLATFORM UPGRADE. Our software may be readily upgraded to new
versions of our system. New versions of the software, when installed, are
designed to recognize the historical data and configurations from the previous
version of the system and automatically convert them to the new data format.
This enables an e-business to upgrade our software without any programming or
advanced technical capability.
SALES AND MARKETING
SALES. Our sales strategy is to pursue targeted accounts through a
combination of our direct sales force and our strategic alliances. To date, we
have targeted our sales efforts at the e-business divisions of Global 2000
companies
10
<PAGE>
and at rapidly growing Internet companies. We maintain direct sales personnel
domestically in Arizona, California, Colorado, Connecticut, Florida, Georgia,
Illinois, Maryland, Massachusetts, Michigan, New Hampshire, New Jersey, New
York, Texas, Utah, Virginia, Washington and Washington D.C., and internationally
in the United Kingdom, Germany, Australia and Japan. The direct sales force is
organized into regional teams, which include both sales representatives and
systems engineers. As of June 30, 2000, we employed in our sales force 70
persons in our offices outside of North America. Our office in the United
Kingdom is primarily responsible for sales in Europe generally, and our office
in Australia is primarily responsible for sales in Australia and Asia. Sales
managers currently based in the United States handle other international sales
and report to our Vice President, International. Our direct sales force is
complemented by telemarketing representatives based at our headquarters in
Redwood City, California and Manchester, New Hampshire.
We complement our direct sales force with a series of reseller and sales
alliances, such as those with Andersen Consulting, Convergys Corporation.,
Davox, KPMG Consulting, IBM and Siemens. Through these alliances we are able to
leverage additional sales, marketing and deployment capabilities. In the future,
we intend to expand our distribution capabilities by increasing the size of our
direct sales force, establishing additional sales offices both domestically and
internationally and broadening our alliance activities. See "Business--Strategic
Relationships."
MARKETING. Our marketing programs are targeted at e-businesses and are
currently focused on educating our target market, generating new sales
opportunities and creating awareness for our e-business customer communications
software. We conduct marketing programs worldwide to educate our target market.
In addition, we engage in a variety of marketing activities, including:
o conducting seminars;
o hosting regular customer events;
o participating in industry and technology-related conferences and
trade shows;
o establishing and maintaining close relationships with recognized
industry analysts;
o conducting electronic and traditional direct mailings and ongoing
public relations campaigns;
o managing and maintaining our Web site;
o conducting market research;
o organizing and implementing electronic and traditional direct
marketing; and
o creating and placing advertisements.
Our marketing organization also serves an integral role in acquiring,
organizing and prioritizing industry and customer feedback in order to help
provide product direction to our development organizations. We have a detailed
product management process that surveys customer and market needs to predict and
prioritize future customer requirements, and a product marketing team dedicated
to delivering product positioning and messaging. We also focus on developing a
range of joint marketing strategies and programs in order to leverage our
existing strategic relationships and resources. These alliances provide
collaborative resources to help extend the reach of our presence in the
marketplace. We intend to continue to pursue these alliances in the future.
STRATEGIC RELATIONSHIPS
We have three types of strategic relationships: service relationships,
technology relationships, and reseller and strategic sales relationships, all
designed to expand our market coverage. These relationships are formal or
informal agreements with third parties. We view these relationships as critical
to our success in providing enterprise-wide integrated e-business products and
services.
Recently introduced, the Kana Alliance Program was developed to meet the
increasing demand by companies to partner with us. The program provides partners
with the tools, information and marketing benefits through which they can
develop, promote and sell our products and services. Companies participate in
the program at different levels based on their market presence and on mutual
commitments to establishing successful relationships.
11
<PAGE>
SERVICE RELATIONSHIPS. We collaborate with systems integrators such as
Andersen Consulting, CSC Consulting and KPMG Consulting. With the implementation
of our Alliance Program, formal agreements are put into place for these
relationships. These systems integrators are highly trained in our software and
provide integration and implementation services to mutual customers.
TECHNOLOGY RELATIONSHIPS. We have established relationships with technology
partners across a variety of solution areas, including sales force automation,
analytics, content management, telephony systems and IT hardware, that allow us
to provide comprehensive solutions to e-businesses. These technology
relationships are typically formalized in a written agreement and are focused on
technology initiatives and marketing. The agreements are annually renewable, but
generally may be terminated at any time by either party and do not contain
penalties for nonperformance.
RESELLER AND STRATEGIC SALES RELATIONSHIPS. We complement our direct sales
force with reseller and strategic sales relationships with companies in targeted
geographies and industries. Our agreements with these companies are typically in
the form of value-added reseller agreements.
In the future, we intend to establish additional strategic relationships to
further broaden our product offerings and enhance our distribution channels.
Many of the companies with which we have initiated relationships also work
with competing software companies, and the success of the relationship will
depend on their willingness and ability to devote sufficient resources and
efforts to our products and services. Our arrangements with these parties
typically are in the form of non-exclusive agreements that may be terminated by
either party without cause or penalty and with limited notice. Therefore, we can
provide no guarantee that any of these parties will continue their relationship
with us.
12
<PAGE>
CUSTOMERS
Our customers range from Global 2000 companies pursuing an e-business
strategy to rapidly growing Internet companies. As of June 30, 2000, we have
licensed our solution to more than 600 customers in a variety of industries
worldwide. The following is a list of customers that we believe are
representative of our overall customer base:
INTERNET SERVICES FINANCIAL TRAVEL
CityIndex Ameritrade American Airlines
ebay BankAmerica Canadian Airlines
eFax.com CBOE Mapquest.com
Excite@Home ChannelPoint Royal Carribean
GoTo.com Datek Skanadish Railroads
Homeshare DimeSavingsBank Travel Company
iVendor DowJones
iVillage eCloser OTHER
JFAX.com E*Trade Coleman
Lycos FinancialEngines Estee Lauder
priceline.com WitCapital Esteel
TheMotleyFool Ford Motor Company
TheStreet.com FuelSpot
General Motors
E-TAILING COMMUNICATIONS Hewlett-Packard
barnesandnoble.com Ameritech Microsoft
CDNOW AT&T S&H Greenpoints
Cendant BellSouth Shell International
Dan'sChocolates Convergys The Gap
Drugstore.com Davox Utility.com
etoys NTL Williams-Sonoma
Furniture.com Sprint PCS
InsWeb Sprynet(Mindspring)
OfficeDepot StreamInternational
Priceline
PrintConnect
Tickets.com
No customer accounted for 10% or more of our total revenues for 1999.
Although a substantial portion of our license and service revenues in any given
quarter has been, and is expected to continue to be, generated from a limited
number of customers with large financial commitment contracts, we do not depend
on any ongoing commitments from our large customers.
RESEARCH AND DEVELOPMENT
We believe that strong product development capabilities are essential to
our strategy of enhancing our core technology, developing additional
applications incorporating that technology and maintaining the competitiveness
of our product and service offerings. We have invested significant time and
resources in creating a structured process for undertaking all product
development. This process involves several functional groups at all levels
within our organization and is designed to provide a framework for defining and
addressing the activities required to bring product concepts and development
projects to market successfully. In addition, we have recruited key engineers
and software developers with experience in the customer communications and
internetworking markets and have complemented these individuals by hiring senior
management with experience in enterprise application development, sales and
deployment.
As of June 30, 2000, 295 of our employees were engaged in research and
development activities. Our success depends, in part, on our ability to enhance
our existing customer interactions solutions and to develop new services,
functionality and technology that address the increasingly sophisticated and
varied needs of our prospective customers. Delays in bringing to market new
products or their enhancements, or the existence of defects in new
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<PAGE>
products or enhancements, could be exploited by our competitors. If we were to
lose market share as a result of lapses in our product management, our business
would suffer.
COMPETITION
The market for our products and services is intensely competitive, evolving
and subject to rapid technological change. We expect the intensity of
competition to increase in the future. We currently face competition for our
products from systems designed by in-house and third-party development efforts.
We expect that these systems will continue to be a principal source of
competition for the foreseeable future. Our competitors include a number of
companies offering one or more products for the e-business communications and
relationship management market, some of which compete directly with our
products. For example, our competitors include companies providing stand-alone
point solutions, including Annuncio, Inc., AskJeeves, Inc., Brightware, Inc.,
Broadbase, Inc., Digital Impact, Inc., eGain Communications Corp., E.piphany
Inc., Inference Corp., Marketfirst, Inc., Live Person, Inc., Mustang Software,
Inc., Responsys.com and Servicesoft, Inc. In addition, we compete with companies
providing traditional, client-server based customer management and
communications solutions, such as Clarify Inc. (which was recently acquired by
Northern Telecom), 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, we may face increased competition should we expand our product
line, through acquisition of complementary businesses or otherwise.
We believe that the principal competitive factors affecting our market
include a significant base of referenceable customers, the breadth and depth of
a given solution, product quality and performance, customer service, core
technology, product scaleability and reliability, product features, the ability
to implement solutions and the value of a given solution. Although we believe
that our solution currently competes favorably with respect to these factors,
our market is relatively new and is evolving rapidly. We may not be able to
maintain our competitive position against current and potential competitors,
especially those with significantly greater financial, marketing, service,
support, technical and other resources.
Many of our competitors have longer operating histories, significantly
greater financial, technical, marketing and other resources, significantly
greater name recognition and a larger installed base of customers than do we. In
addition, many of our competitors have well-established relationships with our
current and potential customers and have extensive knowledge of our industry. It
is possible that new competitors or alliances among competitors may emerge and
rapidly acquire significant market share. We also expect that competition will
increase as a result of industry consolidations. See "Risk Factors--We face
substantial competition and may not be able to compete effectively."
INTELLECTUAL PROPERTY
We rely upon a combination of patent, copyright, trade secret and
trademark laws to protect our intellectual property. We currently have nine U.S.
patent applications pending. These patents, if allowed, will cover a material
portion of our products and services. We have also filed international patent
applications corresponding to four of our U.S. applications.
In addition, we have one U.S. trademark registration and seven pending
U.S. trademark registrations as well as pending trademark registrations in
Australia, Canada, the European Union, India, Japan, South Korea and Taiwan.
Although we rely on patent, copyright, trade secret and trademark law to protect
our technology, we believe that factors such as the technological and creative
skills of our personnel, new product developments, frequent product enhancements
and reliable product maintenance are more essential to establishing and
maintaining a technology leadership position. We can give no assurance that
others will not develop technologies that are similar or superior to our
technology.
We generally enter into confidentiality or license agreements with our
employees, consultants and alliance partners, and generally control access to
and distribution of our software, documentation and other proprietary
information. Despite our efforts to protect our proprietary rights, unauthorized
parties may attempt to copy or otherwise obtain and use our products or
technology or to develop products with the same functionality as our products.
Policing unauthorized use of our products is difficult, and we cannot be certain
that the steps we have taken
14
<PAGE>
will prevent misappropriation of our technology, particularly in foreign
countries where the laws may not protect proprietary rights as fully as do the
laws of the United States. In addition, some of our license agreements require
us to place the source code for our products into escrow. These agreements
generally provide that some parties will have a limited, non-exclusive right to
use this code if:
o there is a bankruptcy proceeding instituted by or against us;
o we cease to do business without a successor; or
o we discontinue providing maintenance and support.
Substantial litigation regarding intellectual property rights exists in
the software industry. Our software products may be increasingly subject to
third-party infringement claims as the number of competitors in our industry
segment grows and the functionality of products in different industry segments
overlaps. Some of our competitors in the market for customer communications
software may have filed or may intend to file patent applications covering
aspects of their technology that they may claim our technology infringes. Some
of these competitors may make a claim of infringement against us with respect to
our products and technology. See "Risk Factors--We may become involved in
litigation over proprietary rights, which could be costly and time consuming,
and Genesys Telecommunication Laboratories, Inc., has filed an infringement suit
against us."
EMPLOYEES
As of June 30, 2000, we had 889 full-time employees, 214 of whom were in
our professional services group, 287 in sales and marketing, 295 in research and
development, and 93 in finance, administration and operations. We have added 791
employees between June 30, 1999 and June 30, 2000. Our future performance
depends in significant part upon the continued service of our key technical,
sales and marketing, and senior management personnel, none of whom is bound by
an employment agreement requiring service for any defined period of time. The
loss of the services of one or more of our key employees could harm our
business.
Our future success also depends on our continuing ability to attract,
train and retain highly qualified technical, sales and managerial personnel.
Competition for these personnel is intense, particularly in the San Francisco
Bay Area where we are headquartered. Due to the limited number of people
available with the necessary technical skills and understanding of the Internet,
we can give no assurance that we can retain or attract key personnel in the
future. None of our employees is represented by a labor union. We have not
experienced any work stoppages and consider our relations with our employees to
be good. See "Risk Factors--We may be unable to hire and retain the skilled
personnel necessary to develop our engineering, professional services and
support capabilities in order to continue to grow" and "--We may face
difficulties in hiring and retaining qualified sales personnel to sell our
products and services, which could harm our ability to increase our revenues in
the future."
ITEM 2. PROPERTIES
Our corporate offices are located in Redwood City, California, where we
lease approximately 60,861 square feet under a lease that expires in October
2006. As of December 31, 1999, the annual base rent for this facility was
approximately $1.9 million. Also, we lease approximately 88,094 square feet of
space in two office buildings in Manchester, New Hampshire. The lease expires in
April 2005, and we have an option to extend the lease for two additional
five-year terms. In addition, we lease facilities and offices in several cities
throughout the United States, including New York, New York, Westport,
Connecticut, Chicago, llinois and Richardson, Texas, and internationally in the
United Kingdom, Germany and Australia. The terms of these leases expire
beginning in August 2000, and automatically renew unless earlier terminated. On
February 11, 2000, we entered into an agreement to lease approximately 62,500
additional square feet in Redwood City, California under a lease that expires in
December 2010. The annual base rent for this facility for the first year is
approximately $2.4 million. We believe that our corporate office space in
Redwood City and the other facilities we currently lease will be sufficient to
meet our needs through at least the next 12 months.
15
<PAGE>
ITEM 3. LEGAL PROCEEDINGS
On October 8, 1999, Genesys Telecommunications Laboratories, Inc. filed a
complaint against us in the United States District Court for the District of
Delaware. Genesys has amended its complaint to allege that our 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 we have not received material
information or documentation. We intend to fight this claim vigorously and do
not expect it to impact our results from operations. 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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
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<PAGE>
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
(A) MARKET INFORMATION AND RECENT SALES OF UNREGISTERED SECURITIES
Our common stock is listed on the Nasdaq Stock Market under the Symbol
"KANA".
The following table sets forth the range of high and low closing sales
prices for each period indicated, adjusted for the two-for-three reverse stock
split effective September 1999 and the two for one forward stock split effective
February 2000:
<TABLE>
<CAPTION>
HIGH LOW
--------- ---------
<S> <C> <C>
YEAR ENDED DECEMBER 31, 1999:
Fourth quarter......................................................................... $ 122.50 $ 24.03
Third quarter (from September 22, 1999)................................................ $ 26.13 $ 22.78
</TABLE>
The reported last sale price of our common stock on the Nasdaq Stock Market
on August 18, 2000 was $40.50. The approximate number of holders of record of
the shares of our common stock was 601 as of such date. This number does not
include stockholders whose shares are held in trust by other entities. The
actual number of stockholders is greater than this number of holders of record.
We estimate that the beneficial stockholders of the shares of Kana common stock
as of August 18, 2000 was approximately 97,000.
We have authorized common stock, $.001 par value and Preferred Stock, $.001
par value. We have not issued any Preferred Stock.
We have not paid any cash dividends on our capital stock. We currently
intend to retain our earnings to fund the development and growth of our business
and, therefore, do not anticipate paying any cash dividends in the foreseeable
future. In addition, our existing credit facilities prohibit the payment of cash
or stock dividends on our capital stock without the lender's prior written
consent. See Item 7--"Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources."
We made the following unregistered sales of our common stock during the
quarter ended December 31, 1999:
<TABLE>
<CAPTION>
NAME OF PERSONS OF CLASS
AMOUNT OF UNDERWRITER OR OF PERSONS TO
TRANSACTION SECURITIES PLACEMENT CONSIDERATION WHOM SECURITIES EXEMPTION FROM
DATE SOLD AGENT RECEIVED WERE SOLD REGISTRATION CLAIMED
---------------- ------------- ----------------- -------------- ---------------- ------------------------------
<S> <C> <C> <C> <C> <C>
12/3/99 1,120,286 None (1) Stockholders Section 4(2) of the Securities
Act of 1933, as amended
12/3/99 1,890,200 None (2) Stockholders Section 4(2) of the Securities
Act of 1933, as amended
</TABLE>
--------------
(1) Pursuant to an Agreement and Plan of Reorganization dated as of December 3,
1999, by and among Kana Communications, Inc., Kong Acquisition Corp., a
wholly-owned subsidiary of Kana Communications, Inc., and netDialog, Inc.,
on December 3, 1999 (the effective date of the acquisition), all
outstanding shares of netDialog capital stock were converted into 1,120,286
shares of Kana common stock.
(2) Pursuant to an Agreement and Plan of Reorganization dated as of December 3,
1999, by and among Kana Communications, Inc., King Acquisition Corp., a
wholly-owned subsidiary of Kana Communications, Inc., and Business
Evolution, Inc., on December 3, 1999 (the effective date of the
acquisition), all outstanding shares of Business Evolution capital stock
were converted into 1,890,200 shares of Kana common stock.
(B) REPORT OF OFFERING SECURITIES AND USE OF PROCEEDS THERE FROM:
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
Sach & 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
17
<PAGE>
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, we 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.
<TABLE>
<S> <C>
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
============
</TABLE>
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.
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<PAGE>
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the consolidated financial statements of Kana
Communications, Inc. and the notes to consolidated financial statements included
elsewhere in this annual report.
The consolidated statement of operations data for each of the years in the
three-year period ended December 31, 1999, and the consolidated balance sheet
data at December 31, 1998 and 1999 are derived from our consolidated financial
statements. These consolidated financial statements have been audited by KPMG
LLP, independent auditors, and are included elsewhere in this annual report. The
diluted net loss per share computation excludes potential shares of common stock
(preferred stock, options to purchase common stock and common stock subject to
repurchase rights held by Kana), since their effect would be antidilutive. See
Note 1 of Notes to Consolidated Financial Statements for a detailed explanation
of the determination of the shares used to compute actual basic and diluted net
loss per share. The historical results are not necessarily indicative of results
to be expected for any future period. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations."
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------
1999 1998 1997
------------ ----------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues:
License................................................................. $ 10,536 $ 2,014 --
Service................................................................. 3,528 333 617
------------ ----------- ---------
Total revenues........................................................ 14,064 2,347 617
------------ ----------- ---------
Cost of revenues:
License................................................................. 271 54
Service................................................................. 6,610 666 253
------------ ----------- ---------
Total cost of revenues..................................................... 6,881 720 253
------------ ----------- ---------
Gross profit............................................................... 7,183 1,627 364
Operating expenses:
Sales and marketing..................................................... 21,199 5,504 512
Research and development................................................ 12,854 5,669 971
General and administrative.............................................. 5,018 1,826 378
Amortization of stock-based compensation................................ 80,476 1,456 113
Acquisition related costs............................................... 5,635 -- --
------------ ----------- ---------
Total operating expenses.............................................. 125,182 14,455 1,974
------------ ----------- ---------
Operating loss............................................................. (117,999) (12,828) (1,610)
Other income (expense), net................................................ (744) 227 57
------------ ----------- ---------
Net loss.............................................................. $ (118,743) $ (12,601) $ (1,553)
============ =========== =========
Basic and diluted net loss per share....................................... $ (4.61) $ (2.01) $ (0.37)
============ =========== =========
Shares used in computing basic and diluted net loss per share amounts...... 25,772 6,258 4,152
============ =========== =========
<CAPTION>
DECEMBER 31,
-----------------------------------
1999 1998 1997
------------ ----------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and short-term investments.......................... $ 53,217 $ 14,035 $ 5,594
Working capital............................................................ 38,591 11,833 5,364
Total assets............................................................... 70,229 16,876 6,158
Notes payable, less current portion........................................ 412 726 51
Total stockholders' equity................................................. $ 48,500 $ 12,951 $ 5,684
</TABLE>
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION OF THE FINANCIAL CONDITION AND RESULTS OF
OPERATIONS OF KANA CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF
SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934. OUR ACTUAL RESULTS AND
TIMING OF CERTAIN EVENTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE
FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS, INCLUDING, BUT NOT
LIMITED TO, THOSE SET FORTH UNDER "RISK FACTORS", ELSEWHERE IN THIS REPORT AND
IN OUR OTHER PUBLIC FILINGS.
OVERVIEW
We were incorporated in July 1996 in California and were reincorporated in
Delaware in September 1999. We had no significant operations until 1997. Through
January 1998, we were a development stage enterprise and had no revenues. Our
operating activities during this period related primarily to conducting
research, developing our initial products, raising capital and building our
sales and marketing organization. In February 1998, we released the first
commercially available version of the Kana platform. To date, we have derived
substantially all of our revenues from licensing our software and related
services, and we have sold our products worldwide primarily through our direct
sales force.
On August 13, 1999, we completed a merger with Connectify, Inc. pursuant to
which Connectify became our wholly-owned subsidiary. Connectify develops,
markets and supports electronic direct marketing software for e-businesses.
Connectify's software enables e-businesses to profile and target potential and
existing customers and then deliver and track personalized e-mails to their
customers. By using electronic direct marketing software in this way,
e-businesses can build customer loyalty, increase the probability of repeat
transactions and reduce customer attrition. Connectify was based in San Mateo,
California, and had 31 employees as of the merger.
In connection with the merger, we issued approximately 6,982,542 shares of
our common stock in exchange for all outstanding shares of Connectify capital
stock and reserved 416,690 shares of common stock for issuance upon the exercise
of Connectify options and warrants we assumed in connection with the merger. The
merger was accounted for as a pooling of interests.
On December 3, 1999, we completed a merger with Business Evolution, Inc.
pursuant to which Business Evolution became our wholly-owned subsidiary.
Business Evolution is a leading provider of customer assistance support software
that helps companies prioritize customer queries by urgency, and send responses
through delayed or realtime channels. Business Evolution's offerings, now called
Kana I-Mail and Kana Voice, let e-businesses engage their customers in a live
two-way dialog while they are browsing a Web site, helping them to conduct more
business and increase customer loyalty. Business Evolution was based in
Princeton, New Jersey, and had 66 employees as of the merger.
In connection with the acquisition of Business Evolution, 1,890,200 shares
of our common stock were issued for all outstanding shares and warrants of
Business Evolution. This transaction was accounted for as a pooling of
interests.
On December 3, 1999, we completed a merger with netDialog, Inc. pursuant to
which netDialog became our wholly-owned subsidiary. netDialog provides
context-sensitive, self-service customer service software. netDialog's online
self-service solution, now called Kana Assist, turns e-business Web sites into
knowledge bases by delivering predictive and proactive answers to customer
questions directly on the Web site. In addition to building customer loyalty by
enabling e-business customers to conveniently and quickly obtain answers to
their questions, it also allows e-businesses to reduce customer support costs by
helping customers directly on the Web site without the intervention of a
customer service representative. netDialog was based in San Mateo, California,
and had 45 employees as of the merger.
In connection with the acquisition of netDialog, 1,120,286 shares of our
common stock were issued for all outstanding shares, warrants and convertible
notes of netDialog. This transaction was accounted for as a pooling of
interests.
We derive our revenues from the sale of software product licenses and from
professional services including implementation, consulting, hosting and
maintenance. License revenue is recognized when persuasive evidence of an
20
<PAGE>
agreement exists, the product has been delivered, the arrangement does not
involve significant customization of the software, acceptance has occurred, the
license fee is fixed and determinable and collection of the fee is probable.
Service revenue includes revenues from maintenance contracts, implementation,
consulting and hosting services. Revenue from maintenance contracts is
recognized ratably over the term of the contract. Revenue from implementation,
consulting and hosting services is recognized as the services are provided.
Revenue under arrangements where multiple products or services are sold together
is allocated to each element based on its relative fair value.
Our cost of license revenue includes royalties due to third parties for
technology integrated into some of our products, the cost of product
documentation, the cost of the media used to deliver our products and shipping
costs. Cost of service revenue consists primarily of personnel-related expenses,
travel costs, equipment costs and overhead associated with delivering
professional services to our customers.
Our operating expenses are classified into three general categories: sales
and marketing, research and development, and general and administrative. We
classify all charges to these operating expense categories based on the nature
of the expenditures. Although each category includes expenses that are unique to
the category, some expenditures, such as compensation, employee benefits,
recruiting costs, equipment costs, travel and entertainment costs, facilities
costs and third-party professional services fees, occur in each of these
categories.
We allocate the total costs for information services and facilities to each
functional area that uses the information services and facilities based on its
relative headcount. These allocated costs include rent and other
facility-related costs, communication charges and depreciation expense for
furniture and equipment.
In connection with the granting of stock options to our employees, we
recorded deferred stock-based compensation totaling approximately $97.0 million
through December 31, 1999. 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. Kana recorded
approximately $93.2 million of deferred stock-based compensation for the year
ended December 31, 1999, approximately $3.0 million of deferred stock- based
compensation for the year ended December 31, 1998, and approximately $890,000 of
deferred stock-based compensation for the year ended December 31, 1997. The
amortization of deferred stock-based compensation is classified as a separate
component of operating expenses in Kana's consolidated statements 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 incurred substantial losses since inception and, for the year ended December
31, 1999, incurred a net loss of $118.7 million. As of December 31, 1999, we had
an accumulated deficit of $132.6 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 development, client services and infrastructure to
support these activities. We therefore expect to continue to incur substantial
operating losses for the foreseeable future.
We believe that our prospects must be considered in light of the risks,
expenses and difficulties frequently experienced by companies in early stages of
development, particularly companies in new and rapidly evolving markets like
ours. Although we have experienced significant revenue growth recently, this
trend may not continue. Furthermore, we may not achieve or maintain
profitability in the future.
RECENT DEVELOPMENT
On June 12, 2000, we sold 2,500,000 shares of our common stock for gross
proceeds of $125.0 million (net proceeds of approximately $120.0 million) in a
private placement transaction with entities affiliated with Putnam Investment
Management, Inc. and The Putnam Advisory Company, Inc., entities affiliated with
The Galleon Group, DWS Investments and Metzler Investments. On June 28, 2000, we
registered with the Securities and Exchange Commission our common stock for
resale by these selling stockholders.
21
<PAGE>
On April 19, 2000, we completed a merger with Silknet Software, Inc. under
which Silknet became our wholly-owned subsidiary. Silknet provides electronic
relationship management software, or eRM software, that allows companies to
offer marketing, sales, e-commerce and support services through a single Web
site interface personalized for individual customers. Silknet's products enable
a company to deliver these services to its customers over the Web through
customer self-service, assisted service or immediate, direct collaboration among
that company and its customers, partners, employees and suppliers. These users
can choose from a variety of communications media, such as the Web, e-mail and
the telephone, to do business with that company. Silknet's software can capture
and consolidate data derived from all of these sources and distribute it
throughout a company and to its partners to provide a single view of the
customer's interaction with that company.
In connection with the Silknet 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 our common stock and we assumed
Silknet's outstanding stock options and warrants based on the exchange ratio,
issuing approximately 29.2 million shares of our common stock and reserving 4.0
million shares of common stock for issuance upon the exercise of Silknet options
and warrants we assumed in connection with the merger. The transaction was
accounted for using the purchase method of accounting. In connection with the
merger, we have recorded goodwill and intangible assets of approximately $3.8
billion, which will be amortized over a period of three years.
This report relates to Kana's financial and operating condition for the
year ended December 31, 1999. For further information about the Silknet merger
and other more recent developments, please see our Registration Statements on
Forms S-4 and S-1, quarterly reports on 10-Q and other reports filed with the
SEC.
22
<PAGE>
QUARTERLY RESULTS OF OPERATIONS
The following tables set forth a summary of our unaudited quarterly
operating results for each of the eight quarters in the period ended December
31, 1999. The information has been derived from Kana's unaudited consolidated
financial statements that, in management's opinion, have been prepared on a
basis consistent with the audited consolidated financial statements contained
elsewhere in this annual report and include all adjustments, consisting of only
normal recurring adjustments, necessary for a fair presentation of such
information when read in conjunction with our audited consolidated financial
statements and notes thereto. The operating results for any quarter are not
necessarily indicative of results for any future period.
<TABLE>
<CAPTION>
QUARTER ENDED
-------------------
JUNE SEPT.
MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 30, 30, DEC. 31,
1999 1999 1999 1999 31, 1998 1998 1998 1998
-------- -------- ---------- --------- -------- ------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Revenues:
License....................... $ 1,209 $ 1,821 $ 2,781 $ 4,725 $ 161 $ 464 $ 600 $ 788
Service....................... 280 517 998 1,733 25 89 139 80
-------- -------- ---------- --------- -------- ------- -------- --------
Total revenues............ 1,489 2,338 3,779 6,458 186 553 739 868
-------- -------- ---------- --------- -------- ------- -------- --------
Cost of revenues:
License....................... 34 38 52 147 4 12 17 21
Service....................... 498 851 2,191 3,070 36 63 225 342
-------- -------- ---------- --------- -------- ------- -------- --------
Total cost of revenues.... 532 889 2,243 3,217 40 75 242 363
-------- -------- ---------- --------- -------- ------- -------- --------
Gross profit..................... 957 1,449 1,536 3,241 146 478 497 505
-------- -------- ---------- --------- -------- ------- -------- --------
Operating expenses:
Sales and marketing........... 2,479 4,180 5,482 9,058 586 1,218 1,723 1,977
Research and development...... 2,329 2,732 3,384 4,409 918 1,023 1,787 1,941
General and administrative.... 725 1,086 1,402 1,805 255 443 529 599
Amortization of deferred
stock-based compensation.... 520 2,734 3,377 73,845 200 277 405 575
Acquisition related costs..... -- -- 910 4,725 -- -- -- --
-------- -------- ---------- --------- -------- ------- -------- --------
Total operating expenses.. 6,053 10,732 14,555 93,842 1,959 2,961 4,444 5,092
-------- -------- ---------- --------- -------- ------- -------- --------
Operating loss................... (5,096) (9,283) (13,019) (90,601) (1,813) (2,483) (3,947) (4,587)
Other income, net................ (125) (394) (231) 6 43 24 51 109
-------- -------- ---------- --------- -------- ------- -------- --------
Net loss......................... $(5,221) $(9,677) $ (13,250) $(90,595) $(1,770) $(2,459) $(3,896) $(4,478)
======== ======== ========== ========= ======== ======= ======== ========
AS A PERCENTAGE OF TOTAL REVENUES:
Revenues:
License....................... 81.2% 77.9% 73.6% 73.2% 86.6% 83.9% 81.2% 90.8%
Service....................... 18.8 22.1 26.4 26.8 13.4 16.1 18.8 9.2
-------- -------- ---------- --------- -------- ------- -------- --------
Total revenues............ 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
-------- -------- ---------- --------- -------- ------- -------- --------
Cost of revenues:
License....................... 2.3 1.6 1.4 2.3 2.2 2.2 2.3 2.4
Service....................... 33.4 36.4 58.0 47.5 19.4 11.4 30.4 39.4
-------- -------- ---------- --------- -------- ------- -------- --------
Total cost of revenues.... 35.7 38.0 59.4 49.8 21.5 13.6 32.7 41.8
-------- -------- ---------- --------- -------- ------- -------- --------
Gross profit..................... 64.3 62.0 40.6 50.2 78.5 86.4 67.3 58.2
-------- -------- ---------- --------- -------- ------- -------- --------
Operating expenses:
Sales and marketing........... 166.5 178.8 145.1 140.3 315.1 220.3 233.2 227.8
Research and development...... 156.4 116.9 89.5 68.3 493.5 185.0 241.8 223.6
General and administrative.... 48.7 46.4 37.1 27.9 137.1 80.1 71.6 69.0
Amortization of deferred
stock-based compensation.... 34.9 116.9 89.4 1,143.45 107.5 50.1 54.8 66.2
Acquisition related costs..... -- -- 24.1 73.2 -- -- -- --
-------- -------- ---------- --------- -------- ------- -------- --------
Total operating expenses.. 406.5 459.0 385.2 1,453.1 1,053.2 535.4 601.4 586.6
Operating loss................... (342.2) (397.0) (344.5) (1,402.9) (974.7) (449.0) (564.1) (528.5)
Other income, net................ (8.4) (16.9) (6.1) 0.1 23.1 4.3 6.9 12.6
-------- -------- ---------- --------- -------- ------- -------- --------
Net loss.................. (350.6)% (413.9)% (350.6)% (1,402.8)% (951.6)% (444.7)% (527.2)% (515.9)%
======== ======== ========== ========= ======== ======= ======== ========
</TABLE>
The amount and timing of Kana's operating expenses generally will vary
from quarter to quarter depending on Kana's level of actual and anticipated
business activities. Kana's revenues and operating results are difficult to
forecast and will fluctuate, and Kana believes that period-to-period comparisons
of Kana's operating results will not necessarily be meaningful. As a result, you
should not rely upon them as an indication of future performance.
23
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth the results of operations for the periods
presented expressed as a percentage of total revenues.
YEARS ENDED DECEMBER 31,
-----------------------------
1999 1998 1997
--------- -------- -------
Revenues:
License.................................... 74.9% 85.8% --%
Service.................................... 25.1 14.2 100.0
--------- -------- -------
Total revenues........................... 100.0 100.0 100.0
--------- -------- -------
Cost of revenues:
License...................................... 1.9 2.3 --
Service...................................... 47.0 28.4 41.0
--------- -------- -------
Total cost of revenues................... 48.9 30.7 41.0
--------- -------- -------
Gross profit.................................... 51.1 69.3 59.0
Operating expenses:
Sales and marketing.......................... 150.7 234.5 83.0
Research and development..................... 91.4 241.6 157.4
General and administrative................... 35.7 77.8 61.3
Amortization of stock-based compensation..... 572.2 62.0 18.3
Acquisition related costs.................... 40.1 -- --
--------- -------- -------
Total operating expenses................. 890.1 615.9 320.0
--------- -------- -------
Operating loss.................................. (839.0) (546.6) 261.0
--------- -------- -------
Other income, (expense) net..................... (5.3) 9.7 9.2
--------- -------- -------
Net loss................................. (844.3)% (536.9)% (251.8)%
========= ======== =======
OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
REVENUES
Total revenues increased by 500% to $14.1 million for the year ended
December 31, 1999 from $2.3 million for the year ended December 31, 1998,
primarily as a result of increased license revenue. License revenues increased
by 423% to $10.5 million for the year ended December 31, 1999 from $2.0 million
for 1998. This increase in license revenue was due primarily to increased market
acceptance of our products, expansion of our product line and increased sales
generated by our expanded sales force. Total headcount in our sales department
increased to 93 people at December 31, 1999 from 20 people at December 31, 1998.
License revenue represented 75% of total revenues for the year ended December
31, 1999 and 86% of total revenues for 1998.
Service revenues increased by 960% to $3.5 million for the year ended
December 31, 1999 from $333,000 for 1998. Service revenue increased primarily
due to increased licensing activity, resulting in increased revenue from
maintenance contracts, customer implementations and hosted service. Service
revenue represented 25% of total revenues for the year ended December 31, 1999
and 14% of total revenues for 1998.
Total revenues increased by 280% to $2.3 million for the year ended
December 31, 1998 from $617,000 for 1997, primarily because we began recognizing
license revenues in February 1998. License revenue represented 86% of total
revenues for the year ended December 31, 1998. No license revenues were
recognized in 1997. License revenue resulted from introduction of our product
line and growing market acceptance of our software products.
Service revenues decreased by 46% to $333,000 for the year ended December
31, 1998 from $617,000 for 1997. This decrease in service revenues was due
primarily to the completion of a special consulting project. Service revenue
represented 14% of total revenues for the year ended December 31, 1998 and 100%
of total revenues for the year ended December 31, 1997.
Revenues from international sales for the years ended December 31, 1999,
1998 and 1997 were less than 10% of total revenues.
24
<PAGE>
COST OF REVENUES
Total cost of revenues increased by 856% to $6.9 million in 1999 from
$720,000 in 1998, primarily due to increased cost of service revenues. Cost of
license revenues increased by 402% to $271,000 in 1999 from $54,000 in 1998,
associated with increased license revenues. As a percentage of license revenues,
cost of license revenues was 3% in 1999 and 1998. Cost of license revenues
includes third party software royalties, product packaging, documentation,
production and delivery costs for shipments to customers.
Cost of service revenues consists primarily of personnel, facilities and
system costs incurred in providing customer support and with building our
customer service organization. Cost of service revenues increased by 893% to
$6.6 million in 1999 from $666,000 in 1998. The growth in cost of service
revenues was attributable primarily to an increase in personnel dedicated to
support our growing number of customers and related recruiting and travel
expenses as well as facility expenses and system costs. As a percentage of
service revenues, cost of service revenues was 187% in 1999 and 200% in 1998.
Total cost of revenues increased by 185% to $720,000 in 1998 from
$253,000 in 1997, primarily due to increased cost of service revenues. Cost of
license revenues increased to $54,000 in 1998 from none in 1997. The increase in
the cost of license revenue was due primarily to royalties, product
documentation costs and delivery costs for shipments to customers. As a
percentage of license revenues, cost of license revenues was 3% in 1998 and none
in 1997.
Cost of service revenues increased by 163% to $666,000 for the year ended
December 31, 1998 from $253,000 in 1997. The growth in cost of service revenues
was attributable primarily to an increase in personnel dedicated to support our
growing number of customers and related facility expenses and system costs. We
further expect our cost of service expenses to increase due to its recent
mergers and anticipated growth. As a percent of service revenues, cost of
service revenues was 200% in 1998 and 41% in 1997.
We anticipate that the cost of license revenue will increase in absolute
dollars as our licenses additional technologies, although cost of license
revenue will vary as a percentage of license revenue from period to period. We
anticipate that cost of service revenue will increase in absolute dollars.
OPERATING EXPENSES
SALES AND MARKETING. Sales and marketing expenses consist primarily of
compensation and related costs for sales and marketing personnel and promotional
expenditures, including public relations, advertising, trade shows, and
marketing collateral materials. Sales and marketing expenses increased by 285%
to $21.2 million for the year ended December 31, 1999 from $5.5 million for the
year ended December 31, 1998. This increase was attributable primarily to the
addition of sales and marketing personnel, an increase in sales commissions
associated with increased revenues and higher marketing costs due to expanded
promotional activities including advertising and trade show participation. As a
percentage of total revenues, sales and marketing expenses were 151% for the
year ended December 31, 1999 and 235% for the year ended December 31, 1998. 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.
Sales and marketing expenses were $5.5 million for the year ended
December 31,1998 and $512,000 for 1997. The increase was due primarily to the
addition of sales and marketing personnel, increased sales commissions related
to increased total revenues and, to a lesser extent, increased marketing costs.
As a percentage of total revenues, sales and marketing expenses were 235% in
1998 and 83% in 1997.
RESEARCH AND DEVELOPMENT. Research and development expenses consist
primarily of compensation and related costs for research and development
employees and contractors and enhancement of existing products and quality
assurance activities. Research and development expenses increased by 127% to
$12.9 million for the year ended December 31, 1999 from $5.7 million for the
year ended December 31, 1998. This increase was attributable primarily to the
addition of personnel associated with product development and related benefits
and recruiting costs and related consulting expenses. As a percentage of total
revenues, research and development expenses were 91%
25
<PAGE>
for the year ended December 31, 1999 and 242% for the year ended December 31,
1998. 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 anticipates 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.
Research and development expenses increased by 484% to $5.7 million for
the year ended December 31,1998 from $971,000 for 1997. The increase was
attributable primarily to the addition of personnel associated with product
development. As a percentage of total revenues, research and development
expenses were 242% in 1998 and 157% in 1997.
GENERAL AND ADMINISTRATIVE. General and administrative expenses consist
primarily of compensation and related costs for administrative personnel, legal,
accounting and other general corporate expenses. General and administrative
expenses increased by 175% to $5.0 million for the year ended December 31, 1999
from $1.8 million for the year ended December 31, 1998, due primarily to
increased personnel, consultants, facilities expenses and outside services
necessary to support our growth. As a percentage of total revenues, general and
administrative expenses were 36% for the year ended December 31, 1999 and 78%
for 1998. This decrease in general and administrative expenses as a percent of
total revenues from 1999 to 1998 was due primarily to the proportionately
greater increase in total revenues than general and administrative expenses over
the period. We expect that general and administrative expenses will increase in
absolute dollars as we add personnel and incurs additional costs related to the
anticipated growth of our business and operation as a public company. We further
expect our general and administrative expenses to increase due to our recent
mergers and anticipated growth. However, we expect that these expenses will vary
as a percentage of total revenues from period to period.
General and administrative expenses increased by 383% to $1.8 million for
the year ended December 31, 1998 from $378,000 for the year ended December 31,
1997. The increase was due primarily to the addition of management and financial
personnel necessary to support our growth. As a percentage of total revenues,
general and administrative expenses were 78% in 1998 and 61% in 1997.
AMORTIZATION OF STOCK-BASED COMPENSATION
In connection with the granting of stock options to its employees, we
recorded stock-based compensation totaling approximately $97.0 million through
December 31, 1999. 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):
YEARS ENDED, DECEMBER 31,
------------------------------
1999 1998 1997
------------ --------- -------
Cost of service.............................. $ 19,752 $ 143 $ 13
Sales and marketing.......................... 34,000 564 52
Research and development..................... 19,864 438 31
General and administrative................... 6,860 311 17
------------ --------- -------
Total..................................... $ 80,476 $ 1,456 $ 113
============ ========= =======
Subsequent to the mergers with Business Evolution and netDialog, we
granted options to certain employees hired from the acquired companies for an
exercise price below the fair market value of the common stock. These options
immediately vested on the date of grant. The difference between the market value
of the underlying common stock and the exercise price of the options was
recorded as compensation expense in the fourth quarter of 1999 in the amount of
approximately $60.4 million.
26
<PAGE>
ACQUISITION RELATED COSTS
In connection with the merger with Connectify, we recorded a charge for
merger integration costs of $1.2 million consisting primarily of transaction
fees for attorneys and accountants of approximately $390,000 and employee
severance benefits and facility related costs of $780,000 in 1999. As of
December 31, 1999, we had $30,000 remaining in accrued merger expenses, which we
expect to pay by the first quarter of 2000.
In connection with the mergers with Business Evolution and netDialog, we
recorded a nonrecurring charge for merger integration costs of $4.5 million,
consisting primarily of transaction fees for attorneys and accountants of
approximately $1.5 million, advertising and announcements of $1.7 million
incurred as of December 31, 1999, charges for the elimination of duplicate
facilities of approximately $840,000 and severance costs and certain other
related costs of approximately $433,000. As of December 31, 1999, we had
$3,118,000 remaining in accrued acquisition related costs, which we expect to
pay during 2000.
OTHER INCOME (EXPENSE)
Other income (expense) consists primarily of interest earned on cash and
short-term investments, offset by interest expense related to warrants issued to
convertible debt holders. Other income (expense) decreased by 428% to an expense
of $744,000 for the year ended December 31, 1999 from income of $227,000 for
1998. The decrease in other income (expense) was due primarily to interest
expense associated with warrants issued to convertible debt holders offset by
increased interest income earned on higher average cash balances.
Other income, net increased by 298% to $227,000 for the year ended
December 31, 1998 from $57,000 for 1997. The increase was due primarily to an
increase in interest income earned on higher balances of cash and short-term
investments primarily from our Series C preferred stock financing in September
1998.
PROVISION FOR INCOME TAXES
We have incurred operating losses for all periods from inception through
December 31, 1999, and therefore have not recorded a provision for income taxes.
We have recorded a valuation allowance for the full amount of our gross deferred
tax assets, as the future realization of the tax benefit is not currently
likely.
As of December 31, 1999, we had net operating loss carryforwards for
federal and state tax purposes of approximately $44.0 million and $34.6 million,
respectively. These federal and state loss carryforwards are available to reduce
future taxable income. The federal loss carryforwards expire at various dates
into the year 2019. Under the provisions of the Internal Revenue Code,
substantial changes in ownership may limit the amount of net operating loss
carryforwards that could be utilized annually in the future to offset taxable
income.
NET LOSS
Our net loss was $118.7 million, $12.6 million and $1.6 million for the
years ended December 31, 1999, 1998 and 1997, respectively. We have experienced
substantial increases in our expenditures since inception consistent with growth
in our operations and personnel. In addition, stock based compensation charges
have contributed to the significant increase in net loss during 1999. 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 it
can sustain this growth or that it will generate sufficient revenue to attain
profitability.
LIQUIDITY AND CAPITAL RESOURCES
In September 1999, we completed the initial public offering of our common
stock and realized net proceeds from the offering of approximately $51.1
million. Prior to the offering, we financed our operations primarily from
private sales of convertible preferred and common stock totaling $40.8 million
and, to a lesser extent, from bank borrowings and lease financing.
Our operating activities used $25.7 million of cash for the year ended
December 31, 1999, which is primarily attributable to net losses experienced
during this period excluding amortization of stock-based compensation as we
invested in the development of our products, expanded our sales force and
expanded our infrastructure to support our growth. Our operating activities used
$10.1 million of cash for the year ended December 31, 1998, which is
27
<PAGE>
primarily attributable to net losses experienced during this period, excluding
amortization of stock-based compensation.
Our investing activities, consisting of purchases of computer equipment,
furniture, fixtures and leasehold improvements to support our growing number of
employees and net purchases of short-term investments, used $44.4 million of
cash for the year ended December 31, 1999. Our investing activities used $1.4
million of cash for the year ended December 31, 1998, which is primarily due to
purchases of computer equipment, furniture, fixtures and leasehold improvements.
Our financing activities generated $75.0 million in cash for the year
ended December 31, 1999, primarily from the net proceeds of our initial public
offering, net proceeds from private sales of preferred and common stock, and net
proceeds from debt arrangements. Our financing activities generated $20.0
million in cash for the year ended December 31, 1998, primarily from the net
proceeds from private sales of preferred stock.
At December 31, 1999, we had cash and cash equivalents aggregating $18.7
million and short-term investments totaling $34.5 million. A portion of our
short-term investments secure three letters of credit totalling $1,806,000,
issued in connection with the lease of our corporate office and two other
offices. We had a line of credit totaling $3.0 million, which is secured by all
of Kana's assets, bears interest at the bank's prime rate (8.5% as of December
31, 1999), and expires in May 2000. Our total bank debt was $1.2 million at
December 31, 1999. In October 1999, we issued $2.8 million of subordinated
promissory notes which bear an annual interest rate of 10%. These were paid in
the first quarter of 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 inception consistent with growth in operations and personnel,
and we anticipate that our expenditures will continue to increase in the future.
We believe that our current cash and projected revenues will be sufficient to
meet our working capital and operating resource expenditure requirements for at
least the next 12 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.
YEAR 2000 READINESS DISCLOSURE
YEAR 2000 COMPLIANCE
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 will 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.
In the fourth quarter of 1998 we initiated a Year 2000 compliance
program. The program was directed by our quality assurance group. Kana's quality
assurance group was charged with identifying issues of potential risk within
each department and making the appropriate evaluation, modification, upgrade or
replacement. Members of the quality assurance group have worked with members of
each of our principal internal divisions in the course of assessing Year 2000
compliance.
We have not observed any Year 2000 related problems with our business or
products as of this date. However, computer experts have warned that there may
still be residual consequences of the change in centuries and any Year 2000
difficulties could result in a decrease in sales of our products, an increase in
allocation of resources to address Year 2000 problems of our customers without
additional revenue commensurate with the dedication of resources, or an increase
in litigation costs relating to losses suffered by our customers due to Year
2000 problems.
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SCOPE OF YEAR 2000 ASSESSMENT
The scope of Kana's Year 2000 compliance program included testing the
Kana platform and the IT and non-IT systems used at our corporate office in
Redwood City, California. Our other sales offices use the same third-party
hardware and software systems as those in the Redwood City office. Accordingly,
the quality assurance group determined that it would not conduct an independent
review of those systems. The operational areas under investigation included:
o products;
o software applications;
o facilities;
o suppliers and vendors; and
o computer systems.
We have not observed any significant Year 2000 related problems as of
this date.
BUDGET AND SCHEDULE
We funded our Year 2000 plan from available cash and has not separately
accounted for these expenses. To date, external expenditures for Year 2000
compliance have totaled less than $20,000. Because our products were designed to
be Year 2000 compliant, most of our expenses have related to, and are expected
to continue to relate to, the operating costs associated with time spent by
employees in the internal evaluation process and Year 2000 compliance matters
generally. We may experience unanticipated, material problems and expenses
associated with Year 2000 compliance that could harm our business. Finally, we
are also subject to external forces that might generally affect industry and
commerce, such as Year 2000 compliance failures by utility or transportation
companies and related service interruptions.
We have completed the evaluation of our products and our third-party
software systems.
PRODUCTS
We have tested the products shipped to date. Our testing determined that
these products are capable of properly distinguishing between 20th and 21st
century dates, when configured and used in accordance with the related
documentation, and provided that the underlying operating system of the host
machine and any other software used with these products are also capable of
properly distinguishing between 20th and 21st century dates.
THIRD-PARTY HARDWARE AND SOFTWARE SYSTEMS AND SERVICES
We evaluated all of the critical third-party systems and software we use
in our business. We received written statements of Year 2000 compliance from
substantially all of the providers of hardware used in our business. We have
identified approximately 20 different software vendors that provide software
products in our business. If any of the compliance statements received from our
third-party software or hardware providers are false, our internal systems and
ability to ship our product would be materially harmed.
We obtained written compliance statements as to Year 2000 compliance from
our hosting service provider and our other third-party service providers,
including our Internet service providers, cellular telephone providers and all
of our utilities. We received compliance statements from such entities without
additional expenditures by December 31, 1999.
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CONTINGENCY PLAN
We may discover residual Year 2000 compliance problems in our systems
that will require substantial revision. In addition, third-party software,
hardware or services incorporated into our products and services may need to be
revised or replaced, all of which could be time-consuming and expensive and
result in the following, any of which could adversely affect our business:
o delay or loss of revenue;
o cancellation of customer contracts;
o diversion of development resources;
o damage to our reputation;
o increased service and warranty costs; and
o litigation costs.
We did not experience any significant disruptions to its business,
results of operations, or products as a result of the transition from 1999 to
2000. We plan to retain our Year 2000 contingency plans in case of any potential
Year 2000 related events that may arise in the first half of 2000, including any
Year 2000 problems encountered by Kana's customers and third-party providers. We
believe we have taken the steps necessary to understand and resolve Year 2000
issues; however, failure to adequately address all known and unknown Y2K
readiness issues could result in, among other things, unforseen operating
expenses and lower net income.
Our failure to fix or replace our third-party software, hardware or
services on a timely basis could result in lost revenues, increased operating
costs, the loss of customers and other business interruptions.
Kana has not observed any significant problems with Year 2000 as of this
date.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 133 "Accounting for Derivative Instruments
and Hedging Activities." SFAS 133 establishes accounting and reporting standards
for derivative instruments and for hedging activities. 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 defers the effective date of SFAS 133 until June
15, 2000. We will adopt SFAS 133 in 2001. We expect the adoption of SFAS 133
will not affect results of our operations, financial position or cash flows.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements." SAB
101 provides guidance for revenue recognition under certain circumstances. SAB
101 is effective in the quarter beginning October 1, 2000. We do not believe SAB
101 will have a material impact on our results of operations, financial position
or cash flows.
In March 2000, the Financial Accounting Standards Board 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 has not and will not have a material impact on
our results of operations, financial position or cash flows.
RISK FACTORS
OUR FUTURE OPERATING RESULTS MAY VARY SUBSTANTIALLY FROM PERIOD TO
PERIOD. THE PRICE OF OUR COMMON STOCK WILL FLUCTUATE IN THE FUTURE, AND AN
INVESTMENT IN OUR COMMON STOCK IS SUBJECT TO A VARIETY OF RISKS, INCLUDING BUT
NOT LIMITED TO THE SPECIFIC RISKS IDENTIFIED BELOW. INEVITABLY, SOME INVESTORS
IN OUR SECURITIES WILL EXPERIENCE GAINS WHILE OTHERS WILL EXPERIENCE LOSSES
DEPENDING ON THE PRICES AT WHICH THEY PURCHASE AND SELL SECURITIES. PROSPECTIVE
AND
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EXISTING INVESTORS ARE STRONGLY URGED TO CAREFULLY CONSIDER THE VARIOUS
CAUTIONARY STATEMENTS AND RISKS SET FORTH IN THIS REPORT AND OUR OTHER PUBLIC
FILINGS.
THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS THAT ARE NOT HISTORICAL
FACTS BUT RATHER ARE BASED ON CURRENT EXPECTATIONS, ESTIMATES AND PROJECTIONS
ABOUT OUR BUSINESS AND INDUSTRY, OUR BELIEFS AND ASSUMPTIONS. WORDS SUCH AS
"ANTICIPATES", "EXPECTS", "INTENDS", "PLANS", "BELIEVES", "SEEKS", ESTIMATES"
AND VARIATIONS OF THESE WORDS AND SIMILAR EXPRESSIONS ARE INTENDED TO IDENTIFY
FORWARD-LOOKING STATEMENTS. THESE STATEMENTS ARE NOT GUARANTEES OF FUTURE
PERFORMANCE AND ARE SUBJECT TO RISKS, UNCERTAINTIES AND OTHER FACTORS, SOME OF
WHICH ARE BEYOND OUR CONTROL, ARE DIFFICULT TO PREDICT AND COULD CAUSE ACTUAL
RESULTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED OR FORECASTED IN THE
FORWARD-LOOKING STATEMENTS. THESE RISKS AND UNCERTAINTIES INCLUDE THOSE
DESCRIBED IN "RISKS RELATED TO OUR BUSINESS", "RISKS RELATED TO OUR INDUSTRY"
AND ELSEWHERE IN THIS REPORT. FORWARD-LOOKING STATEMENTS THAT WERE TRUE AT THE
TIME MADE MAY ULTIMATELY PROVE TO BE INCORRECT OR FALSE. READERS ARE CAUTIONED
NOT TO PLACE UNDUE RELIANCE ON FORWARD-LOOKING STATEMENTS, WHICH REFLECT OUR
MANAGEMENT'S VIEW ONLY AS OF THE DATE OF THIS REPORT. EXCEPT AS REQUIRED BY LAW,
WE UNDERTAKE NO OBLIGATION TO UPDATE ANY FORWARD-LOOKING STATEMENT, WHETHER AS A
RESULT OF NEW INFORMATION, FUTURE EVENTS OR OTHERWISE.
RISKS RELATED TO OUR BUSINESS
BECAUSE WE HAVE A LIMITED OPERATING HISTORY, THERE IS LIMITED INFORMATION UPON
WHICH YOU CAN EVALUATE OUR BUSINESS
We are still in the early stages of our development, and our limited
operating history makes it difficult to evaluate our business and prospects. We
were incorporated in July 1996 and first recorded revenue in February 1998.
Thus, we have a limited operating history upon which you can evaluate our
business and prospects. In addition, our operating results include the results
of operations of Connectify, Inc., netDialog, Inc., Business Evolution, Inc.,
and Silknet Software, Inc., four companies acquired by us the first three of
which were accounted for as pooling of interests and the last accounted for as a
purchase. Due to our limited operating history, it is difficult or impossible to
predict future results of operations. For example, we cannot forecast operating
expenses based on our historical results because they are limited, and we are
required to forecast expenses in part on future revenue projections. Moreover,
due to our limited operating history, any evaluation of our business and
prospects must be made in light of the risks and uncertainties often encountered
by early-stage companies in Internet-related markets. Many of these risks are
discussed in the subheadings below, and include our ability to:
o attract more customers;
o implement our sales, marketing and after-sales service initiatives,
both domestically and internationally;
o execute our 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 our 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 we are unsuccessful in addressing these risks or in executing our
business strategy, our business, results of operations and financial condition
would be materially and adversely affected.
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OUR QUARTERLY REVENUES AND OPERATING RESULTS MAY FLUCTUATE IN FUTURE PERIODS AND
WE MAY FAIL TO MEET EXPECTATIONS, WHICH MAY CAUSE THE PRICE OF OUR COMMON STOCK
TO DECLINE
Our quarterly revenues and operating results are difficult to predict and
may fluctuate significantly from quarter to quarter particularly because our
products and services are relatively new and our prospects uncertain. If
quarterly revenues or operating results fall below the expectations of investors
or public market analysts, the price of our common stock could decline
substantially. Factors that might cause quarterly fluctuations in our operating
results include the factors described in the subheadings below as well as:
o the evolving and varying demand for customer communication software
products and services for e-businesses, particularly our products and
services;
o costs associated with integrating our recent acquisitions, and costs
associated with any future acquisitions;
o the timing of new releases of our products;
o the discretionary nature of our customers' purchasing and budgetary
cycles;
o changes in our pricing policies or those of our competitors;
o the timing of execution of large contracts that materially affect our
operating results;
o the mix of sales channels through which our products and services are
sold;
o the mix of our domestic and international sales;
o costs related to the customization of our products;
o our ability to expand our operations, and the amount and timing of
expenditures related to this expansion; and
o global economic the conditions, as well as those specific to large
enterprises with high e-mail volume.
We also often offer volume-based pricing, which may affect operating
margins. Most of our expenses, such as employee compensation and rent, are
relatively fixed in the short term. Moreover, our expense levels are based, in
part, on our expectations regarding future revenue levels. As a result, if total
revenues for a particular quarter are below expectations, we could not
proportionately reduce operating expenses for that quarter. Therefore, this
revenue shortfall would have a disproportionate effect on our expected operating
results for that quarter. In addition, because our service revenue is largely
correlated with our license revenue, a decline in license revenue could also
cause a decline in service revenue in the same quarter or in subsequent
quarters.
Due to the foregoing factors, we believe that quarter-to-quarter
comparisons of our operating results are not a good indication of our future
performance.
WE HAVE A HISTORY OF LOSSES AND MAY NOT BE PROFITABLE IN THE FUTURE, WHICH MAY
REDUCE THE TRADING PRICE OF OUR COMMON STOCK
Since we began operations in 1997, we have incurred substantial operating
losses in every quarter. As a result of accumulated operating losses, as of June
30, 2000, we had an accumulated deficit of approximately $432.0 million. For the
six months ended June 30, 2000, we had a net loss of approximately $299.4
million, or 827.7% of revenues for that period. Since inception, we have funded
our business primarily through selling our stock, not from cash generated by our
business. Our growth in recent periods has been from a limited base of
customers, and we may not be able to sustain these growth rates. We expect to
continue to increase our operating expenses. As a result, we expect to continue
to experience losses and negative cash flows, even if sales of our products and
services continue to grow, and we may not generate sufficient revenues to
achieve profitability in the future.
In addition, as a result of our mergers with Connectify, netDialog,
Business Evolution and Silknet, we expect that our 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;
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o an increase in sales and marketing activities; and
o assimilation of operations and personnel.
If we do achieve profitability, we may not be able to sustain or increase
any profitability on a quarterly or annual basis in the future.
WE HAVE COMPLETED FOUR MERGERS IN THE PAST ELEVEN MONTHS, AND THOSE MERGERS MAY
RESULT IN DISRUPTIONS TO OUR BUSINESS AND MANAGEMENT DUE TO DIFFICULTIES IN
ASSIMILATING PERSONNEL AND OPERATIONS
We may not realize the benefits from the significant mergers we have
completed. In August 1999, we acquired Connectify, and in December 1999, we
acquired netDialog and Business Evolution. On April 19, 2000, we completed our
merger with Silknet. We may not be able to successfully assimilate the
additional personnel, operations, acquired technology and products into our
business. In particular, we will need to assimilate and retain key professional
services, engineering and marketing personnel. This is particularly difficult
with Business Evolution and Silknet, since their operations are located on the
east coast and we are headquartered on the west coast. Key personnel from the
acquired companies have in certain instances decided, and they may in the future
decide, that they do not want to work for us. In addition, products of these
companies will have to be integrated into our products, and it is uncertain
whether we may accomplish this easily or at all. These difficulties could
disrupt our ongoing business, distract management and employees or increase
expenses. Acquisitions are inherently risky and we may also face unexpected
costs, which may adversely affect operating results in any quarter.
THE MERGER OF SILKNET INTO OUR COMPANY COULD ADVERSELY AFFECT COMBINED FINANCIAL
RESULTS
If the benefits of the merger of Silknet into our company do not exceed
the costs associated with the merger, including any dilution to our stockholders
resulting from the issuance of shares in connection with the merger, our
financial results, including earnings per share, could be adversely affected. In
addition, we have recorded goodwill and intangible assets of approximately $3.8
billion in connection with the merger, which will be amortized over a period of
three years.
THE MARKET PRICE OF OUR COMMON STOCK MAY DECLINE AS A RESULT OF THE MERGER OF
SILKNET INTO OUR COMPANY
The market price of our common stock may decline as a result of the
merger if:
o the integration of our company and Silknet is unsuccessful;
o we do 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 our financial results is not consistent
with the expectations of financial or industry analysts or investors.
The market price of our 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 our common stock could materially and adversely affect our
operating results.
IF WE ACQUIRE ADDITIONAL COMPANIES, PRODUCTS OR TECHNOLOGIES, WE MAY FACE RISKS
SIMILAR TO THOSE FACED IN OUR OTHER MERGERS
If we are presented with appropriate opportunities, we intend to make
other investments in complementary companies, products or technologies. We may
not realize the anticipated benefits of any other acquisition or investment. If
we acquire another company, we will likely face the same risks, uncertainties
and disruptions as discussed above with respect to our other mergers.
Furthermore, we may have to incur debt or issue equity securities to pay for any
additional future acquisitions or investments, the issuance of which could be
dilutive to our company or our existing stockholders. In addition, our
profitability may suffer because of acquisition-related costs or amortization
costs for acquired goodwill and other intangible assets.
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WE FACE SUBSTANTIAL COMPETITION AND MAY NOT BE ABLE TO COMPETE EFFECTIVELY
The market for our products and services is intensely competitive,
evolving and subject to rapid technological change. We expect the intensity of
competition to increase in the future. Increased competition may result in price
reductions, reduced gross margins and loss of market share.
We currently face competition for our products from systems designed by
in-house and third-party development efforts. We expect that these systems will
continue to be a principal source of competition for the foreseeable future. Our
competitors include a number of companies offering one or more products for the
e-business communications and relationship management market, some of which
compete directly with our products. For example, our competitors include
companies providing stand-alone point solutions, including Annuncio, Inc.,
AskJeeves, Inc., Brightware, Inc., Broadbase, Inc., Digital Impact, Inc., eGain
Communications Corp., E.piphany, Inc., Inference Corp., Marketfirst, Inc., Live
Person, Inc., Mustang Software, Inc., Responsys.com and Servicesoft, Inc. In
addition, we compete with companies providing traditional, client-server based
customer management and communications solutions, such as Clarify Inc. (which
was acquired by Northern Telecom), Genesys Telecommunications Laboratories, Inc.
(which was acquired by Alcatel), Cisco Systems, Inc., Lucent Technologies, Inc.,
Message Media, Inc., Oracle Corporation, Pivotal Corporation, Siebel Systems,
Inc. and Vantive Corporation (which was acquired by PeopleSoft, Inc.).
Furthermore, we may face increased competition should we expand our product
line, through acquisition of complementary businesses or otherwise.
Many of our competitors have longer operating histories, significantly
greater financial, technical, marketing and other resources, significantly
greater name recognition and a larger installed base of customers than we have.
In addition, many of our competitors have well-established relationships with
our current and potential customers and have extensive knowledge of our
industry. We may lose potential customers to competitors for various reasons,
including the ability or willingness of competitors to offer lower prices and
other incentives that we cannot match. Accordingly, it is possible that new
competitors or alliances among competitors may emerge and rapidly acquire
significant market share. We also expect that competition will increase as a
result of recently-announced industry consolidations, as well as future
consolidations.
We may not be able to compete successfully against current and future
competitors, and competitive pressures may seriously harm our business.
OUR FAILURE TO CONSUMMATE OUR EXPECTED SALES IN ANY GIVEN QUARTER COULD
DRAMATICALLY HARM OUR OPERATING RESULTS BECAUSE OF THE LARGE SIZE OF TYPICAL
ORDERS
Our sales cycle is subject to a number of significant risks, including
customers' budgetary constraints and internal acceptance reviews, over which we
have little or no control. Consequently, if sales expected from a specific
customer in a particular quarter are not realized in that quarter, we are
unlikely to be able to generate revenue from alternate sources in time to
compensate for the shortfall. As a result, and due to the relatively large size
of a typical order, a lost or delayed sale could result in revenues that are
lower than expected. Moreover, to the extent that significant sales occur
earlier than anticipated, revenues for subsequent quarters may be lower than
expected.
WE MAY NOT BE ABLE TO FORECAST OUR REVENUES ACCURATELY BECAUSE OUR PRODUCTS HAVE
A LONG AND VARIABLE SALES CYCLE
The long sales cycle for our products may cause license revenue and
operating results to vary significantly from period to period. To date, the
sales cycle for our products has taken 3 to 12 months in the United States and
longer in foreign countries. Our sales cycle has required pre-purchase
evaluation by a significant number of individuals in our customers'
organizations. Along with third parties that often jointly market our software
with us, we invest significant amounts of time and resources educating and
providing information to prospective customers regarding the use and benefits of
our products. Many of our customers evaluate our software slowly and
deliberately, depending on the specific technical capabilities of the customer,
the size of the deployment, the complexity of the customer's network
environment, and the quantity of hardware and the degree of hardware
configuration necessary to deploy our products.
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OUR STOCK PRICE MAY BE HIGHLY VOLATILE AND COULD DROP, PARTICULARLY BECAUSE OUR
BUSINESS DEPENDS ON THE INTERNET
The trading price of our common stock has fluctuated widely in the past
and is expected to continue to do so in the future, as a result of a number of
factors, many of which are outside our control. In addition, the stock market
has experienced extreme price and volume fluctuations that have affected the
market prices of many technology and computer software companies, particularly
Internet-related companies, and that have often been unrelated or
disproportionate to the operating performance of these companies. These broad
market fluctuations could adversely affect the market price of our common stock.
FUTURE SALES OF STOCK COULD AFFECT OUR STOCK PRICE
If our stockholders sell substantial amounts of our common stock,
including shares issued upon the exercise of outstanding options and warrants,
in the public market, the market price of our common stock could fall. These
sales also might make it more difficult for us to sell equity or equity-related
securities in the future at a time and price that we deem appropriate.
In particular, in July 2000, the lockup agreement executed by the
affiliates of Kana and Silknet elapsed and such stockholders are eligible to
sell all vested shares. In addition, on August 14, 2000, shares held by former
Connectify stockholders became eligible for sale under Rule 144. Also in July
2000, we filed a registration statement that allows the resale of shares held by
former netDialog and Business Evolution stockholders in accordance with the
terms of those merger agreements.
WE MAY ISSUE STOCK AT A DISCOUNT TO THE CURRENT MARKET PRICE, WHICH WOULD DILUTE
OUR EXISTING STOCKHOLDERS
In order to raise the funds we need to execute our business plan and fund
operations generally, we may continue to issue stock at a discount to the
current market price. Transactions of that kind would result in dilution to our
existing stockholders.
DIFFICULTIES IN IMPLEMENTING OUR PRODUCTS COULD HARM OUR REVENUES AND MARGINS
Forecasting our revenues depends upon the timing of implementation of our
products. This implementation typically involves working with sophisticated
software, computing and communications systems. If we experience difficulties
with implementation or do not meet project milestones in a timely manner, we
could be obligated to devote more customer support, engineering and other
resources to a particular project. Some customers may also require us to develop
customized features or capabilities. If new or existing customers have
difficulty deploying our products or require significant amounts of our
professional services support or customized features, our revenue recognition
could be further delayed and our costs could increase, causing increased
variability in our operating results.
OUR BUSINESS DEPENDS ON THE ACCEPTANCE OF OUR PRODUCTS AND SERVICES, AND IT IS
UNCERTAIN WHETHER THE MARKET WILL ACCEPT OUR PRODUCTS AND SERVICES
Of our total revenue of $36.2 million for the six months ended June 30,
2000, $22.9 million was derived from licenses of products and $13.3 million from
related services. We are not certain that our target customers will widely adopt
and deploy our products and services. Our future financial performance will
depend on the successful development, introduction and customer acceptance of
new and enhanced versions of our products and services. In the future, we may
not be successful in marketing our products and services, including any new or
enhanced products.
WE MAY BE UNABLE TO HIRE AND RETAIN THE SKILLED PERSONNEL NECESSARY TO DEVELOP
OUR ENGINEERING, PROFESSIONAL SERVICES AND SUPPORT CAPABILITIES IN ORDER TO
CONTINUE TO GROW
We intend to increase our sales, marketing, engineering, professional
services and product management personnel over the next 12 months. Competition
for these individuals is intense, and we may not be able to attract, assimilate
or retain highly qualified personnel in the future. Our business cannot continue
to grow if we cannot attract qualified personnel. Our failure to attract and
retain the highly trained personnel that are integral to our product development
and professional services group, which is the group responsible for
implementation and customization
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of, and technical support for, our products and services, may limit the rate at
which we can develop and install new products or product enhancements, which
would harm our business. We will need to increase our staff to support new
customers and the expanding needs of our existing customers, without
compromising the quality of our customer service. Since our inception, a number
of employees have left or have been terminated, and we expect to lose more
employees in the future. Hiring qualified professional services personnel, as
well as sales, marketing, administrative and research and development personnel,
is very competitive in our industry, particularly in the San Francisco Bay Area,
where we are headquartered, due to the limited number of people available with
the necessary technical skills. We face greater difficulty attracting these
personnel with equity incentives as a public company than we did as a privately
held company.
WE MAY FACE DIFFICULTIES IN HIRING AND RETAINING QUALIFIED SALES PERSONNEL TO
SELL OUR PRODUCTS AND SERVICES, WHICH COULD HARM OUR ABILITY TO INCREASE OUR
REVENUES IN THE FUTURE
Our financial success depends to a large degree on the ability of our
direct sales force to increase sales to a level required to adequately fund
marketing and product development activities. Therefore, our ability to increase
revenues in the future depends considerably upon our success in recruiting,
training and retaining additional direct sales personnel and the success of the
direct sales force. Also, it may take a new salesperson a number of months
before he or she becomes a productive member of our sales force. Our business
will be harmed if we fail to hire or retain qualified sales personnel, or if
newly hired salespeople fail to develop the necessary sales skills or develop
these skills more slowly than we anticipate.
LOSS OF OUR CHIEF EXECUTIVE OFFICER OR ANY OF OUR EXECUTIVE OFFICERS COULD HARM
OUR BUSINESS
Our future success depends to a significant degree on the skills,
experience and efforts of our senior management. In particular, we depend upon
the continued services of Michael J. McCloskey, our Chief Executive Officer. The
loss of the services of Mr. McCloskey or any of our executive officers could
harm our business and operations. In addition, we have not obtained life
insurance benefiting us on any of our employees or entered into employment
agreements with our key employees. If any of our key employees left or was
seriously injured and unable to work and we were unable to find a qualified
replacement, our business could be harmed.
A FAILURE TO MANAGE OUR INTERNAL OPERATING AND FINANCIAL FUNCTIONS COULD LEAD TO
INEFFICIENCIES IN CONDUCTING OUR BUSINESS AND SUBJECT US TO INCREASED EXPENSES
Our ability to offer our products and services successfully in a rapidly
evolving market requires an effective planning and management process. We have
limited experience in managing rapid growth. We are experiencing a period of
growth that is placing a significant strain on our managerial, financial and
personnel resources. Our business will suffer if this growth continues and we
fail to manage it successfully. On June 30, 2000, we had a total of 889
full-time employees compared to 98 on June 30, 1999. We expect to continue to
hire new employees at a rapid pace. The recent completion of the merger with
Silknet resulted in approximately 300 new employees joining us. Moreover, we
will need to assimilate substantially all of Silknet's operations into our
operations. The rate of our recent growth has made management of that growth
more difficult. Any additional growth will further strain our management,
financial, personnel, internal training and other resources. To manage any
future growth effectively, we must improve our financial and accounting systems,
controls, reporting systems and procedures, integrate new personnel and manage
expanded operations. Any failure to do so could negatively affect the quality of
our products, our ability to respond to our customers and retain key personnel,
and our business in general.
THE INTEGRATION OF OUR NEW PRESIDENT, VICE PRESIDENT OF DEVELOPMENT, VICE
PRESIDENT OF MARKETING, CHIEF FINANCIAL OFFICER, VICE PRESIDENT OF HUMAN
RESOURCES, VICE PRESIDENT OF EBUSINESS SERVICES AND VICE PRESIDENT OF REALTIME
INTO OUR MANAGEMENT TEAM MAY INTERFERE WITH OUR 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, we have recently hired a Chief Financial Officer and
Vice President of Human Resources, each of whom has been with us for less than
nine months. To integrate into our company, these individuals must spend a
significant amount of time learning our 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 our
ongoing operations.
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DELAYS IN THE DEVELOPMENT OF NEW PRODUCTS OR ENHANCEMENTS TO EXISTING PRODUCTS
WOULD HURT OUR SALES AND DAMAGE OUR REPUTATION
To be competitive, we must develop and introduce on a timely basis new
products and product enhancements for companies with significant e-business
customer interactions needs. Any failure to do so could harm our business. If we
experience product delays in the future, we may face:
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, our efforts to remedy this situation may not be successful
and we may lose customers as a result. Delays in bringing to market new products
or their enhancements, or the existence of defects in new products or their
enhancements, could be exploited by our competitors. If we were to lose market
share as a result of lapses in our product management, our business would
suffer.
TECHNICAL PROBLEMS WITH EITHER OUR INTERNAL OR OUTSOURCED COMPUTER AND
COMMUNICATIONS SYSTEMS COULD INTERRUPT OUR KANA ONLINE SERVICE
The success of the Kana Online service depends on the efficient and
uninterrupted operation of our own and outsourced computer and communications
hardware and software systems. These systems and operations are vulnerable to
damage or interruption from human error, natural disasters, telecommunications
failures, break-ins, sabotage, computer viruses, intentional acts of vandalism
and similar adverse events. We have entered into an Internet-hosting agreement
with Exodus Communications, Inc. to maintain certain of the Kana Online servers
at Exodus' data center in Santa Clara, California. Our operations depend on
Exodus' ability to protect its and our systems in Exodus' data center against
damage or interruption. Exodus does not guarantee that our Internet access will
be uninterrupted, error-free or secure. We have no formal disaster recovery plan
in the event of damage or interruption, and our insurance policies may not
adequately compensate us for any losses that we may incur. Any system failure
that causes an interruption in our service or a decrease in responsiveness could
harm our relationships with customers and result in reduced revenues.
IF WE FAIL TO BUILD SKILLS NECESSARY TO SELL OUR KANA ONLINE SERVICE, WE WILL
LOSE REVENUE OPPORTUNITIES AND OUR SALES WILL SUFFER
The skills necessary to market and sell Kana Online are different from
those relating to our software products. We license our software products for a
fixed fee based on the number of concurrent users and the optional applications
purchased. We license Kana Online based on a fixed fee for installation,
configuration and training, and a variable monthly component depending on actual
customer usage. Our sales force sells both our software products and Kana
Online. Because different skills are necessary to sell Kana Online as compared
to selling software products, our sales and marketing groups may not be able to
maintain or increase the level of sales of either Kana Online or our software
products.
OUR PENDING PATENTS MAY NEVER BE ISSUED AND, EVEN IF ISSUED, MAY PROVIDE LITTLE
PROTECTION
Our success and ability to compete depend to a significant degree upon the
protection of our software and other proprietary technology rights. We regard
the protection of patentable inventions as important to our future
opportunities. We currently have nine U.S. patent applications pending relating
to our software. Although we have filed four international patent applications
corresponding to four of our U.S. patent applications, none of our technology is
patented outside of the United States. It is possible that:
o our pending patent applications may not result in the issuance of
patents;
o any patents issued may not be broad enough to protect our proprietary
rights;
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o any issued patent could be successfully challenged by one or more
third parties, which could result in our loss of the right to prevent
others from exploiting the inventions claimed in those patents;
o current and future competitors may independently develop similar
technology, duplicate our products or design around any of our
patents; and
o effective patent protection may not be available in every country in
which we do business.
WE RELY UPON TRADEMARKS, COPYRIGHTS AND TRADE SECRETS TO PROTECT OUR PROPRIETARY
RIGHTS, WHICH MAY NOT BE SUFFICIENT TO PROTECT OUR INTELLECTUAL PROPERTY
We also rely on a combination of laws, such as copyright, trademark and
trade secret laws, and contractual restrictions, such as confidentiality
agreements and licenses, to establish and protect our proprietary rights. In the
United States, we currently have a registered trademark, "Kana," and seven
pending trademark applications, including trademark applications for our logo
and "KANA COMMUNICATIONS and Design." Although none of our trademarks is
registered outside of the United States, we have trademark applications pending
in Australia, Canada, the European Union, India, Japan, South Korea and Taiwan.
However, despite the precautions that we have taken:
o laws and contractual restrictions may not be sufficient to prevent
misappropriation of our 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 our marks;
and
o policing unauthorized use of our products and trademarks is difficult,
expensive and time-consuming, and we may be unable to determine the
extent of this unauthorized use.
Also, the laws of other countries in which we market our products may offer
little or no effective protection of our proprietary technology. Reverse
engineering, unauthorized copying or other misappropriation of our proprietary
technology could enable third parties to benefit from our technology without
paying us for it, which would significantly harm our business.
WE MAY BECOME INVOLVED IN LITIGATION OVER PROPRIETARY RIGHTS, WHICH COULD BE
COSTLY AND TIME CONSUMING, AND GENESYS TELECOMMUNICATIONS LABORATORIES, INC. HAS
FILED AN INFRINGEMENT SUIT AGAINST US
Substantial litigation regarding intellectual property rights exists in our
industry. We expect that software in our industry may be increasingly subject to
third-party infringement claims as the number of competitors grows and the
functionality of products in different industry segments overlaps. Third parties
may currently have, or may eventually be issued, patents upon which our products
or technology infringe. Any of these third parties might make a claim of
infringement against us. Many of our software license agreements require us to
indemnify our customers from any claim or finding of intellectual property
infringement. Any litigation, brought by us or others, could result in the
expenditure of significant financial resources and the diversion of management's
time and efforts. In addition, litigation in which we are accused of
infringement might cause product shipment delays, require us to develop
non-infringing technology or require us to enter into royalty or license
agreements, which might not be available on acceptable terms, or at all. If a
successful claim of infringement were made against us and we could not develop
non-infringing technology or license the infringed or similar technology on a
timely and cost-effective basis, our business could be significantly harmed.
On October 8, 1999, Genesys Telecommunications Laboratories, Inc. filed a
complaint against us in the United States District Court for the District of
Delaware. Genesys has amended its complaint to allege that our Customer
Messaging System 3.0 infringes upon 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 we have not received material
information or
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documentation. We intend to defend ourselves from this claim vigorously and do
not expect it to materially impact our results from operations. We are not
currently a party to any other material legal proceedings.
WE MAY FACE HIGHER COSTS AND LOST SALES IF OUR SOFTWARE CONTAINS ERRORS
We face the possibility of higher costs as a result of the complexity of
our products and the potential for undetected errors. Due to the
mission-critical nature of our products and services, undetected errors are of
particular concern. We have only a few "beta" customers that test new features
and functionality of our software before we make these features and
functionalities generally available to our customers. If our software contains
undetected errors or we fail to meet customers' expectations in a timely manner,
we could experience:
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 our reputation;
o increased service and warranty costs;
o legal actions by customers; and
o increased insurance costs.
WE MAY FACE LIABILITY CLAIMS THAT COULD RESULT IN UNEXPECTED COSTS AND DAMAGE TO
OUR REPUTATION
Our licenses with customers generally contain provisions designed to limit
our exposure to potential product liability claims, such as disclaimers of
warranties and limitations on liability for special, consequential and
incidental damages. In addition, our license agreements generally cap the
amounts recoverable for damages to the amounts paid by the licensee to us for
the product or service giving rise to the damages. However, these contractual
limitations on liability may not be enforceable and we may be subject to claims
based on errors in our software or mistakes in performing our services including
claims relating to damages to our customers' internal systems. A product
liability claim, whether or not successful, could harm our business by
increasing our costs, damaging our reputation and distracting our management.
WE INTEND TO EXPAND OUR INTERNATIONAL OPERATIONS, WHICH COULD DIVERT MANAGEMENT
ATTENTION AND PRESENT FINANCIAL ISSUES
Our international operations are located in the United Kingdom, Australia,
Germany and Japan and, to date, have been limited. We plan to expand our
existing international operations and establish additional facilities in other
parts of the world. We may face difficulties in accomplishing this expansion,
including finding adequate staffing and management resources for our
international operations. The expansion of our existing international operations
and entry into additional international markets will require significant
management attention and financial resources. In addition, in order to expand
our international sales operations, we will need to, among other things:
o expand our international sales channel management and support
organizations;
o customize our products for local markets; and
o develop relationships with international service providers and
additional distributors and system integrators.
Our investments in establishing facilities in other countries may not
produce desired levels of revenues. Even if we are able to expand our
international operations successfully, we may not be able to maintain or
increase international market demand for our products. In addition, we have only
licensed our products internationally since January 1999 and have limited
experience in developing localized versions of our software and marketing and
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distributing them internationally. Localizing our products may take longer than
we anticipate due to difficulties in translation and delays we may experience in
recruiting and training international staff.
OUR GROWTH COULD BE LIMITED IF WE FAIL TO EXECUTE OUR PLAN TO EXPAND
INTERNATIONALLY
For the six month periods ended June 30, 2000 and June 30, 1999, we derived
approximately 10.4% and 9%, respectively, of our total revenues from sales
outside North America. We have established offices in the United Kingdom,
Australia, Germany and Japan. As of June 30, 2000, we had 70 sales persons in
our offices outside of North America. As a result, we face risks from doing
business on an international basis, any of which could impair our internal
revenues. We could, in the future, encounter greater difficulty in accounts
receivable collection, longer sales cycles and collection periods or seasonal
reductions in business activity. In addition, our international operations could
cause our average tax rate to increase. Any of these events could harm our
international sales and results of operations.
INTERNATIONAL LAWS AND REGULATIONS MAY EXPOSE US TO POTENTIAL COSTS AND
LITIGATION
Our international operations will increase our exposure to international
laws and regulations. If we cannot comply with foreign laws and regulations,
which are often complex and subject to variation and unexpected changes, we
could incur unexpected costs and potential litigation. For example, the
governments of foreign countries might attempt to regulate our products and
services or levy sales or other taxes relating to our activities. In addition,
foreign countries may impose tariffs, duties, price controls or other
restrictions on foreign currencies or trade barriers, any of which could make it
more difficult for us to conduct our business. The European Union has enacted
its own privacy regulations that may result in limits on the collection and use
of certain user information, which, if applied to the sale of our products and
services, could negatively impact our results of operations.
WE MAY SUFFER FOREIGN EXCHANGE RATE LOSSES
Our international revenues are denominated in local currency. Therefore, a
weakening of other currencies versus the U.S. dollar could make our products
less competitive in foreign markets. We do not currently engage in currency
hedging activities. We have not yet but may in the future experience significant
foreign currency translation losses, especially to the extent that we do not
engage in hedging.
OUR PROSPECTS FOR OBTAINING ADDITIONAL FINANCING, IF REQUIRED, ARE UNCERTAIN AND
FAILURE TO OBTAIN NEEDED FINANCING COULD AFFECT OUR ABILITY TO PURSUE FUTURE
GROWTH
We may need to raise additional funds to develop or enhance our products or
services, to fund expansion, to respond to competitive pressures or to acquire
complementary products, businesses or technologies. We do not have a long enough
operating history to know with certainty whether our existing cash and expected
revenues will be sufficient to finance our anticipated growth. Additional
financing may not be available on terms that are acceptable to us. If we raise
additional funds through the issuance of equity or convertible debt securities,
the percentage ownership of our stockholders would be reduced and these
securities might have rights, preferences and privileges senior to those of our
current stockholders. If adequate funds are not available on acceptable terms,
our ability to fund our expansion, take advantage of unanticipated
opportunities, develop or enhance products or services, or otherwise respond to
competitive pressures would be significantly limited.
OUR EXECUTIVE OFFICERS AND DIRECTORS CAN EXERCISE SIGNIFICANT INFLUENCE OVER
STOCKHOLDER VOTING MATTERS
Our executive officers and directors, and their affiliates together control
approximately 33.6% of our outstanding common stock. As a result, these
stockholders, if they act together, will have a significant impact on all
matters requiring approval of our stockholders, including the election of
directors and significant corporate transactions. This concentration of
ownership may delay, prevent or deter a change in control of our company, could
deprive our stockholders of an opportunity to receive a premium for their common
stock as part of a sale of our company or our assets and might affect the market
price of our common stock.
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WE HAVE ADOPTED ANTI-TAKEOVER DEFENSES THAT COULD DELAY OR PREVENT AN
ACQUISITION OF OUR COMPANY
Our board of directors has the authority to issue up to 5,000,000 shares of
preferred stock. Moreover, without any further vote or action on the part of the
stockholders, the board of directors has the authority to determine the price,
rights, preferences, privileges and restrictions of the preferred stock. This
preferred stock, if issued, might have preference over and harm the rights of
the holders of common stock. Although the issuance of this preferred stock will
provide us with flexibility in connection with possible acquisitions and other
corporate purposes, this issuance may make it more difficult for a third party
to acquire a majority of our outstanding voting stock. We currently have no
plans to issue preferred stock.
Our certificate of incorporation, bylaws and equity compensation plans
include provisions that may deter an unsolicited offer to purchase our company.
These provisions, coupled with the provisions of the Delaware General
Corporation Law, may delay or impede a merger, tender offer or proxy contest
involving our company. Furthermore, our board of directors is divided into three
classes, only one of which is elected each year. Directors are removable by the
affirmative vote of at least 66 2/3% of all classes of voting stock. These
factors may further delay or prevent a change of control of our company.
RISKS RELATED TO OUR INDUSTRY
OUR FAILURE TO MANAGE MULTIPLE TECHNOLOGIES AND TECHNOLOGICAL CHANGE COULD HARM
OUR FUTURE PRODUCT DEMAND
Future versions of hardware and software platforms embodying new
technologies and the emergence of new industry standards could render our
products obsolete. The market for e-business customer communication software is
characterized by:
o rapid technological change;
o frequent new product introductions;
o changes in customer requirements; and
o evolving industry standards.
Our products are designed to work on a variety of hardware and software
platforms used by our customers. However, our software may not operate correctly
on evolving versions of hardware and software platforms, programming languages,
database environments and other systems that our customers use. For example, the
server component of the current version of our products runs on the Windows NT
operating system from Microsoft, and we must develop products and services that
are compatible with UNIX and other operating systems to meet the demands of our
customers. If we cannot successfully develop these products in response to
customer demands, our business could suffer. Also, we must constantly modify and
improve our products to keep pace with changes made to these platforms and to
database systems and other back-office applications and Internet-related
applications. This may result in uncertainty relating to the timing and nature
of new product announcements, introductions or modifications, which may cause
confusion in the market and harm our business. If we fail to modify or improve
our products in response to evolving industry standards, our products could
rapidly become obsolete, which would harm our business.
IF WE FAIL TO RESPOND TO CHANGING CUSTOMER PREFERENCES IN OUR MARKET, DEMAND FOR
OUR PRODUCTS AND OUR ABILITY TO ENHANCE OUR REVENUES WILL SUFFER
We must continually improve the performance, features and reliability of
our products, particularly in response to competitive offerings. Our success
depends, in part, on our ability to enhance our existing software and to develop
new services, functionality and technology that address the increasingly
sophisticated and varied needs of our prospective customers. If we do not
properly identify the feature preferences of prospective customers, or if we
fail to deliver features that meet the requirements of these customers, our
ability to market our products successfully and to increase our revenues could
be impaired. The development of proprietary technology and necessary service
enhancements entails significant technical and business risks and requires
substantial expenditures and lead time.
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IF THE INTERNET AND E-MAIL FAIL TO GROW AND BE ACCEPTED AS MEDIA OF
COMMUNICATION, DEMAND FOR OUR PRODUCTS AND SERVICES WILL DECLINE
We sell our products and services primarily to organizations that receive
large volumes of e-mail and Web-based communications. Many of our customers have
business models that are based on the continued growth of the Internet.
Consequently, our future revenues and profits, if any, substantially depend upon
the continued acceptance and use of the Internet and e-mail, which are evolving
as media of communication. Rapid growth in the use of e-mail is a recent
phenomenon and may not continue. As a result, a broad base of enterprises that
use e-mail as a primary means of communication may not develop or be maintained.
In addition, the market may not accept recently introduced products and services
that process e-mail, including our products and services. Moreover, companies
that have already invested significant resources in other methods of
communications with customers, such as call centers, may be reluctant to adopt a
new strategy that may limit or compete with their existing investments. If
businesses do not continue to accept the Internet and e-mail as media of
communication, our business will suffer.
FUTURE REGULATION OF THE INTERNET MAY SLOW OUR GROWTH, RESULTING IN DECREASED
DEMAND FOR OUR PRODUCTS AND SERVICES AND INCREASED COSTS OF DOING BUSINESS
Due to the increasing popularity and use of the Internet, it is possible
that state, federal and foreign regulators could adopt laws and regulations that
impose additional burdens on those companies that conduct business online. These
laws and regulations could discourage communication by e-mail or other Web-based
communications, particularly targeted e-mail of the type facilitated by the
Connectify product, which could reduce demand for our products and services.
The growth and development of the market for online services may prompt
calls for more stringent consumer protection laws or laws that may inhibit the
use of Internet-based communications or the information contained in these
communications. The adoption of any additional laws or regulations may decrease
the expansion of the Internet. A decline in the growth of the Internet,
particularly as it relates to online communication, could decrease demand for
our products and services and increase our costs of doing business, or otherwise
harm our business. Our costs could increase and our growth could be harmed by
any new legislation or regulation, the application of laws and regulations from
jurisdictions whose laws do not currently apply to our business, or the
application of existing laws and regulations to the Internet and other online
services.
OUR SECURITY COULD BE BREACHED, WHICH COULD DAMAGE OUR REPUTATION AND DETER
CUSTOMERS FROM USING OUR SERVICES
We must protect our computer systems and network from physical break-ins,
security breaches and other disruptive problems caused by the Internet or other
users. Computer break-ins could jeopardize the security of information stored in
and transmitted through our computer systems and network, which could adversely
affect our ability to retain or attract customers, damage our reputation and
subject us to litigation. We have been in the past, and could be in the future,
subject to denial of service, vandalism and other attacks on our systems by
Internet hackers. Although we intend to continue to implement security
technology and establish operational procedures to prevent break-ins, damage and
failures, these security measures may fail. Our insurance coverage in certain
circumstances may be insufficient to cover losses that may result from such
events.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We develop products in the United States and sell these products in North
America, Europe, Asia 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 against
foreign exchange risk.
Our exposure to market rate risk for changes in interest rates relates
primarily to our investment portfolio. Our investments consist primarily of
short-term municipals and commercial paper, which have an average fixed yield
rate of 6%. These all mature within six months. We do not consider our cash
equivalents to be subject to interest rate risk due to their short maturities.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our consolidated financial statements, together with related notes and the
report of KPMG LLP, independent auditors, are set forth on the pages indicated
in Item 14, and incorporated herein by this reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
KPMG LLP was previously our principal accountants. On March 22, 2000, we
and KPMG LLP mutually agreed to terminate KPMG LLP's appointment as principal
accountants due to an anticipated business relationship between our two
companies. The decision to change accountants was approved by the audit
committee of our board of directors. In connection with the audits of the fiscal
years ended December 31, 1998 and 1999, and the subsequent interim period
through March 22, 2000, there were no disagreements with KPMG LLP on any matter
of accounting principles or practices, financial statement disclosure, or
auditing scope or procedures, which disagreements, if not resolved to their
satisfaction, would have caused them to make reference in connection with their
opinion to the subject matter of the disagreement. The audit reports of KPMG LLP
on our consolidated financial statements as of and for the years ended December
31, 1998 and 1999, did not contain any adverse opinion or disclaimer of opinion,
nor were they qualified or modified as to uncertainty, audit scope, or
accounting principles.
Effective April 19, 2000, PricewaterhouseCoopers LLP was engaged as our
independent accountants. Prior to April 19, 2000, we had not consulted with
PricewaterhouseCoopers LLP regarding the application of accounting principles to
a specified transaction, either completed or proposed, or the type of audit
opinion that might be rendered on our financial statements, and either a written
report was provided to us or oral advice was provided that
PricewaterhouseCoopers LLP concluded was an important factor considered by us in
reaching a decision as to the accounting, auditing or financial reporting issue.
Additionally, prior to April 19, 2000, we had not consulted with
PricewaterhouseCoopers LLP regarding any matter that was either the subject of a
disagreement, or a reportable event.
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth information regarding our executive officers
and directors (including ages as of August 18, 2000):
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Michael J. McCloskey....................... 44 Chief Executive Officer and Chairman of the Board of Directors
James C. Wood ............................. 43 President and Director
Brian K. Allen ............................ 39 Chief Financial Officer
Ian P. Cavanagh............................ 34 Vice President, Business Development
Nigel K. Donovan........................... 44 Vice President, Development
Alexander E. Evans......................... 43 Vice President, International
David B. Fowler............................ 46 Vice President, Corporate Marketing
Paul R. Holland............................ 39 Vice President, Worldwide Sales
William R. Phelps.......................... 38 Vice President, Professional Services
Toya A. Rico............................... 40 Vice President, Human Resources
Michael R. Wolfe........................... 32 Chief Technology Officer
David M. Beirne............................ 36 Director
Robert W. Frick............................ 63 Director
Mark S. Gainey ............................ 32 Director
Eric A. Hahn............................... 40 Director
Charles A. Holloway, Ph.D.................. 64 Director
Steven T. Jurvetson........................ 33 Director
</TABLE>
MICHAEL J. MCCLOSKEY. Mr. McCloskey joined us in June 1999 as Chief
Executive Officer and a director, and currently serves as our Chairman of the
Board of Directors. Prior to joining us, from September 1996 to February 1999,
Mr. McCloskey served in various positions with Genesys Telecommunications
Laboratories, Inc., a provider of enterprise interaction management software,
including President from July 1998 to December 1998, Chief Operating Officer
from September 1997 to July 1998 and Vice President, Finance and International,
Chief Financial Officer and Secretary from September 1996 to July 1998. From May
1995 to September 1996, he served as Vice President, Finance, Chief Financial
Officer and Vice President, Operations at Network Appliance, Inc., a network
data storage device company. From September 1993 to May 1995, Mr. McCloskey
served as Executive Vice President and Chief Financial Officer at Digital
Microwave Corporation, a telecommunications company. From 1991 to 1993, Mr.
McCloskey was the Chief Operating Officer and a member of the board of directors
of Wavefront Technologies, a 3-D graphics visualization software development
company. Mr. McCloskey holds a B.S. in Business Administration from Santa Clara
University.
JAMES C. WOOD. Mr. Wood joined us in April 2000 as a director in connection
with our acquisition of Silknet Software, Inc. and has served as our President
since May 2000. Mr. Wood founded Silknet in March 1995 and served as its
Chairman of the Board, President and Chief Executive Officer. From January 1988
until November 1994, Mr. Wood served as President and Chief Executive Officer of
CODA Incorporated, a subsidiary of CODA Limited, a financial accounting software
company. Mr. Wood also served as a director of CODA Limited from November 1988
until November 1994. Mr. Wood holds a B.S. in Electrical Engineering from
Villanova University.
BRIAN K. ALLEN. Mr. Allen joined us in April 2000 as Chief Financial
Officer. Prior to joining us, from 1983 until 1986 and from 1989 to April 2000,
Mr. Allen was with KPMG LLP, and was admitted to the partnership in 1995. From
1986 to 1989, Mr. Allen was a member of the staff of the Division of Corporation
Finance at the Securities and Exchange Commission. Mr. Allen holds a B.S. in
Business Administration from the University of Montana and is a CPA.
IAN P. CAVANAGH. Mr. Cavanagh joined us in July 1999 as Vice President,
Business Development. Prior to joining us, from February 1996 to July 1999, Mr.
Cavanagh served in various management roles at Genesys Telecommunications
Laboratories, Inc., a provider of enterprise interaction management software,
most recently as Vice President, Asia Pacific and Managing Director, Canada.
From 1994 to February 1996, Mr. Cavanagh served as
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Senior Manager-Call Centre Service Development with the New Brunswick Telephone
Company. Prior to 1994, Mr. Cavanagh served as Senior Manager-Service
Development with Stentor Canadian Network Management, an alliance of Canadian
telecommunication service providers. Previously, Mr. Cavanagh held several
engineering positions with NBTel. Mr. Cavanagh holds a Bachelor of Electrical
Engineering from the Technical University of Nova Scotia and Acadia University.
NIGEL K. DONOVAN. Mr. Donovan joined us in April 2000 as Vice President,
Development in connection with our acquisition of Silknet Software, Inc. Prior
to joining us, from February 1999 to April 2000, Mr. Donovan served as Senior
Vice President and Chief Operating Officer of Silknet. From November 1995 to
February 1999 Mr. Donovan served as Silknet's Vice President--Professional
Services. From November 1996 to October 1998, he also served as Silknet's
Treasurer and from May 1997 to October 1998 as its Chief Financial Officer. In
addition, Mr. Donovan served as director of Silknet from October 1996 to
February 1999. From March 1988 until October 1995, Mr. Donovan served as Vice
President--Professional Services of CODA Incorporated. Mr. Donovan holds a B.A.
in Accounting and Finance from the London School of Business Studies.
ALEXANDER E. EVANS. Mr. Evans joined us in July 1999 as Vice President,
International. Prior to joining us, from May 1994 to July 1999, Mr. Evans served
as the Managing Director, Europe for Genesys Telecommunications Laboratories,
Inc., with responsibility for Europe, Middle East and Africa. Prior to May 1994,
Mr. Evans served in various managerial and sales capacities at Digital Systems
Ltd., a company that supplies outbound predictive dialers. Previously, Mr. Evans
served in various managerial, technical and marketing positions at Digital
Equipment Corp. Prior to his employment by Digital Equipment, Mr. Evans worked
in various technical and project roles involving material requirement planning,
process control and automated manufacturing systems at Dupont, Inc., Mars
Electronics Ltd. and Metal Box PLC. Mr. Evans holds a degree in Electronics from
John Moore University, England.
DAVID B. FOWLER. Mr. Fowler joined us in April 2000 as Vice President,
Corporate Marketing in connection with our acquisition of Silknet Software, Inc.
Prior to joining us, from April 1999 to April 2000, Mr. Fowler served as Vice
President--Marketing of Silknet. From April 1995 to March 1999, Mr. Fowler
served as Vice President--Sales and Marketing for Gradient Technologies, a
software company. From December 1993 to March 1995, Mr. Fowler served as Vice
President--Sales and Marketing for FTP Software. Mr. Fowler holds a B.S. in
Computer Science from Worcester Polytechnic Institute and an M.B.A. from New
York University.
PAUL R. HOLLAND. Mr. Holland joined us in December 1997 as Vice President,
Worldwide Sales. Prior to joining us, from September 1994 to September 1997, Mr.
Holland worked at Pure Atria Corporation (now Rational Software Corporation), a
software tools company, most recently as its Vice President, Europe. From June
1992 to September 1994, Mr. Holland held various sales positions at Pure Atria
Corporation (then Pure Software Corporation). From 1988 to 1992, Mr. Holland was
director of marketing and sales for Rothchild Consultants, a high technology
market research company. Mr. Holland holds a B.S. in Public Administration from
James Madison University, an M.A. in Foreign Affairs from the University of
Virginia and an M.B.A. from the University of California at Berkeley.
WILLIAM R. PHELPS. Mr. Phelps joined us in December 1998 as Vice President,
Professional Services. Prior to joining us, from March 1997 to November 1998,
Mr. Phelps served as Vice President, Professional Services for CrossWorlds
Software, Inc., an application integration software company. From January 1994
to February 1997, Mr. Phelps served as a principal consultant at Booz, Allen &
Hamilton, a management consulting firm. Mr. Phelps holds a B.S. in Industrial
Engineering from Stanford University.
TOYA A. RICO. Ms. Rico joined us in January 2000 as Vice President, Human
Resources. Prior to joining us, from October 1996 through May 1999, Ms. Rico
served as Director, Human Resources at Adaptec, Inc., a bandwidth management
company. From May 1988 through September 1996, Ms. Rico served in a variety of
human resources management positions at 3Com Corporation, a computer networking
company. Ms. Rico holds a B.A. in Communications from California State
University, San Francisco.
MICHAEL R. WOLFE. Mr. Wolfe joined us in May 1997 and served as Director
of Engineering until April 1998, as Vice President, Engineering from April 1998
through April 2000 and is currently our Chief Technology Officer. Prior to
joining us, from March 1995 to February 1997, Mr. Wolfe served as Director of
Engineering at Internet Profiles Corporation, an Internet marketing company.
From February 1994 to March 1995, Mr. Wolfe was an associate at Wells Fargo
Nikko, specializing in software development. From June 1991 to February 1994,
Mr. Wolfe
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<PAGE>
was a software programming analyst at Goldman, Sachs & Co. Mr. Wolfe has taught
computer science at Stanford University and the University of California at
Berkeley. Mr. Wolfe holds a B.S. and M.S. in Computer Science from Stanford
University.
DAVID M. BEIRNE. Mr. Beirne has served as one of our directors since
September 1997. Mr. Beirne has been a Managing Member of Benchmark Capital, a
venture capital firm, since June 1997. Prior to joining Benchmark Capital, Mr.
Beirne founded Ramsey/Beirne Associates, an executive search firm, and served as
its Chief Executive Officer from October 1987 to June 1997. Mr. Beirne serves on
the board of directors of Scient Corporation, PlanetRx.com, Inc., Webvan Group,
Inc., 1-800-FLOWERS.COM, Inc., and several private companies. Mr. Beirne holds a
B.S. in Management from Bryant College.
ROBERT W. FRICK. Mr. Frick has served as one of our directors since August
1999. Mr. Frick previously served as the Vice Chairman of the Board, Chief
Financial Officer and head of the World Banking Group for Bank of America, as
Managing Director of BankAmerica International, and as President of Bank of
America's venture capital subsidiary. He is now retired. Mr. Frick previously
served as a director of Connectify, Inc. from its founding to its acquisition by
us, and he currently serves on the board of directors of six private companies.
Mr. Frick holds a B.S. in Civil Engineering and an M.B.A. from Washington
University in St. Louis, Missouri.
MARK S. GAINEY. Mr. Gainey co-founded our company in January 1996, has
served as a director since January 1996, served as our Chief Executive Officer
from January 1996 to June 1999, served as our President from January 1996
through April 2000 and served as our Chairman of the Board of Directors from
April 2000 through June 2000. Prior to co-founding our company, from April 1991
to September 1995, Mr. Gainey served as an associate with TA Associates, Inc., a
venture capital firm, where he focused primarily on technology and business
services investments. Mr. Gainey holds a B.A. in General Studies from Harvard
University.
ERIC A. HAHN. Mr. Hahn has served as one of our directors since June 1998.
Mr. Hahn is a founding partner of Inventures Group, a venture capital firm. From
November 1996 to June 1998, Mr. Hahn served as the Executive Vice President and
later as the Chief Technical Officer of Netscape Communications Corporation and
served as a member of Netscape's Executive Committee. Mr. Hahn also served as
General Manager of Netscape's Server Products Division, overseeing Netscape's
product development and marketing activities for enterprise Internet, intranet
and extranet servers, from November 1995 to November 1996. Prior to joining
Netscape, from February 1993 to November 1995, Mr. Hahn was founder and Chief
Executive Officer of Collabra Software, Inc., a groupware provider that was
acquired by Netscape. Mr. Hahn holds a B.S. and Ph.D. in Computer Science from
the Worcester Polytechnic Institute.
DR. CHARLES A. HOLLOWAY. Dr. Holloway has served as one of our directors
since December 1996. Dr. Holloway holds the Kleiner, Perkins, Caufield & Byers
Professorship in Management at the Stanford Graduate School of Business and has
been a faculty member of the Stanford Graduate School of Business since 1968.
Dr. Holloway is also currently co-director of the Stanford Center for
Entrepreneurial Studies at the Graduate School of Business. Dr. Holloway was the
founding co-chair of the Stanford Integrated Manufacturing Association, a
cooperative effort between the Graduate School of Business and the School of
Engineering, which focuses on research and curriculum development in
manufacturing and technology. Dr. Holloway serves on the board of directors of
several private companies. Dr. Holloway holds a B.S. in Electrical Engineering
from the University of California at Berkeley and an M.S. in Nuclear Engineering
and Ph.D. in Business Administration from the University of California, Los
Angeles.
STEVEN T. JURVETSON. Mr. Jurvetson has served as one of our directors since
April 1997. Mr. Jurvetson has been a Managing Director of Draper Fisher
Jurvetson, a venture capital firm, since June 1995. Prior to joining Draper
Fisher Jurvetson, from July 1990 to September 1993, Mr. Jurvetson served as a
consultant with Bain & Company, a management consulting firm. Mr. Jurvetson
served as a research and development engineer at Hewlett-Packard during the
summer months from June 1987 to August 1989. Mr. Jurvetson serves on the boards
of directors of Cognigine Corporation, FastParts, Inc., iTv Corp., Tacit
Knowledge Corporation, Third Voice, Inc., ReleaseNow.com Corporation, Everdream
Corporation and Vivaldi Networks, Inc. Mr. Jurvetson holds a B.S. and an M.S. in
Electrical Engineering from Stanford University and an M.B.A. from the Stanford
Graduate School of Business.
46
<PAGE>
BOARD OF DIRECTORS AND COMMITTEES
We currently have authorized nine directors. At present, the board consists
of eight directors divided into three classes, with each class serving for a
term of three years, and we currently have one vacancy. At each annual meeting
of stockholders, directors will be elected by the holders of common stock to
succeed the directors whose terms are expiring. Messrs. Beirne, Frick and
Jurvetson are Class I directors whose terms will expire in 2000, Mr. Hahn and
Dr. Holloway are Class II directors whose terms will expire in 2001 and Messrs.
Gainey, McCloskey and Wood are Class III directors whose terms will expire in
2002. Our officers serve at the discretion of the board.
We have established an audit committee composed of independent directors,
which reviews and supervises our financial controls, including the selection of
our auditors, reviews the books and accounts, meets with our officers regarding
our financial controls, acts upon recommendations of the auditors and takes any
further actions the audit committee deems necessary to complete an audit of our
books and accounts, as well as addressing other matters that may come before us
or as directed by the board. The audit committee currently consists of three
directors, Dr. Holloway and Messrs. Jurvetson and Frick.
We have established a compensation committee, which reviews and approves
the compensation and benefits for our executive officers, administers our stock
plans and performs other duties as may from time to time be determined by the
board. The compensation committee currently consists of two directors, Messrs.
Beirne and Hahn.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
During 1999, our compensation committee consisted of Messrs. Beirne and
Hahn. Neither Mr. Beirne nor Mr. Hahn was an employee of us or our subsidiaries
during 1999 or at any time prior to 1999. None of our executive officers serves
on the board of directors or compensation committee of any entity that has one
or more executive officers serving as a member of our board of directors or
compensation committee.
DIRECTOR COMPENSATION
We currently do not compensate any non-employee member of the board.
Directors who are also our employees do not receive additional compensation for
serving as directors.
Non-employee directors are eligible to receive discretionary option grants
and stock issuances under the 1999 Stock Incentive Plan. In addition, under the
1999 Stock Incentive Plan, each new non-employee director will receive an
automatic option grant for 40,000 shares upon his or her initial appointment or
election to the board, and continuing non-employee directors will receive an
automatic option grant for 10,000 shares on the date of each annual meeting of
stockholders.
In August 1999, we granted an option to purchase 66,666 shares of common
stock to Mr. Frick at an exercise price of $4.50 per share under our 1997 Stock
Option/Stock Issuance Plan. The option was fully vested and immediately
exercisable on the grant date. Mr. Frick exercised this option in full in
September 1999. Mr. Frick delivered a full-recourse promissory note in the
amount of $300,000 to us in full payment of the purchase price. The note bears
interest at a rate of 6.0% per annum, compounded annually, and is payable in a
lump sum on September 18, 2004.
In September 1999, we granted an option to purchase 60,000 shares of common
stock to Dr. Holloway at an exercise price of $7.50 per share under the
Discretionary Grant program of our 1999 Stock Incentive Plan. The option may be
exercised for unvested shares, subject to our right to repurchase those shares
at the exercise price paid per share if Dr. Holloway leaves the board before the
shares vest. Twenty-five percent of the option shares will vest upon Dr.
Holloway's completion of one year of service measured from September 20, 1999,
and the balance of the option shares will vest in a series of 36 equal monthly
installments upon his completion of each additional month of service thereafter.
All unvested shares will immediately vest upon a merger or asset sale, the
successful completion of a hostile tender offer for more than 50% of our
outstanding voting securities, or a change in the majority of the board through
one or more contested elections for board membership.
47
<PAGE>
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
The members of the board of directors, our executive officers and persons
who hold more than 10% of our outstanding common stock are subject to the
reporting requirements of Section 16(a) of the Securities Exchange Act of 1934,
as amended, which require them to file reports with respect to their ownership
of the common stock and their transactions in such common stock. Based upon (i)
the copies of Section 16(a) reports which we received from such persons for
their fiscal year 1999 transactions in the common stock and their common stock
holdings, and (ii) the written representations received from one or more of such
persons that no annual Form 5 reports were required to be filed by them for
fiscal year 1999, we believe that the executive officers and the board members
complied with all their reporting requirements under Section 16(a) for such
fiscal year, although Mr. Gregory Gretsch did not timely file a Form 4 and
Messrs. Timothy Campbell and Donald Whitt did not timely file Form 5's.
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table sets forth certain information concerning compensation
earned for the year ended December 31, 1999, by the two individuals who served
as our Chief Executive Officer during the 1999 fiscal year, and by each of our
four other most highly compensated current executive officers whose salary and
bonus for the 1999 fiscal year exceeded $100,000. The listed individuals are
referred to in this report as the Named Executive Officers. No other executive
officers who otherwise would have been includable in this table on the basis of
salary and bonus earned during 1999 have been excluded because they terminated
employment or changed their executive status during the year.
The salary figures include amounts the employees put into our tax-qualified
plan pursuant to Section 401(k) of the Internal Revenue Code. However,
compensation in the form of perquisites and other personal benefits that
constituted less than the lesser of either $50,000 or 10% of the total annual
salary and bonus of each of the Named Executive Officers in fiscal 1999 is
excluded. The option grants reflected in the table below were made under our
1997 Stock Option Issuance Plan.
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
AWARDS
ANNUAL COMPENSATION SECURITIES
------------------------------------------ UNDERLYING
NAME AND PRINCIPAL POSITION YEAR SALARY($) BONUS($) OPTIONS (#)
-------------------------- ------------ ------------ ------------ --------------
<S> <C> <C> <C> <C>
Michael J. McCloskey(1)........................... 1999 81,250 -- 1,866,666
Chief Executive Officer
Mark S. Gainey(2)................................. 1999 122,500 -- --
Former Chief Executive Officer
Joseph D. McCarthy(3)............................. 1999 143,308 -- 100,000
Former Vice President, Finance and Operations
Paul R. Holland................................... 1999 75,000 721,600 --
Vice President, Worldwide Sales
William R. Phelps................................. 1999 130,000 56,000 413,330
Vice President, Professional Services
Michael R. Wolfe.................................. 1999 135,000 -- 100,000
Chief Technology Officer
</TABLE>
--------------
(1) Mr. McCloskey joined us and became our Chief Executive Officer in June
1999. His annualized salary for 1999 was $150,000.
(2) Mr. Gainey served as our Chief Executive Officer through June 1999 and
served as our President from January 1996 through April 2000.
(3) Mr. McCarthy joined us in March 1998 and resigned from his position as
Vice President, Finance and Operations effective May 2000.
48
<PAGE>
OPTION GRANTS IN LAST FISCAL YEAR
The following table sets forth information with respect to stock options
granted to each of the Named Executive Officers in 1999. We granted options to
purchase up to a total of 8,760,866 shares to employees during the year, and the
table's percentage column shows how much of that total was granted to the Named
Executive Officers. No stock appreciation rights were granted to the Named
Executive Officers during 1999.
The table includes the potential realizable value over the 10-year term of
the options, based on assumed rates of stock price appreciation of 5% and 10%,
compounded annually. The potential realizable value is calculated based on the
initial public offering price of the common stock, assuming that price
appreciates at the indicated rate for the entire term of the option and that the
option is exercised and sold on the last day of its term at the appreciated
price. All options listed have a term of 10 years. The stock price appreciation
rates of 5% and 10% are assumed pursuant to the rules of the Securities and
Exchange Commission. We can give no assurance that the actual stock price will
appreciate over the 10-year option term at the assumed 5% and 10% levels or at
any other defined level. Actual gains, if any, on stock option exercises will be
dependent on the future performance of our common stock. Unless the market price
of the common stock appreciates over the option term, no value will be realized
from the option grants made to the Named Executive Officers.
The option grants to the Named Executive Officers were made under our 1997
Stock Option/Stock Issuance Plan. The exercise price for each option grant is
equal to the fair market value of our common stock on the date of grant, as
determined in good faith by the board of directors. All options are immediately
exercisable in full, but we can buy back any shares purchased under those
options, at the exercise price paid per share, to the extent the shares are not
vested when the officer leaves our employment. Our repurchase rights will lapse
on an accelerated basis under certain conditions in conjunction with a change of
control. See "Employment Arrangements, Termination of Employment Arrangements
and Change in Control Arrangements."
OPTION GRANTS IN 1999 FISCAL YEAR
<TABLE>
<CAPTION>
% OF
TOTAL POTENTIAL REALIZABLE
NUMBER OPTIONS VALUE AT ASSUMED
OF GRANTED INDIVIDUAL GRANT ANNUAL RATES OF STOCK
SECURITIES TO -------------------- PRICE APPRECIATION FOR
UNDERLYING EMPLOYEES EXERCISE OPTION TERM (1)
OPTIONS FISCAL PRICE EXPIRATION ------------------------
NAME GRANTED(#) YEAR ($/SH) DATE 5% ($) 10%($)
-------- ---------- ---------- -------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Michael J. McCloskey.................... 1,866,666 21.31 0.3375 06/16/09 22,169,850 35,677,715
Mark S. Gainey ......................... -- -- -- -- -- --
Joseph McCarthy ........................ 100,000 1.14 0.3375 06/16/09 1,187,671 1,911,307
Paul R. Holland......................... -- -- -- -- -- --
William R. Phelps....................... 366,664 4.19 0.175 12/06/08 4,415,286 7,068,612
46,666 0.53 0.3375 06/16/09 554,239 891,930
Michael R. Wolfe ....................... 100,000 1.14 4.50 08/17/09 771,671 1,495,307
</TABLE>
--------------
(1) The 5% and 10% values are based upon the $7.50 price per share at which
the common stock was sold in the initial public offering on September 21,
1999.
AGGREGATED OPTION EXERCISES AND FISCAL YEAR-END VALUES
The following table sets forth the number of shares the Named Executive
Officers purchased in connection with option exercises during the 1999 fiscal
year and the value they realized on those exercises. None of these Named
Executive Officers held any unexercised options at the end of the 1999 fiscal
year. None of them exercised any stock appreciation rights during 1999, and none
held any stock appreciation rights at the end of the year.
The value realized is based on the fair market value of our common stock on
the date of exercise, minus the exercise price payable for the shares. The fair
market value was determined in good faith by the board of directors for
exercises before September 21, 1999, and was based on our closing price on the
exercise date for exercises on or after September 21, 1999. The exercise price
for each grant equaled the fair market value on the date of exercise, so the
Named Executive Officers who exercised did not realize any value on the
exercises.
49
<PAGE>
<TABLE>
<CAPTION>
# OF SECURITIES UNDERLYING VALUE OF UNEXERCISED IN-THE-MONEY
NUMBER OF UNEXERCISED OPTIONS/SARS OPTIONS/SARS
SHARES AT FISCAL YEAR-END(#) AT FISCAL YEAR-END($)
ACQUIRED ON VALUE --------------------------- ---------------------------------
NAME EXERCISE(#) REALIZED ($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ------------ ----------- ------------ ------------- --------------- ----------------
<S> <C> <C> <C> <C> <C> <C>
Michael J. McCloskey..... 1,866,666 0 -- -- -- --
Mark S. Gainey........... -- -- -- -- -- --
Joseph D. McCarthy....... 100,000 0 -- -- -- --
Paul R. Holland.......... -- -- -- -- -- --
William R. Phelps........ 366,664 0 -- -- -- --
46,666 0 -- -- -- --
Michael R. Wolfe......... 100,000 0 -- -- -- --
</TABLE>
EMPLOYMENT ARRANGEMENTS, TERMINATION OF EMPLOYMENT ARRANGEMENTS AND
CHANGE IN CONTROL ARRANGEMENTS
In February 1997, Dr. Holloway, one of our directors, exercised an option
to purchase 106,666 shares of common stock and entered into a stock purchase
agreement for the purchase of those shares. At the time of this report, these
shares were fully vested.
In April 1997, we sold to Mr. Gainey, our co-founder and one of our
directors, 5,000,000 shares of common stock at a purchase price of $0.01 per
share. At the time of this report, these shares were fully vested.
In April 1998, Mr. Holland, our Vice President, Worldwide Sales, exercised
an option to purchase 811,406 shares of common stock and entered into a stock
purchase agreement for the purchase of those shares. To the extent the shares
are unvested at the time of his termination of service, we will have the right
to repurchase those shares at the exercise price paid per share. Under the stock
purchase agreement, if we are acquired by merger or asset sale, our right to
repurchase the unvested shares will automatically lapse in its entirety, and the
shares will vest in full, unless the repurchase right is assigned to the
successor entity. In addition, if we are acquired by merger or asset sale and
Mr. Holland is not offered comparable employment by the successor entity, our
right to repurchase the unvested shares will automatically lapse and the shares
will vest in full.
Also in April 1998, Mr. Wolfe, our Chief Technology Officer, exercised an
option to purchase 466,666 shares of common stock and entered into a stock
purchase agreement for the purchase of those shares. To the extent the shares
are unvested at the time of his termination of service, we will have the right
to repurchase those shares at the exercise price paid per share. Under the stock
purchase agreement, if we are acquired by merger or asset sale, our right to
repurchase the unvested shares will automatically lapse in its entirety and the
shares will vest in full.
In June 1998, Mr. McCarthy, our former Vice President, Finance and
Operations, exercised an option to purchase 213,330 shares of common stock and
entered into a stock purchase agreement for the purchase of those shares. Mr.
McCarthy will continue to provide services to the Company through August 31,
2000. We will repurchase all shares unvested as of August 31, 2000 at the
exercise price paid per share. Under the stock purchase agreement, if we are
acquired by merger or asset sale, our right to repurchase the unvested shares
will automatically lapse in its entirety and the shares will vest in full.
In July 1998, Mr. Hahn, one of our directors, exercised an option to
purchase 150,064 shares of common stock and entered into a stock purchase
agreement for the purchase of those shares. To the extent the shares are
unvested at the time of his termination of service, we will have the right to
repurchase those shares at the exercise price paid per share. Under the stock
purchase agreement, if we are acquired by merger or asset sale, our right to
repurchase the unvested shares will automatically lapse in its entirety and the
shares will vest in full.
Also in July 1998, Dr. Holloway, one of our directors exercised an option
to purchase 53,332 shares of common stock and entered into a stock purchase
agreement for the purchase of those shares. To the extent the shares are
unvested at the time of his termination of service, we will have the right to
repurchase those shares at the exercise price paid per share. Under the stock
purchase agreement, if we are acquired by merger or asset sale, our right to
repurchase all of the unvested shares will automatically lapse in its entirety,
and the shares will vest in full, unless the repurchase right is assigned to the
successor entity. In addition, if we are acquired by merger or asset sale and
Dr. Holloway does not provide services to the successor entity, 25% of the
unvested shares will vest and no longer be subject to repurchase.
50
<PAGE>
In February and June 1999, Mr. Phelps, our Vice President, Professional
Services, exercised options to purchase a total of 413,330 shares of common
stock and entered into a stock purchase agreement for the purchase of those
shares. To the extent the shares are unvested at the time of his termination of
service, we will have the right to repurchase those shares at the exercise price
paid per share. Under the stock purchase agreement, if we are acquired by merger
or asset sale, our right to repurchase the unvested shares will automatically
lapse in its entirety, and the shares will vest in full, unless the repurchase
right is assigned to the successor entity. In addition, if we are acquired by
merger or asset sale and Mr. Phelps is not offered employment by the successor
entity, 25% of the unvested shares will vest and no longer be subject to
repurchase.
In June 1999, we entered into an employment arrangement with Mr. McCloskey,
our Chief Executive Officer. In connection with this arrangement, we granted Mr.
McCloskey an option to purchase 1,866,666 shares of common stock, which Mr.
McCloskey exercised in June 1999. Of these shares, 1,119,999 are subject to a
right of repurchase granted to us which will allow us to repurchase those shares
at the option exercise price paid per share, to the extent those shares are
unvested at the time of his termination of service. Under the stock purchase
agreement and the terms of Mr. McCloskey's employment arrangement, the unvested
shares will vest in a series of 48 successive equal monthly installments upon
his completion of each month of service over the 48-month period measured from
June 17, 1999. However, all or part of the shares will vest on an accelerated
basis, following a change of control of our company, under the following
circumstances:
o if Mr. McCloskey is not offered full-time employment with the
successor corporation, all of his then unvested shares of common stock
will accelerate and vest in full;
o if Mr. McCloskey is offered full-time employment with the successor
corporation as that corporation's chief executive officer, all of his
then unvested shares of common stock will continue to vest in
accordance with their original terms;
o if Mr. McCloskey is offered full-time employment with the successor
corporation as other than that corporation's chief executive officer,
the rate at which his then unvested shares of common stock vest will
double, such that his shares of common stock will vest at a rate
equivalent to 62,224 shares of common stock per month;
o if Mr. McCloskey is offered full-time employment with the successor
corporation as set forth in the second and third points above and he
does not accept the position, his shares of common stock will be
subject to immediate repurchase; and
o if Mr. McCloskey is terminated without cause by the successor
corporation following the change in control, all of his then unvested
shares of common stock will accelerate and vest in full.
Also in June 1999, Mr. McCarthy exercised an option to purchase 100,000
shares of common stock and entered into a stock purchase agreement for the
purchase of those shares. Mr. McCarthy will continue to provide services to the
Company through August 31, 2000. We will repurchase all shares unvested as of
August 31, 2000 at the exercise price paid per share. Under the stock purchase
agreement, if we are acquired by merger or asset sale, our right to repurchase
the unvested shares will automatically lapse in its entirety and the shares will
vest in full.
In August 1999, we granted an option to purchase 66,666 fully vested shares
of common stock to Mr. Frick, one of our directors, at an exercise price of
$4.50 per share, which he exercised in full in September 1999.
In September 1999, Mr. Wolfe exercised an option to purchase 100,000 shares
of common stock and entered into a stock purchase agreement for the purchase of
those shares. To the extent the shares are unvested at the time of his
termination of service, we will have the right to repurchase those shares at the
exercise price paid per share.
Under the stock purchase agreement, if we are acquired by merger or asset
sale, our right to repurchase the unvested shares will automatically lapse in
its entirety, and the shares will vest in full, unless the repurchase right is
assigned to the successor entity. In addition, if we are acquired by merger or
asset sale and Mr. Wolfe is not offered employment by the successor entity, 25%
of the unvested shares will vest and no longer be subject to repurchase.
Also in September 1999, Mr. Wolfe exercised an option to purchase 66,666
shares of common stock and entered into a stock purchase agreement for the
purchase of those shares. To the extent the shares are unvested at the time of
his termination of service, we will have the right to repurchase those shares at
the exercise price paid per
51
<PAGE>
share. Under the stock purchase agreement, if we are acquired by merger or asset
sale, our right to repurchase the unvested shares will automatically lapse in
its entirety and the shares will vest in full.
In April 2000, we entered into an employment arrangement with Mr. Allen,
our Chief Financial Officer. Mr. Allen's annual salary is $200,000. In
connection with this arrangement, we granted Mr. Allen an option to purchase
500,000 shares of common stock, of which the option to purchase 80,000 shares
was granted at an exercise price of $15 per share, and the option to purchase
the remaining 420,000 shares was granted at the fair market value which was
$39.31 on the grant date. Under the stock purchase agreement and the terms of
Mr. Allen's employment arrangement, the option shares will vest in a series of
48 successive equal monthly installments upon his completion of each month of
service over the 48-month period measured from April 19, 2000. However, part of
the shares will vest on an accelerated basis if we sign an agreement to acquire
another company within 90 days after April 19, 2000 and the acquisition is
consummated within 90 days of signing the agreement, as follows:
o if Mr. Allen is offered a position with us in a capacity other than as
the Chief Financial Officer following the acquisition, the rate of
vesting on each of his options will double beginning on the closing
date of the acquisition;
o if Mr. Allen is not offered a position with us following the
acquisition, his options will accelerate with respect to 12 months of
additional vesting beginning on the closing date of the acquisition;
o if Mr. Allen continues to serve as Chief Financial Officer following
the acquisition, then all of his then unvested shares of common stock
will continue to vest in accordance with their original terms.
If Mr. Allen is involuntarily terminated or voluntarily resigns for good
reason during the 12 months following a change of control of our company, he
will accelerate with respect to 24 months of additional vesting measured from
his termination or resignation date.
Generally, our option grants to employees, other than those under the 1999
Special Stock Option Plan, provide that if we are acquired by merger or asset
sale and the employee is not offered employment by the successor entity, then
25% of any unvested shares held by that individual will vest and no longer be
subject to repurchase.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The table below sets forth information regarding the beneficial ownership
of our common stock as of June 30, 2000, by the following individuals or groups:
o each person or entity who is known by us to own beneficially more than
five percent of our outstanding stock;
o each of the Named Executive Officers;
o each of our directors; and
o all current directors and executive officers as a group.
Applicable percentage ownership in the following table is based on
93,162,339 shares of common stock outstanding as of June 30, 2000, as adjusted
to include all options exercisable within 60 days of June 30, 2000 held by the
particular stockholder and that are included in the first column.
Unless otherwise indicated, the principal address of each of the
stockholders below is c/o Kana Communications, Inc., 740 Bay Road, Redwood City,
CA 94063. Except as otherwise indicated, and subject to applicable community
property laws, the persons named in the table have sole voting and investment
power with respect to all shares of common stock held by them.
52
<PAGE>
<TABLE>
<CAPTION>
NUMBER OF PERCENTAGE
SHARES OF SHARES
BENEFICIALLY BENEFICIALL
NAME AND ADDRESS OF BENEFICIAL OWNER OWNED (#) OWNED (%)
----------------------------------- -------------- ------------
<S> <C> <C>
Entities affiliated with Draper Fisher Jurvetson(1)................................ 8,077,674 8.7
Entities affiliated with Benchmark Capital Partners L.P.(2)........................ 8,624,250 9.3
Entities affiliated with CMG @Ventures II LLC(10).................................. 4,707,553 5.1
Mark S. Gainey(3).................................................................. 4,579,966 4.9
Michael J. McCloskey(4)............................................................ 1,869,466 2.0
James C. Wood...................................................................... 2,582,230 2.8
Paul R. Holland(5)................................................................. 816,206 *
William R. Phelps(6)............................................................... 416,130 *
Joseph D. McCarthy(7).............................................................. 316,130 *
Michael R. Wolfe................................................................... 630,782 *
Steven T. Jurvetson(1)............................................................. 8,077,674 8.7
David M. Beirne(2)(11)............................................................. 8,828,580 9.5
Eric A. Hahn(8).................................................................... 433,898 *
Dr. Charles A. Holloway(9)......................................................... 159,998 *
Robert W. Frick.................................................................... 147,034 *
All current directors and executive officers as a group (18 persons)............... 31,314,960 33.6
</TABLE>
---------------
* Less than one percent.
(1) Principal address is 400 Seaport Court, Suite 250, Redwood City, CA
94063. Includes 7,481,660 shares of common stock held by Draper Fisher
Associates Fund IV, L.P., 563,134 shares of common stock held by Draper
Fisher Partners IV, LLC and 32,880 shares of common stock held by Draper
Richards L.P. Mr. Jurvetson disclaims beneficial ownership of these
shares, except to the extent of his pecuniary interest in the Draper
Fisher Jurvetson Funds.
(2) Principal address is 2480 Sand Hill Road, Suite 200, Menlo Park, CA
94025. Represents 7,566,694 shares of common stock held by Benchmark
Capital Partners, L.P., and 1,057,556 shares of common stock held by
Benchmark Founders' Fund L.P. Mr. Beirne, one of our directors, is a
Managing Member of Benchmark Capital Management Co., LLC. Mr. Beirne
disclaims beneficial ownership of these shares, except to the extent of
his pecuniary interest in the Benchmark funds.
(3) Represents 4,578,666 shares of common stock held by the Mark and
Elisabeth Gainey Family Trust.
(4) Includes 1,057,777 shares of common stock subject to our right of
repurchase. This repurchase right lapses with respect to 31,111 shares
per month.
(5) Includes 26,666 shares of common stock held by The Paul Holland Grantor
Retained Annuity Trust, 26,666 shares of common stock held by The Linda
Yates Holland Grantor Retained Annuity Trust, 53,332 shares of common
stock held by the Yates/Holland 1999 Irrevocable Trust, 571,410 shares of
common stock held by The Yates/Holland Family Trust and 133,332 shares of
common stock held by Paul Holland and Linda Yates as community property.
Includes 270,469 shares of common stock subject to our right of
repurchase. This repurchase right lapses with respect to 16,904 shares
per month.
(6) Includes 26,666 shares of common stock held by The William Phelps Grantor
Retained Annuity Trust, 26,666 shares of common stock held by The
Margaret Phelps Grantor Retained Annuity Trust and 360,000 shares of
common stock held by The Phelps Family Trust. Includes 213,888 shares of
common stock subject to our right of repurchase. This repurchase right
lapses with respect to 7,638 shares per month. Also includes 34,028
shares of common stock subject to our right of repurchase, which lapses
with respect to 972 shares per month.
(7) Includes 33,332 shares of common stock held by The Joseph McCarthy
Grantor Retained Annuity Trust and 33,332 shares of common stock held by
Siobhan Lawlor Grantor Retained Annuity Trust. Includes 88,889 shares of
common stock subject to our right of repurchase. This repurchase right
lapses with respect to 4,444 shares per month. Also includes 72,917
shares of common stock subject to our right of repurchase, which lapses
with respect to 2,084 shares per month. Mr. McCarthy will continue to
provide services to us through August 31, 2000. We will repurchase all
shares unvested as of August 31, 2000 at the exercise price paid per
share.
53
<PAGE>
(8) Includes 68,780 shares of common stock subject to our right of
repurchase. This repurchase right lapses with respect to 3,126 shares per
month.
(9) Includes 8,889 shares of common stock subject to our right of repurchase.
This repurchase right lapses with respect to 1,481 shares per month.
(10) Principal address is 100 Brickstone Plaza, Andover, MA 01810. Includes a
warrant to purchase 123,404 shares of common stock.
(11) Includes 192,000 shares of common stock held by Ramsey/Beirne Investment
Pool II, LLC. Mr. Beirne, one of our directors, was Chief Executive
Officer of Ramsey/Beirne Associates until June 1997. Mr. Beirne disclaims
beneficial ownership of these shares, except to the extent of his
pecuniary interest in the Ramsey/Beirne Investment Pool II, LLC.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
SALES OF SECURITIES
Since January 1999, we have been a party to several transactions in which
the amount involved exceeded $60,000 and in which any of our directors or
executive officers, any holder of more than 5% of our outstanding capital stock
or any member of their immediate families had a direct or indirect material
interest.
These transactions include:
In July 1999, we sold to various investors, including entities affiliated
with Draper Fisher Jurvetson and entities affiliated with Benchmark Capital, a
total of 1,676,932 shares of Series D preferred stock for total consideration of
$10,200,004. At the time of the financing, Mr. Jurvetson, a Managing Director of
Draper Fisher Jurvetson, and Mr. Beirne, a Managing Member of Benchmark Capital,
were two of our directors.
On August 13, 1999, we closed a merger with Connectify, Inc. pursuant to
which Connectify became our wholly-owned subsidiary. In connection with the
acquisition, we issued approximately 6,982,542 shares of our common stock in
exchange for all outstanding shares of Connectify capital stock and reserved
416,690 shares of common stock for issuance upon the exercise of Connectify
options and warrants. In connection with the acquisition, Mr. Frick, a director
of Connectify, Inc., became one of our directors.
On December 3, 1999, we closed a merger with Business Evolution, Inc.
pursuant to which Business Evolution became our wholly-owned subsidiary. In
connection with the acquisition of Business Evolution, approximately 1,890,200
shares of our common stock, valued at approximately $140 million, were issued
for all outstanding shares and warrants of Business Evolution.
On December 3, 1999, we closed a merger with netDialog, Inc. pursuant to
which netDialog became our wholly-owned subsidiary. In connection with the
acquisition of netDialog, approximately 1,120,286 shares of our common stock,
valued at approximately $90 million, were issued for all outstanding shares,
warrants and convertible notes of netDialog.
On April 19, 2000, we closed a merger with Silknet Software, Inc., pursuant
to which Silknet became our wholly-owned subsidiary. In connection with the
acquisition of Silknet, approximately 33 million shares of common stock, valued
at approximately $4.2 billion, were issued or reserved for issuance for all
outstanding shares, warrants and options of Silknet. In connection with the
acquisition, Mr. Wood, a founder and the Chairman of the Board, President and
Chief Executive Officer of Silknet, became one of our directors.
54
<PAGE>
LOANS TO AND OTHER ARRANGEMENTS WITH OFFICERS AND DIRECTORS
In connection with the option exercises described under "Employment
Arrangements, Termination of Employment Arrangements and Change of Control
Arrangements," the following officers and directors delivered five-year full
recourse promissory notes, bearing interest at an annual rate of 5.7%, except in
the case of Messrs. Frick and Wolfe whose notes bear interest at an annual rate
of 6.0%, in amounts and with the balances indicated:
ORIGINAL
AMOUNT OF AMOUNT
OFFICER OR PROMISSORY OUTSTANDING AT
DIRECTOR NOTE JULY 31, 2000
----------- ------------- ----------------
Michael J. McCloskey........................ $ 630,000 $ 672,535
Robert W. Frick............................. 299,997 316,722
William R. Phelps........................... 79,000 75,301
Ian P. Cavanagh............................. 900,000 947,634
Michael R. Wolfe............................ 458,000 0
We have entered into an employment arrangement with Mr. McCloskey, our
Chief Executive Officer. See "Employment Arrangements, Termination of Employment
Arrangements and Change in Control Arrangements."
We have granted options to our executive officers and directors. See
"Management--Director Compensation" and "--Executive Compensation."
We have entered into an indemnification agreement with each of our
executive officers and directors containing provisions that may require us,
among other things, to indemnify our executive officers and directors against
liabilities that may arise by reason of our status or service as executive
officers or directors (other than liabilities arising from willful misconduct of
a culpable nature) and to advance expenses incurred as a result of any
proceeding against them as to which they could be indemnified.
55
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Report:
1. FINANCIAL STATEMENTS.
<TABLE>
<CAPTION>
PAGE
------
<S> <C>
Independent Auditors' Report............................................................................ 65
Consolidated Balance Sheets as of December 31, 1999 and 1998............................................ 66
Consolidated Statements of Operations and Comprehensive Loss for the
Years ended December 31, 1999 1998 and 1997........................................................ 67
Consolidated Statements of Stockholders' Equity for the Years ended
December 31, 1999, 1998 and 1997................................................................... 68
Consolidated Statements of Cash Flows for the Years ended December 31,
1999, 1998 and 1997................................................................................ 70
Notes to Consolidated Financial Statements.............................................................. 71
2. FINANCIAL STATEMENT SCHEDULES.
SCHEDULE TITLE PAGE
----------- ----- ------
Independent Auditors Report on Schedule.................................................... 86
II Valuation and Qualifying Accounts.......................................................... 87
</TABLE>
Schedules not listed above have been omitted because they are not
applicable, not required, or the information required to be set forth therein is
included in the consolidated financial statements or notes thereto.
3. EXHIBITS.
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
---------- ------------------------
2.1* Agreement and Plan of Reorganization, dated December 3, 1999, by
and among Kana, King Acquisition Corp. and Business Evolution, Inc.
2.2* Agreement and Plan of Reorganization, dated December 3, 1999, by
and among Kana, Kong Acquisition Corp. and netDialog.
2.3** Agreement and Plan of Reorganization, dated February 6, 2000, by
and among Kana Communications, Inc., Pistol Acquisition Corp. and
Silknet Software, Inc.
3.1*** Second Amended and Restated Certificate of Incorporation.
3.2*** Amended and Restated Bylaws.
4.1*** Fourth Amended and Restated Investors' Rights Agreement dated
August 13, 1999 by and among Kana and parties listed on Schedule A
therein.
4.2+ Form of amendment to Fourth Amended and Restated Investors' Rights
Agreement.
10.1*** Kana's 1997 Stock Option/Stock Issuance Plan.
10.2*** Kana's 1999 Stock Incentive Plan.
10.3*** Kana's 1999 Employee Stock Purchase Plan.
10.4*** Form of Kana's Directors' and Officers' Indemnification Agreement.
10.5*** Form of Kana's License Agreement.
10.6*** Letter of Credit, dated July 9, 1999, with Silicon Valley Bank and
Kana.
10.7*** Lease, dated May 1998, by and between Encina Properties and Kana.
10.8*** Office/R&D Lease, dated June 18, 1999, by and between Chestnut Bay
LLC and Kana.
10.9*** Form of Kana's Kana On-Line Service Agreement.
10.10*** Form of Kana's Restricted Stock Purchase Agreement.
QuickStart Loan and Security Agreement, dated November 6, 1998,
with Silicon Valley Bank and
10.11*** Connectify, Inc.
10.12+ Lease, dated February 11, 2000, by and between Veterans Self-
Storage, LLC and the Registrant.
10.13+ Amended and Restated 1999 Stock Incentive Plan of Kana
Communications, Inc.
56
<PAGE>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
---------- ------------------------
16.1++++ Letter from KPMG LLP, dated March 30, 2000.
21.1+ Subsidiaries of Kana Communications, Inc.
23.1 Consent of KPMG LLP, Independent Auditors.
24.1++++ Power of Attorney.
27.1 Financial Data Schedule.
99.1++ Connectify, Inc. 1998 Stock Plan.
99.2++ Connectify, Inc. 1998 Stock Plan Form of Incentive Stock Option
Agreement.
99.3++ Connectify, Inc. 1998 Stock Plan Form of Nonstatutory Stock Option
Agreement.
99.4++ Form of Option Assumption Agreement.
99.5+++ Business Evolution, Inc. 1999 Stock Plan.
99.6+++ Business Evolution, Inc. Form of Stock Option Agreement.
99.7+++ Form of Option Assumption Agreement--12 Months Acceleration
(Business Evolution Option Shares).
99.8+++ Form of Option Assumption Agreement--24 Months Acceleration
(Business Evolution Option Shares).
99.9+++ netDialog, Inc. 1997 Stock Plan.
99.10+++ netDialog, Inc. Form of Stock Option Agreement.
99.11+++ Form of Option Assumption Agreement (netDialog Option Shares).
--------------
* Previously filed as an exhibit to the Form 8-K filed with the Commission
by Kana on December 14, 1999, and incorporated into this annual report by
reference.
** Previously filed as an exhibit to the form 13D filed with the Commission
by Kana on February 16, 2000, and incorporated into this annual report by
reference.
*** Incorporated into this annual report by reference to Kana's registration
statement on Form S-1, File No. 333-82587, originally filed with the
Commission on July 9, 1999, as subsequently amended.
+ Incorporated into this annual report by reference to Kana's registration
statement on Form S-4, File No. 333-32428, originally filed with the
Commission on March 14, 2000, as subsequently amended.
++ Previously filed as an exhibit to the Form S-8 filed with the Commission
by Kana on December 6, 1999 and incorporated into this annual report by
reference.
+++ Previously filed as an exhibit to the Form S-8 filed with the Commission
by Kana on December 23, 1999 and incorporated into this annual report by
reference.
++++ Previously filed as an exhibit to the Form 10-K filed with the Commission
by Kana on March 30, 2000 and incorporated into this annual report by
reference.
(B) REPORTS ON FORM 8-K.
1. On December 14, 1999, the Company filed a Current Report on Form 8-K
reporting under Item 5, relating to the acquisitions of Business Evolution,
Inc., a Delaware corporation and netDialog, Inc., a California corporation.
57
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Kana Communications, Inc.
We have audited the accompanying consolidated balance sheets of Kana
Communications, Inc. and subsidiary (the Company) as of December 31, 1999 and
1998, and the related consolidated statements of operations and comprehensive
loss, stockholders' equity, and cash flows for each of the years in the
three-year period ended December 31, 1999. The consolidated financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Kana
Communications, Inc. and subsidiary as of December 31, 1999 and 1998, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1999 in conformity with generally accepted
accounting principles.
/s/ KPMG LLP
--------------------------
Mountain View, California
January 20, 2000, except
as to Note 8, which is
as of February 11, 2000
58
<PAGE>
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1999 1998
---------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............................................................ $ 18,695 $ 13,875
Short-term investments............................................................... 34,522 160
Accounts receivable, less allowance for doubtful accounts of $366 in 1999 and $110
in 1998............................................................................ 4,655 847
Prepaid expenses and other current assets............................................ 2,036 150
---------- -----------
Total current assets................................................................. 59,908 15,032
Property and equipment, net.......................................................... 8,360 1,473
Other assets......................................................................... 1,961 371
---------- -----------
Total assets......................................................................... $ 70,229 $ 16,876
========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of notes payable..................................................... $ 4,224 $ 1,071
Accounts payable..................................................................... 2,766 698
Accrued commissions.................................................................. 1,984 143
Accrued payroll...................................................................... 1,639 280
Other accrued liabilities............................................................ 1,303 445
Accrued acquisition related costs.................................................... 3,148 --
Deferred revenue..................................................................... 6,253 562
---------- -----------
Total current liabilities............................................................ 21,317 3,199
Notes payable, less current portion.................................................. 412 726
---------- -----------
Total liabilities.................................................................... 21,729 3,925
---------- -----------
Commitments and contingencies
Stockholders' equity:
Convertible preferred stock, $0.001 par value; 5,000,000 and 50,000,000 shares
authorized; no and 12,512,641 shares issued and outstanding........................ -- 13
Common stock, $0.001 par value; 60,000,000 and 100,000,000 shares authorized;
60,766,650 and 19,274,516 shares issued and outstanding............................ 61 19
Additional paid-in capital........................................................... 202,473 29,246
Deferred stock-based compensation.................................................... (14,962) (2,284)
Notes receivable from stockholders................................................... (6,380) (164)
Accumulated other comprehensive losses............................................... (75) (5)
Accumulated deficit.................................................................. (132,617) (13,874)
---------- -----------
Total stockholders' equity........................................................... 48,500 12,951
---------- -----------
Total liabilities and stockholders' equity........................................... $ 70,229 $ 16,876
========== ===========
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
59
<PAGE>
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------
1999 1998 1997
------------ ----------- ---------
<S> <C> <C> <C>
Revenue:
License............................................................... $ 10,536 $ 2,014 $ --
Service............................................................... 3,528 333 617
------------ ----------- ---------
Total revenue..................................................... 14,064 2,347 617
------------ ----------- ---------
Cost of revenue:
License............................................................... 271 54 --
Service, excluding amortization of stock-based compensation of
$19,752, $143 and $13............................................... 6,610 666 253
------------ ----------- ---------
Total cost of revenue............................................. 6,881 720 253
------------ ----------- ---------
Gross profit...................................................... 7,183 1,627 364
------------ ----------- ---------
Operating expenses:
Sales and marketing, excluding amortization of stock-based
compensation of $34,000, $564 and $52............................... 21,199 5,504 512
Research and development, excluding amortization of stock-
based compensation of $19,864, $438 and $31......................... 12,854 5,669 971
General and administrative, excluding amortization of stock-
based compensation of $6,860, $311 and $17.......................... 5,018 1,826 378
Amortization of stock-based compensation.............................. 80,476 1,456 113
Acquisition related costs............................................. 5,635 -- --
------------ ----------- ---------
Total operating expenses.......................................... 125,182 14,455 1,974
------------ ----------- ---------
Operating loss............................................................. (117,999) (12,828) (1,610)
Other income (expense), net................................................ (744) 227 57
------------ ----------- ---------
Net loss.......................................................... (118,743) (12,601) (1,553)
------------ ----------- ---------
Other comprehensive loss:
Net unrealized gain on available for sale securities.................. 26 -- --
Foreign currency translation adjustments.............................. (96) (5) --
------------ ----------- ---------
Total other comprehensive loss.................................... (70) (5) --
------------ ----------- ---------
Comprehensive loss................................................ $ (118,813) $ (12,606) $ (1,553)
Basic and diluted net loss per share....................................... $ (4.61) $ (2.01) $ (0.37)
============ =========== =========
Shares used in computing basic and diluted net loss per share
amounts................................................................. 25,772 6,258 4,152
============ =========== =========
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
60
<PAGE>
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
CONVERTIBLE PREFERRED STOCK
STOCK COMMON STOCK ADDITIONAL
----------------------------- --------------------------------- PAID-IN
SHARES AMOUNT SHARES AMOUNT CAPITAL
---------------- ----------- ---------------- --------------- ---------------
<S> <C> <C> <C> <C> <C>
Balances, January 1, 1997..................... -- $ -- 106,742 $ -- $ --
Issuance of common stock to Kana and -- -- 6,931,916 7 (6)
netDialog founders.........................
Issuance of common stock upon exercise of
stock options.............................. -- -- 106,666 -- --
Repurchase of founders' common stock, net..... -- -- (833,332) -- --
Issuance of Series A and B convertible
preferred stock, net....................... 8,917,855 9 -- -- 4,764
Issuance of common stock of pooled company.... -- -- 173,232 -- 2,070
Deferred stock-based compensation............. -- -- -- -- 890
Issuance of shares of common stock in
exchange for services...................... -- -- 1,334 -- 7
Amortization of deferred stock-based
compensation............................... -- -- -- -- --
Net loss...................................... -- -- -- -- --
Balances, December 31, 1997................... 8,917,855 9 6,486,558 7 7,725
Issuance of common stock to Connectify and
BEI founders............................... -- -- 3,954,940 4 61
Issuance of stock upon exercise of stock
options and warrants, net of repurchases... 68,139 -- 5,314,624 5 174
Issuance of common stock of pooled companies.. -- -- 3,442,704 3 6,573
Issuance of Series B and C convertible
preferred stock, net....................... 3,526,647 4 -- -- 11,624
Issuance of common stock and warrants in
exchange for services and intellectual
property................................... -- -- 75,690 -- 133
Deferred stock-based compensation -- -- -- -- 2,956
Amortization of deferred stock-based
compensation............................... -- -- -- -- --
Other comprehensive loss...................... -- -- -- -- --
Net loss...................................... -- -- -- -- --
---------------- ----------- ---------------- --------------- ---------------
Balances, December 31, 1998................... 12,512,641 13 19,274,516 19 29,246
</TABLE>
<TABLE>
<CAPTION>
NOTES ACCUMULATED
DEFERRED RECEIVABLE OTHER
STOCK-BASED FROM COMPREHENSIVE ACCUMULATED
COMPENSATION STOCKHOLDERS LOSSES DEFICIT
------------------ ---------------- ------------------ ----------------
<S> <C> <C> <C> <C>
Balances, January 1, 1997..................... $ -- $ -- $ -- $ 280
Issuance of common stock to Kana and -- -- -- --
netDialog founders.........................
Issuance of common stock upon exercise of
stock options.............................. -- -- -- --
Repurchase of founders' common stock, net..... -- -- -- --
Issuance of Series A and B convertible
preferred stock, net....................... -- -- -- --
Issuance of common stock of pooled company.... -- -- -- --
Deferred stock-based compensation............. (890) -- -- --
Issuance of shares of common stock in
exchange for services...................... -- -- -- --
Amortization of deferred stock-based
compensation............................... 106 -- -- --
Net loss...................................... -- -- -- (1,553)
Balances, December 31, 1997................... (784) -- -- (1,273)
Issuance of common stock to Connectify and
BEI founders............................... -- -- -- --
Issuance of stock upon exercise of stock
options and warrants, net of repurchases... -- (164) -- --
Issuance of common stock of pooled companies.. -- -- -- --
Issuance of Series B and C convertible
preferred stock, net....................... -- -- -- --
Issuance of common stock and warrants in
exchange for services and intellectual
property................................... -- -- -- --
Deferred stock-based compensation (2,956) -- -- --
Amortization of deferred stock-based
compensation............................... 1,456 -- -- --
Other comprehensive loss...................... -- -- (5) --
Net loss...................................... -- -- -- (12,601)
------------------ ---------------- ------------------ ----------------
Balances, December 31, 1998................... (2,284) (164) (5) (13,874)
</TABLE>
TOTAL
STOCKHOLDERS'
EQUITY
----------------
Balances, January 1, 1997..................... $ 280
Issuance of common stock to Kana and 1
netDialog founders.........................
Issuance of common stock upon exercise of
stock options.............................. --
Repurchase of founders' common stock, net..... --
Issuance of Series A and B convertible
preferred stock, net....................... 4,773
Issuance of common stock of pooled company.... 2,070
Deferred stock-based compensation............. --
Issuance of shares of common stock in
exchange for services...................... 7
Amortization of deferred stock-based
compensation............................... 106
Net loss...................................... (1,553)
Balances, December 31, 1997................... 5,684
Issuance of common stock to Connectify and
BEI founders............................... 65
Issuance of stock upon exercise of stock
options and warrants, net of repurchases... 15
Issuance of common stock of pooled companies.. 6,576
Issuance of Series B and C convertible
preferred stock, net....................... 11,628
Issuance of common stock and warrants in
exchange for services and intellectual
property................................... 133
Deferred stock-based compensation --
Amortization of deferred stock-based
compensation............................... 1,456
Other comprehensive loss...................... (5)
Net loss...................................... (12,601)
----------------
Balances, December 31, 1998................... 12,951
61
<PAGE>
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY--(CONTINUED)
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
CONVERTIBLE PREFERRED STOCK COMMON STOCK ADDITIONAL
-------------------------------- ---------------------------------- PAID-IN
SHARES AMOUNT SHARES AMOUNT CAPITAL
----------------- ------------ ---------------- ---------------- ---------------
<S> <C> <C> <C> <C> <C>
Balances, December 31, 1998............ 12,512,641 13 19,274,516 19 29,246
Issuance of common stock upon exercise -- -- 5,749,356 6 6,393
of stock options and warrants, net
of repurchases......................
Issuance of Series D convertible
preferred stock..................... 838,466 -- -- -- 10,169
Conversion of convertible preferred
stock to common stock............... (13,351,107) (13) 26,702,214 27 (14)
Issuance of common stock of pooled
companies........................... -- -- 964,964 1 5,790
Issuance of common stock in exchange
for services........................ -- -- 5,306 -- 60
Issuance of common stock in
conjunction with initial public
offering, net....................... -- -- 7,590,000 8 51,058
Conversion of debt, accrued interest,
and warrants to common stock........ -- -- 480,294 -- 5,058
Payments on notes receivable from
stockholders........................ -- -- -- -- --
Interest receivable from notes
receivable from stockholders........ -- -- -- -- --
Interest expense from warrants issued
in connection with bridge loans..... -- -- -- -- 1,559
Deferred stock-based compensation...... -- -- -- -- 93,154
Amortization of deferred stock-based
compensation........................ -- -- -- -- --
Other comprehensive loss............... -- -- -- -- --
Net loss............................... -- -- -- -- --
----------------- ------------ ---------------- ---------------- ---------------
Balances, December 31, 1999............ -- $ -- 60,766,650 $ 61 $ 202,473
================= ============ ================ ================ ===============
NOTES ACCUMULATED
DEFERRED RECEIVABLE OTHER
STOCK-BASED FROM COMPREHENSIVE ACCUMULATED
COMPENSATION STOCKHOLDERS LOSSES DEFICIT
------------------ ---------------- ------------------ ----------------
<S> <C> <C> <C> <C>
Balances, December 31, 1998............ (2,284) (164) (5) (13,874)
Issuance of common stock upon exercise -- (6,544) -- --
of stock options and warrants, net
of repurchases......................
Issuance of Series D convertible
preferred stock..................... -- -- -- --
Conversion of convertible preferred
stock to common stock............... -- -- -- --
Issuance of common stock of pooled
companies........................... -- -- -- --
Issuance of common stock in exchange
for services........................ -- -- -- --
Issuance of common stock in
conjunction with initial public
offering, net....................... -- -- -- --
Conversion of debt, accrued interest,
and warrants to common stock........ -- -- -- --
Payments on notes receivable from
stockholders........................ -- 501 -- --
Interest receivable from notes
receivable from stockholders........ -- (173) -- --
Interest expense from warrants issued
in connection with bridge loans..... -- -- -- --
Deferred stock-based compensation...... (93,154) -- -- --
Amortization of deferred stock-based
compensation........................ 80,476 -- -- --
Other comprehensive loss............... -- -- (70) --
Net loss............................... -- -- -- (118,743)
------------------ ---------------- ------------------ ----------------
Balances, December 31, 1999............ $ (14,962) $ (6,380) $ (75) $ (132,617)
================== ================ ================== ================
TOTAL
STOCKHOLDERS'
EQUITY
------------------
<S> <C>
Balances, December 31, 1998............ 12,951
Issuance of common stock upon exercise (145)
of stock options and warrants, net
of repurchases......................
Issuance of Series D convertible
preferred stock..................... 10,169
Conversion of convertible preferred
stock to common stock............... --
Issuance of common stock of pooled
companies........................... 5,791
Issuance of common stock in exchange
for services........................ 60
Issuance of common stock in
conjunction with initial public
offering, net....................... 51,066
Conversion of debt, accrued interest,
and warrants to common stock........ 5,058
Payments on notes receivable from
stockholders........................ 501
Interest receivable from notes
receivable from stockholders........ (173)
Interest expense from warrants issued
in connection with bridge loans..... 1,559
Deferred stock-based compensation...... --
Amortization of deferred stock-based
compensation........................ 80,476
Other comprehensive loss............... (70)
Net loss............................... (118,743)
------------------
Balances, December 31, 1999............ $ 48,500
==================
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
62
<PAGE>
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------
1999 1998 1997
----------- ---------- ---------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss................................................................. $ (118,743) $ (12,601) $ (1,553)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization.......................................... 1,531 328 45
Amortization of stock-based compensation and other stock-based items... 80,536 1,589 113
Interest expense from warrants issued in connection with bridge loans.. 1,559 -- --
Conversion of accrued interest to common stock......................... 258 -- --
Interest on stockholders' notes receivable............................. (173) -- --
Changes in operating assets and liabilities:
Accounts receivable.................................................. (3,807) (690) (15)
Prepaid expenses and other assets.................................... (1,831) (469) (50)
Accounts payable and accrued liabilities............................. 9,274 1,177 379
Deferred revenue..................................................... 5,691 562 --
----------- ---------- ---------
Net cash used in operating activities................................ (25,705) (10,104) (1,081)
----------- ---------- ---------
Cash flows from investing activities:
(Purchases) sales of short-term investments, net......................... (35,981) 50 (210)
Purchases of property and equipment...................................... (8,418) (1,446) (371)
----------- ---------- ---------
Net cash used in investing activities................................ (44,399) (1,396) (581)
----------- ---------- ---------
Cash flows from financing activities:
Proceeds from notes payable and convertible notes payable................ 9,790 1,834 256
Payments on notes payable................................................ (2,151) (122) --
Net proceeds from issuance of convertible preferred stock................ 10,169 11,628 4,603
Net proceeds from issuance of common stock and warrants.................. 5,645 6,656 2,070
Net proceeds from initial public offering................................ 51,066 -- --
Payments on stockholders' notes receivable............................... 501 -- --
----------- ---------- ---------
Net cash provided by financing activities............................ 75,020 19,996 6,929
----------- ---------- ---------
Effect of exchange rate changes on cash and cash equivalents................ (96) (5) --
----------- ---------- ---------
Net change in cash and cash equivalents..................................... 4,820 8,491 5,267
Cash and cash equivalents at beginning of year.............................. 13,875 5,384 117
----------- ---------- ---------
Cash and cash equivalents at end of year.................................... $ 18,695 $ 13,875 $ 5,384
=========== ========== =========
Supplemental disclosure of cash flow information:
Cash paid during the year for interest................................... $ 131 $ 36 $ 3
=========== ========== =========
Noncash investing and financial activities:
Issuance of Series A convertible preferred stock upon conversion of
stockholder loan..................................................... $ -- $ -- $ 170
=========== ========== =========
Issuance of common stock upon conversion of convertible note payable... $ 4,800 $ 300 $ --
=========== ========== =========
Issuance of common stock in exchange for notes receivable
from stockholders.................................................... $ 6,544 $ 155 $ --
=========== ========== =========
Grant of options to purchase common stock with an exercise price below
fair value........................................................... $ 93,154 $ 2,273 $ 890
=========== ========== =========
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
63
<PAGE>
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999, 1998 AND 1997
1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(A) DESCRIPTION OF BUSINESS
Kana Communications, Inc. and subsidiaries (the Company or Kana) develop,
market and support customer communications software products and services for
e-Businesses. The Company sells its products primarily in the United States and,
to a lesser extent, in Europe primarily through its direct sales force.
(B) PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the financial statements of
Kana Communications, Inc. and its wholly-owned subsidiaries. All significant
intercompany balances and transactions have been eliminated in consolidation.
(C) USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
(D) FOREIGN CURRENCY TRANSLATION
The functional currency for the Company's international subsidiary is the
local currency of the country in which it operates. Assets and liabilities are
translated using the exchange rate at the balance sheet date. Revenues,
expenses, gains, and losses are translated at the average exchange rates
prevailing during the year. Any translation adjustments are included in other
comprehensive loss.
(E) CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
The Company considers all highly liquid investments with an original
maturity or reset date of three months or less to be cash equivalents. The
Company has classified its cash equivalents and short-term investments as
"available for sale." These items are carried at fair value, based on the quoted
market prices, and unrealized gains and losses, are reported as a separate
component of accumulated other comprehensive losses in stockholders' equity. All
short term investments mature in less than one year. To date, realized gains or
losses have not been material.
(F) PROPERTY AND EQUIPMENT
Property and equipment are stated at cost, less accumulated depreciation
and amortization. Depreciation is computed using the straight-line method over
the estimated useful lives of the respective assets, generally three to five
years. Leasehold improvements are amortized over the lesser of the related lease
term or the life of the improvement.
The Company evaluates long-lived assets for impairment whenever changes in
circumstances indicate that the carrying amount of the asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future net cash flows expected
to be generated by the asset. If assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the carrying
amounts exceed the fair values of the assets. Assets to be disposed of are
reported at the lower of carrying values or fair values, less costs of disposal.
(G) CONCENTRATION OF CREDIT RISK
Financial instruments subjecting the Company to concentrations of credit
risk consist primarily of cash and cash equivalents, short-term investments and
trade accounts receivable. The Company maintains cash and cash equivalents with
two domestic financial institutions. From time to time, the Company's cash
balances with its financial institutions may exceed Federal Deposit Insurance
Corporation insurance limits.
64
<PAGE>
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
The Company's customers are currently concentrated in the United States.
The Company performs ongoing credit evaluations, generally does not require
collateral and establishes an allowance for doubtful accounts based upon factors
surrounding the credit risk of customers, historical trends and other
information. To date, such losses have been immaterial.
(H) REVENUE RECOGNITION
The Company recognizes revenue in accordance with Statement of Position
(SOP) 97-2, Software Revenue Recognition. SOP 97-2 requires that revenue
recognized from software arrangements be allocated to each element of the
arrangement based on the relative fair values of the elements, such as software
products, upgrades, enhancements, post contract customer support, installation,
or training. Under SOP 97-2, the determination of fair value is based on
objective evidence that is specific to the vendor. If evidence of fair value for
each element of the arrangement does not exist, all revenue from the arrangement
is deferred until such time as evidence of fair value does exist or until all
elements of the arrangement are delivered.
License revenue is recognized when there is persuasive evidence of an
arrangement and delivery to the customer has occurred, provided the arrangement
does not require significant customization of the software, the fee is fixed and
determinable, and collectibility is considered probable. Maintenance contracts
generally call for the Company to provide technical support and software updates
and upgrades to customers. Revenue from maintenance contracts is recognized
ratably over the term of the maintenance contract, on a straight- line basis.
Other service revenue, consisting primarily of consulting and implementation, is
generally recognized at the time the service is performed.
(I) SOFTWARE DEVELOPMENT COSTS
Software development costs are expensed as incurred until technological
feasibility of the underlying software product is achieved. After technological
feasibility is established, software development costs are capitalized.
Capitalized costs are then amortized on a straight-line basis over the estimated
product life, or based on the ratio of current revenue to total projected
product revenue, whichever is greater. To date, technological feasibility and
general availability of such software have occurred simultaneously and software
development costs qualifying for capitalization have been insignificant.
Accordingly, the Company has not capitalized any software development costs.
The Company accounts for the costs of computer software developed or
obtained for internal use in accordance with SOP 98-1, Accounting for the Costs
of Computer Software Developed or Obtained for Internal Use, which was effective
for fiscal years beginning after December 15, 1998. This statement requires that
certain costs incurred during a software development project be capitalized.
These costs generally include external direct costs of materials and services
consumed in the project, and internal costs such as payroll and benefits of
those employees directly associated with the development of the software. During
1999, the Company did not capitalize any internal costs as such costs qualifying
for capitalization have been insignificant. External direct costs of purchased
internal use software have been capitalized and included in fixed assets.
(J) INCOME TAXES
The Company uses the asset and liability method of accounting for income
taxes. Deferred tax assets and liabilities are recognized for the estimated
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in tax rates is recognized in
the statement of operations in the period that includes the enactment date. A
valuation allowance is recorded to reduce deferred tax assets to an amount whose
realization is more likely than not.
(K) STOCK-BASED COMPENSATION
The Company accounts for its stock-based compensation arrangements with
employees using the intrinsic-value method. Deferred stock-based compensation is
recorded on the date of grant when the deemed fair
65
<PAGE>
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
value of the underlying common stock exceeds the exercise price for stock
options or the purchase price for the shares of common stock. Nonemployee
options are accounted for under Statement of Financial Accounting Standards
(SFAS) No. 123.
Deferred stock-based compensation resulting from employee and nonemployee
option grants is amortized on an accelerated basis over the vesting period of
the individual options, generally four years, in accordance with Financial
Accounting Standards Board Interpretation No. 28.
(L) COMPREHENSIVE LOSS
Other comprehensive loss recorded by the Company for the years ended
December 31, 1999 and 1998 was attributable to foreign currency translation
adjustments for the Company's U.K. subsidiary and unrealized gain from
investments. Tax effects and reclassification adjustments of comprehensive loss
are not material.
(M) NET LOSS PER SHARE
Basic net loss per share is computed using the weighted-average number of
outstanding shares of common stock, excluding common stock subject to
repurchase. Diluted net loss per share is computed using the weighted-average
number of outstanding shares of common stock and, when dilutive, potential
common shares from options and warrants to purchase common stock and common
stock subject to repurchase using the treasury stock method, and from
convertible securities using the as-if converted basis. All potential common
shares have been excluded from the computation of diluted net loss per share for
all periods presented because the effect would have been antidilutive.
Diluted net loss per share does not include the effect of the following
antidilutive common equivalent shares:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------
1999 1998 1997
------------ ------------- ------------
<S> <C> <C> <C>
Stock options and warrants........................................... 3,771,116 824,630 3,576,632
Common stock subject to repurchase................................... 9,101,206 8,926,146 5,189,824
Convertible preferred stock (as if converted basis).................. -- 25,025,282 17,835,710
------------ ------------- ------------
12,872,322 34,776,058 26,602,166
============ ============= ============
</TABLE>
(N) SEGMENT REPORTING
The Company is organized in a single operating segment for purposes of
making operating decisions and assessing performance. The chief executive
officer, the chief operating decision maker, evaluates performance, makes
operating decisions, and allocates resources based on financial data consistent
with the presentation in the accompanying consolidated financial statements.
The Company's revenues derived from sources outside of the United States,
primarily in the United Kingdom, for the year ended December 31, 1999 were
approximately $1,385,000. Prior to 1999, the Company's revenues have been earned
primarily from customers in the United States. In addition, all significant
operations and assets are based in the United States. No customer accounted for
more than 10% of revenues for the years ended December 31, 1999, 1998 and 1997.
(O) RECENT ACCOUNTING PRONOUNCEMENTS
In December 1998, the American Institute of Certified Public Accountants
issued 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 will be effective beginning January
1, 2000. The Company believes the adoption of SOP 98-9 will not have a material
effect on its results of operations, financial position or cash flows.
66
<PAGE>
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
In June 1998, the FASB issued Statement of Financial Accounting Standard
(SFAS) No. 133, Accounting for Derivative and Hedging Activities. This standard
requires that an entity recognize all derivatives as either assets or
liabilities in the balance sheet and measures those instruments at fair value.
The type and use of the derivative, and whether it qualifies for hedge
accounting, will determine the treatment of gains or losses resulting from
changes in the derivative. The Company believes the adoption of SFAS No. 133
will not have a material effect on its results of operations, financial
position, or cash flows. The statement will be effective for the Company
beginning January 1, 2001.
2. BUSINESS COMBINATIONS
On August 13, 1999, the Company issued 6,982,542 shares of its common stock
to the shareholders of Connectify in exchange for all of the outstanding capital
stock of Connectify. Prior to the consummation of the merger, 5,095,819 shares
of the outstanding Kana perferred stock were converted to 10,191,638 shares of
Kana common stock. As a result of the conversion, the Company created a
controlling class of common stock.
On December 3, 1999, in connection with the acquisition of Business
Evolution, Inc. ("BEI"), 1,935,206 shares of Kana common stock were issued or
reserved for issuance for all outstanding shares, warrants and options of BEI.
Pursuant to the terms of the merger, BEI's convertible preferred stock with a
book value of $4,976,000 converted into 474,332 shares of Kana common stock. On
the same date, in connection with the acquisition of netDialog, Inc.
("netDialog"), 1,244,062 shares of Kana common stock were issued or reserved for
issuance for all outstanding shares, warrants, convertible notes and options of
netDialog. Pursuant to the terms of the merger, netDialog's redeemable preferred
stock with a book value of $4,995,000 and convertible debt with a book value of
$4,800,000 converted into 773,942 shares of Kana's common stock at the closing
of the merger.
The mergers have been accounted for as poolings of interests, and,
accordingly, the Company's consolidated financial statements have been restated
for all periods prior to the merger to include the results of operations,
financial position, and cash flows of the acquired companies. No significant
adjustments were required to conform the accounting policies of the Company and
the acquired companies.
In connection with the merger with Connectify, Kana recorded a charge for
merger integration costs of $1.2 million consisting primarily of transaction
fees for attorneys and accountants of approximately $390,000 and employee
severance benefits and facility related costs of $780,000. As of December 31,
1999, Kana had $30,000 remaining in accrued acquisition related costs, which
Kana expects to pay by the first quarter of fiscal 2000.
In connection with the mergers with BEI and netDialog, the Company recorded
a nonrecurring charge for merger integration costs of $4.5 million, consisting
primarily of transaction fees for attorneys and accountants of approximately
$1.5 million, merger-related advertising and announcements of $1.7 million
incurred by December 31, 1999, charges for the elimination of duplicate
facilities of approximately $840,000 and severance costs and certain other
related costs of approximately $433,000. As of December 31, 1999, Kana had
$3,118,000 remaining in accrued acquisition related costs, which Kana expects to
pay during fiscal 2000.
Certain results of operations data for the separate companies and the
combined amounts presented in the consolidated financial statements were as
follows (in thousands):
NINE MONTHS YEARS ENDED
ENDED DECEMBER 31,
SEPTEMBER 30, -----------------
1999 1998 1997
------------- -------- -------
(UNAUDITED)
Revenues:
Kana.................................... $ 7,174 $ 2,049 $ --
Connectify(1)........................... -- -- --
BEI..................................... 361 298 617
netDialog............................... 72 -- --
------------- -------- -------
$ 7,607 $ 2,347 $ 617
============= ======== =======
67
<PAGE>
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
NINE MONTHS
ENDED YEARS ENDED
SEPTEMBER 30, DECEMBER 31,
------------- ---------------------
1999 1998 1997
------------- ---------- ---------
(UNAUDITED)
Net Loss:.........................
Kana......................... $(16,828) $(6,337) $ (1,384)
Connectify(1)................ (2,627) (1,041) --
BEI.......................... (2,404) (1,360) 93
netDialog.................... (6,288) (3,863) (262)
------------- ---------- ---------
$(28,147) $(12,601) $ (1,553)
============= ========== =========
--------------
(1) Connectify figures included in the nine months ended 1999 are stated for
the six months ended June 30, 1999.
3. FINANCIAL STATEMENTS DETAIL
Cash equivalents consist of the following as of December 31, 1999 (in
thousands):
<TABLE>
UNREALIZED UNREALIZED FAIR
COST LOSS GAIN VALUE
---------- ----------- ----------- ----------
<S> <C> <C> <C> <C>
Money market funds.................... $ 3,553 $ -- $ -- $ 3,553
Municipal securities.................. 4,014 -- -- 4,014
Commercial paper...................... 7,949 -- -- 7,949
Certificates of deposit............... 283 -- -- 283
---------- ----------- ----------- ----------
$ 15,799 $ -- $ -- $ 15,799
========== =========== =========== ==========
</TABLE>
Short-term investments consist of the following as of December 31, 1999 (in
thousands):
<TABLE>
COST UNREALIZED UNREALIZED FAIR
LOSS GAIN VALUE
---------- ---------- ----------- -----------
<S> <C> <C> <C> <C>
Municipal securities................. $ 18,450 $ -- $ -- $ 18,450
Commercial paper..................... 9,286 -- 23 9,307
Corporate bonds...................... 5,115 -- 3 5,118
Certificates of deposit.............. 1,647 -- -- 1,647
---------- ---------- ----------- -----------
$ 34,496 $ -- $ 26 $ 34,522
========== ========== =========== ===========
</TABLE>
As of December 31, 1998, short-term investments consisted of certificates of
deposit.
Property and equipment, net consisted of the following (in thousands):
DECEMBER 31,
-------------------
1999 1998
-------- ---------
Computer equipment................................. $ 6,688 $ 1,352
Furniture and fixtures............................. 1,972 259
Leasehold improvements............................. 1,531 241
-------- ---------
10,191 1,852
Less accumulated depreciation and amortization..... 1,831 379
-------- ---------
$ 8,360 $ 1,473
======== =========
68
<PAGE>
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
Other income (expense), net consisted of the following (in thousands):
<TABLE>
YEAR ENDED
DECEMBER 31,
------------------------
1999 1998 1997
-------- ------- ------
<S> <C> <C> <C>
Interest income........................................................... $ 1,419 $ 324 $ 59
Interest expense.......................................................... (520) (53) (2)
Interest expense from warrants issued in connection with bridge loans..... (1,559) (35) --
Other..................................................................... (84) (9) --
-------- ------- ------
$ (744) $ 227 $ 57
======== ======= ======
</TABLE>
4. NOTES PAYABLE
The Company maintained a line of credit providing for borrowings of up to
$3,000,000 and $2,000,000 as of December 31, 1999 and 1998, respectively, to be
used for qualified equipment purchases or working capital needs. Borrowings
under the line of credit are collateralized by all of the Company's assets and
bear interest at the bank's prime rate (8.50% and 7.75% as of December 31, 1999
and 1998, respectively). Total borrowings as of December 31, 1999 and 1998 were
$1,187,000 and $720,000, respectively. The line of credit expires on March 2,
2000.
As of December 31, 1998, the Company had two commercial loans totalling
$1,077,000. These were paid as of December 31, 1999.
On May 18, 1999, the Company entered into two term loan obligations
totaling $685,000. The loans bear interest at a fixed rate of approximately
14.5% and mature in June 2002. The aggregate principal payments due under these
obligations are as follows (in thousands):
YEAR ENDING DECEMBER 31,
-------------------------
2000................................... $ 237
2001................................... 263
2002................................... 149
-------
$ 649
=======
On October 22, 1999, the Company issued subordinated promissory notes in
the aggregate principal amount of $2,800,000 to entities affiliated with Bay
Partners, BankAmerica Ventures and 5S Ventures LLC. Such notes bear interest at
an annual rate of 10%. This debt was paid in January 2000.
5. STOCKHOLDERS' EQUITY
(a) REINCORPORATION
In September 1999, Kana reincorporated into the State of Delaware, effected
a two for three reverse stock split of Kana's common stock and preferred stock
and increased Kana's authorized common stock to 100,000,000 shares. Kana's
common stock has a par value equal to $0.001 per share. The accompanying
financial statements have been retroactively restated to reflect the effect of
this reincorporation and reverse stock split.
(b) INITIAL PUBLIC OFFERING
On September 21, 1999, Kana consummated its initial public offering in
which it sold 7,590,000 shares of common stock, including 990,000 shares in
connection with the exercise of the underwriters' over-allotment option, at
$7.50 per share. Kana received approximately $51.0 million in cash, net of
underwriting discounts, commissions and other offering costs. The net proceeds
were predominately held in short-term municipal securities and commercial paper
at December 31, 1999.
69
<PAGE>
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
(C) CONVERTIBLE PREFERRED STOCK
Since inception Kana issued 13,351,107 shares of convertible preferred
stock. During 1999, at the time of the Connectify merger, 11,581,379 shares were
converted to common stock and, 1,769,728 shares were converted to common stock
at the initial public offering at a ratio of 1 share of preferred stock for 2
shares of common stock.
(D) COMMON STOCK
The Company has issued to founders 10,994,398 shares of common stock, which
are subject to repurchase on termination of employment. Such repurchase rights
lapse in a series of equal monthly installments over a four year period ending
in June 2000 and May 2002. As of December 31, 1999, 2,401,412 shares were
subject to repurchase. During 1997, the Company repurchased a net of 833,332
shares from one founder at the original exercise price of $0.00005 per share.
Certain option holders have exercised options to purchase shares of
restricted common stock in exchange for five-year full recourse promissory
notes. The notes bear interest at 5.7% and expire on various dates through 2004.
The Company has the right to repurchase all unvested shares purchased by the
notes at the original exercise price in the event of employee termination. The
number of shares subject to this repurchase right decreases as the shares vest
under the original option terms, generally over four years. As of December 31,
1999, there were 6,699,794 shares subject to repurchase. These options were
exercised at prices ranging from $0.02 to $4.50 with a weighted-average exercise
price of $3.29 per share.
(E) STOCK COMPENSATION PLANS
The Company's 1997 Stock Option/Stock Issuance Plan (the 1997 Plan)
provides for stock options to be granted to employees, independent contractors,
officers, and directors. Options are generally granted at an exercise price
equivalent to the estimated fair market value per share at the date of grant, as
determined by the Company's Board of Directors. All options are granted at the
discretion of the Company's Board of Directors and have a term not greater than
10 years from the date of grant. Options are immediately exercisable and
generally vest over four years, 25% one year after the grant date and the
remainder at a rate of 1/36 per month thereafter. Connectify's 1998 Stock Plan,
netDialog's 1997 Stock Plan and BEI's 1999 Stock Plan have similar terms as
those of the 1997 Plan. Outstanding options under all these plans were assumed
in the merger.
On July 7, 1999, the Company's Board of Directors approved the 1999 Stock
Incentive Plan (the 1999 Plan), which will serve as the successor plan to the
1997 Plan. The Board of Directors also approved a 1999 Employee Stock Purchase
Plan (the 1999 ESPP). These plans became effective immediately prior to the IPO.
The common stock reserved for future issuances under these plans was 18% of the
shares of common stock outstanding immediately after the IPO. Additionally, the
share reserve in each plan will automatically increase on the first trading day
in January each year, beginning with calendar year 2000, in an amount equal to
the lesser of (i) the number of shares initially reserved for such increase in
each respective plan, (ii) 4.25% and 0.75% of the then outstanding shares for
the 1999 Plan and the 1999 ESPP, respectively, or (iii) an amount determined by
the Board of Directors.
The 1999 ESPP allows eligible employees to purchase common stock through
payroll deductions of up to 15% of an employee's compensation. The 1999 ESPP
currently has a two-year offering period that ends in October 2001. The purchase
price of the common stock will be equal to 85% of the fair market value per
share on the participant's entry date into the offering period, or, if lower,
85% of fair market value per share on each semi-annual purchase date. The 1999
ESPP qualifies as an employee stock purchase plan under Section 423 of the
Internal Revenue Code of 1986, as amended. No shares have been issued from the
1999 ESPP as of December 31, 1999.
In December 1999, the board of directors approved the 1999 Special Stock
Option Plan and 1,000,000 shares of common stock were reserved for issuance
under this plan. The Special Stock Option Plan has similar terms as those of the
1997 plan, except that options may be granted with an exercise price less than,
equal to, or greater than the fair market value of the option shares on the
grant date.
70
<PAGE>
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
A summary of stock option activity follows:
<TABLE>
<CAPTION>
WEIGHTED
SHARES AVERAGE
AVAILABLE NUMBER EXERCISE
FOR GRANT OF SHARES PRICE
------------- ------------- ----------
<S> <C> <C> <C>
Balances, December 31, 1996............................................. -- -- $ --
Additional shares authorized....................................... 7,434,222 -- --
Options granted.................................................... (3,503,810) 3,503,810 0.03
Options exercised.................................................. -- (106,666) 0.01
Options canceled................................................... -- -- --
------------- -------------
Balances, December 31, 1997............................................. 3,930,412 3,397,144 0.03
Additional shares authorized....................................... 3,825,842 -- --
Options granted.................................................... (3,004,420) 3,004,420 0.13
Options exercised.................................................. -- (5,394,478) 0.04
Options canceled................................................... 230,770 (230,770) 0.12
------------- -------------
Balances, December 31, 1998............................................. 4,982,604 776,316 0.19
Additional shares authorized....................................... 11,976,310 -- --
Options granted.................................................... (9,394,740) 9,394,740 6.24
Options exercised.................................................. -- (6,096,242) 1.01
Options canceled................................................... 303,698 (303,698) 14.88
------------- -------------
Balances, December 31, 1999............................................. 7,867,872 3,771,116 12.71
============= =============
</TABLE>
The following table summarizes information about fixed stock options
outstanding at December 31, 1999:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------- ------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
NUMBER OF CONTRACTUAL EXERCISE NUMBER OF EXERCISE
SHARES LIFE PPRICE SHARES PRICE
----------- ----------- --------- ------------- ---------
<S> <C> <C> <C> <C> <C>
$0.02............................................. 33,332 7.3 $ 0.02 33,332 $ 0.02
$0.03--$0.18...................................... 104,796 9.2 $ 0.17 104,796 $ 0.17
$0.26--$0.34...................................... 10,666 9.3 $ 0.34 10,666 $ 0.34
$1.81--$2.25...................................... 590,048 9.6 $ 2.16 486,058 $ 2.23
$3.38--$4.50...................................... 491,598 9.6 $ 4.45 491,598 $ 4.45
$7.50............................................. 1,346,730 9.7 $ 7.50 60,000 $ 7.50
$15.00............................................ 738,264 10.0 $ 15.00 -- --
$31.63--$40.57.................................... 304,400 9.8 $ 39.62 -- --
$73.50--$85.24.................................... 151,282 9.9 $ 73.64 -- --
----------- -------------
$0.02--$85.24..................................... 3,771,116 9.1 $ 12.71 1,186,450 $ 3.15
=========== =============
</TABLE>
The Company uses the intrinsic-value method in accounting for its stock-
based compensation plans. Accordingly, compensation cost has been recognized in
the financial statements for those options issued with exercise prices at less
than fair value at date of grant. With respect to the stock options granted from
inception through December 31, 1999, the Company recorded deferred stock-based
compensation of $97.0 million for the difference at the grant date between the
exercise price and the fair value of the common stock underlying the options.
Subsequent to the consummation of the BEI and netDialog acquisitions, the
Company granted 698,264 under the 1999 Special Stock Option Plan options to
certain employees hired from the acquired companies for an exercise price below
the fair market value of the common stock. These options were immediately vested
on the date of grant and 50% of the options can be exercised 15 months after the
grant date and the remaining 50% of the options can be exercised 30 months after
the grant date, provided the individual remains an employee of the Company. If
the employee is terminated prior to these dates, the options can be exercised
after 9.5 years. The difference between the
71
<PAGE>
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
fair market value of the underlying common stock and the exercise price of the
options was recorded as compensation expense in the fourth quarter of 1999 in
the amount of approximately $60,372,000.
Pursuant to SFAS No. 123, the Company is required to disclose the pro forma
effects on net loss and net loss per share data as if the Company had elected to
use the fair value approach to account for its employee stock-based compensation
plans. Had compensation costs been determined in accordance with SFAS No. 123
for all of the Company's stock-based compensation plans, net loss and basic and
diluted net loss per share would not have been materially impacted for the years
ended December 31, 1997 and 1998. Had compensation cost for the Company's plans
been determined consistent with the fair value approach enumerated in SFAS No.
123, the Company's net loss and net loss per share for the year ended December
31, 1999 would have been as indicated below (in thousands):
YEAR ENDED
DECEMBER 31,
1999
-------------
Net loss:
As reported........................................ $ (118,743)
Pro forma.......................................... $ (124,603)
Basic and diluted net loss per share:
As reported........................................ $ (4.61)
Pro forma.......................................... $ (4.83)
The fair value of the Company's stock-based awards was estimated assuming
no expected dividends and the following weighted average assumptions:
<TABLE>
<CAPTION>
OPTIONS ESPP
----------------------------- ------------------------------
INTEREST INTEREST
RATE TERM VOLATILITY RATE TERM VOLATILITY
--------- ------ ---------- --------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
1999--Post IPO............................ 5.45% 3 yrs 100% 5.14% 6 mths 100%
1999--Pre IPO............................. 5.30% 3 -- -- -- --
1998..................................... 5.15% 3 -- -- -- --
1997..................................... 6.22% 3 -- -- -- --
</TABLE>
The weighted average fair value of the employee stock purchase rights
granted under the 1999 ESPP during 1999 was $6.55. The weighted average fair
value and exercise price of the options granted in 1997, 1998, and 1999 are as
follows:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE WEIGHTED AVERAGE
EXERCISE PRICE FAIR VALUE
------------------------- -------------------------
1999 1998 1997 1999 1998 1997
-------- ------- ------- -------- ------ -------
<S> <C> <C> <C> <C> <C> <C>
Exercise price equals fair value on grant date............ $ 24.67 $ -- $ -- $ 15.94 $ -- $ --
Exercise price exceeds fair value on grant date........... 2.71 $ 0.13 $ 0.03 12.83 0.13 0.03
Total options............................................. $ 6.24 $ 0.13 $ 0.03 $ 13.39 $0.13 $ 0.03
======== ======= ======= ======== ====== =======
</TABLE>
(F) WARRANTS
In connection with the Series A preferred stock issuance, the Company
issued a warrant to two investors to purchase 89,744 shares of Series A
preferred stock with an exercise price of $0.20 per share. The warrants were
exercisable any time prior to April 7, 1998. The fair value of the warrants
computed using the Black-Scholes option pricing model on the date of grant was
not material. In lieu of paying cash upon exercise of the warrants in 1998, the
warrant holders surrendered 43,209 shares of Series A preferred stock back to
the Company.
In connection with the issuance of convertible notes payable of $300,000,
Connectify issued warrants to purchase 48,314 shares of common stock for $1.25
per share in August 1998. Such warrants were exercised at the time of the
initial public offering. Using the Black-Scholes pricing model, the Company
determined that the fair value of the warrants was $35,000 at the date of grant.
Accordingly, following the conversion of the convertible notes payable in 1998,
the Company recorded $35,000 of interest expense associated with the warrants.
72
<PAGE>
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
In connection with its convertible debt offerings, netDialog issued
warrants to purchase preferred stock. The warrants were initially exercisable
into an amount of preferred stock equal to 10% of the value of the convertible
debt outstanding. As long as the convertible debt remained outstanding, the
amount of preferred stock into which the warrants could be exercised increased
in tranches of 3.33% of the value of the debt every two or three months
following the initial grant date up to a maximum of an additional 10% of the
debt value.
The fair value of each tranche of warrants was measured at each date the
exercise terms of the warrants changed. The fair value of the warrants was
treated as a discount on the convertible debt and recorded as interest expense.
In connection with the acquisition of netDialog, all warrants issued under the
arrangement were converted into approximately 74,000 shares of Kana common stock
at an exercise price of $12.13 per share, of which, approximately 10,000 shares
of Kana common stock were surrendered back to the Company in lieu of paying
cash. The full value of the warrants of approximately $1.6 million was expensed
during the year ended December 31, 1999.
6. COMMITMENTS AND CONTINGENCIES
(A) LEASE OBLIGATIONS
On June 18, 1999, the Company entered into a lease agreement for a new
facility. Payments under this lease began in November 1999. The Company leases
its facilities under noncancelable operating leases with various expiration
dates through October 2006. In connection with its existing leases, the Company
entered into three letters for credit totalling $1,645,000, expiring in 2000 and
2001. The letters of credit are secured by certificates of deposit.
Future minimum lease payments under noncancelable operating leases as of
December 31, 1999, were as follows (in thousands):
<TABLE>
<CAPTION>
OPERATING
YEAR ENDING DECEMBER 31, LEASES
------------------------- ----------
<S> <C>
2000........................................................................................... $ 2,587
2001........................................................................................... 2,487
2002........................................................................................... 2,554
2003........................................................................................... 2,196
2004........................................................................................... 2,189
Thereafter..................................................................................... 4,599
----------
$ 16,612
==========
</TABLE>
Rent expense, net of sublease payments, was approximately $1,620,000,
$604,000 and $85,000 for the years ended December 31, 1999, 1998 and 1997,
respectively. Sublease payments were approximately $212,000, $140,000 and -0- in
the years ended December 31, 1999, 1998 and 1997, respectively. The Company's
sublease and the underlying lease arrangements expired in December 1999.
(B) LITIGATION
On October 8, 1999, Genesys Telecommunications Laboratories, Inc. (Genesys)
filed a complaint against Kana in the United States District Court for the
District of Delaware. Genesys alleges that Kana's Customer Messaging System 3.0
infringes upon 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-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.
73
<PAGE>
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
7. INCOME TAXES
The 1999, 1998 and 1997 income tax benefit differed from the amounts
computed by applying the U.S. federal income tax rate of 34% to pretax loss as a
result of the following (in thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------
1999 1998 1997
----------- --------- --------
<S> <C> <C> <C>
Federal tax benefit at statutory rate.......................................... $ (40,372) $ (4,284) $ (528)
Stock compensation expense..................................................... 27,222 432 --
Merger costs................................................................... 726 -- --
Current year foreign losses, no tax benefit recognized......................... 486 -- --
Current year net operating losses and temporary differences, no tax benefit
recognized.................................................................. 11,896 3,172 478
S corporation income, no tax effect............................................ -- 123 12
Other permanent differences.................................................... 42 557 38
----------- --------- --------
Total tax expense........................................................... $ -- $ -- $ --
=========== ========= ========
</TABLE>
The types of temporary differences that give rise to significant portions
of the Company's deferred tax assets and liabilities are set out below (in
thousands):
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
--------------------
1999 1998
--------- ---------
<S> <C> <C>
Deferred tax assets:
Accruals and reserves................................................................ $ 2,489 $ 1,065
Plant and equipment.................................................................. -- 2
Net operating loss and credit carryforwards.......................................... 18,020 4,409
---------
Gross deferred tax assets................................................................. 20,509 5,476
Valuation allowance....................................................................... (20,469) (5,459)
--------- ---------
Total deferred tax assets.......................................................... 40 17
Deferred tax liabilities:
Plant and equipment.................................................................. (40) (17)
--------- ---------
Total deferred tax liabilities..................................................... (40) (17)
--------- ---------
Net deferred tax assets (liabilities).............................................. $ -- $ --
========= =========
</TABLE>
The net change in the valuation allowance for the year ended December 31,
1999 was an increase of approximately $15,010,000. Management believes that
sufficient uncertainty exists as to whether the deferred tax assets will be
realized, and accordingly, a valuation allowance is required.
As of December 31, 1999, the Company had net operating loss carryforwards
for federal and state income tax purposes of approximately $43,969,000 and
$34,621,000, respectively. The federal net operating loss carryforwards, if not
offset against future taxable income, will expire from 2011 through 2019. The
state net operating loss carryforwards, if not offset against future taxable
income, expire from 2003 through 2004.
As of December 31, 1999, unused research and development tax credits of
approximately $623,000 and $425,000 were available to reduce future federal and
state income taxes, respectively. Federal credit carryforwards expire from 2011
through 2019. The Company also has an unused California manufacturers'
investment credit of approximately $15,000. The California manufacturers'
investment credit, if not utilized, will expire in 2008.
The Tax Reform Act of 1986 imposes substantial restrictions on the
utilization of net operating losses and tax credits in the event of an
"ownership change" as defined. Some of the U.S. federal and California net
operating loss carryforwards are subject to limitation as a result of these
restrictions. The ownership change restrictions are not expected to impair the
Company's ability to utilize the affected carryforward items. If there should be
a subsequent ownership change, as defined, of the Company, its ability to
utilize its carryforwards could be reduced.
74
<PAGE>
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1999, 1998 AND 1997
8. SUBSEQUENT EVENTS
On January 10, 2000, the Company announced that its Board of Directors has
approved a two-for-one stock split of its common stock. The split will be
effected in the form of a stock dividend. Stockholders will receive 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.
On February 6, 2000, the Company, Pistol Acquisition Corp., a wholly-owned,
subsidiary of Kana, and Silknet Software, Inc. ("Silknet") entered into an
Agreement and Plan of Reorganization. As a result of the merger, each
outstanding share of Silknet common stock will be 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 will be assumed by Kana, adjusted
for the exchange ratio. On a fully diluted basis, Kana will issue (or reserve)
approximately 32.8 million shares of its common stock having a value of
approximately $4.2 billion based on Kana's closing stock price on February 4,
2000. The transaction will be accounted for as a purchase.
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.
75
<PAGE>
INDEPENDENT AUDITORS REPORT ON SCHEDULE
The Board of Directors and Stockholders
Kana Communications, Inc.:
The audits referred to in our report included herein dated January 20, 2000,
except as to Note 8, which is as of February 11, 2000, included the accompanying
financial statement schedule as of December 31, 1999, and for each of the years
in the three-year period ended December 31, 1999. The financial statement
schedule is the responsibility of the Company's management. Our responsibility
is to express an opinion on the financial statement schedule based on our
audits. In our opinion, the accompanying financial statement schedule, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
/s/ KPMG LLP
-------------------------------
Mountain View, California
January 20, 2000
76
<PAGE>
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
KANA COMMUNICATIONS, INC.
<TABLE>
<CAPTION>
BALANCE AT CHARGED BALANCE AT
BEGINNING TO END OF
OF PERIOD REVENUES DEDUCTIONS YEAR
----------- --------- ----------- ----------
<S> <C> <C> <C> <C>
Allowance for Doubtful Accounts:
Year ended December 31, 1999.............................. $ 110 $ 156 $ -- $ 366
Year ended December 31, 1998.............................. -- 110 -- 110
Year ended December 31, 1997.............................. -- -- -- --
</TABLE>
77
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of Redwood
City, State of California, on this 28th day of August, 2000.
Kana Communications, Inc.
By: /S/ MICHAEL J. MCCLOSKEY
-----------------------------
Michael J. McCloskey
CHIEF EXECUTIVE OFFICER
Pursuant to the requirements of the Securities Exchange Act of 1934, this
annual report has been signed below by the following persons in the capacities
and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/S/ MICHAEL J. MCCLOSKEY Chief Executive Officer and August 28, 2000
-------------------------------------------- Chairman of the Board of Directors
Michael J. McCloskey (Principal Executive Officer)
/S/ JAMES C. WOOD President and Director August 28, 2000
--------------------------------------------
James C. Wood
/S/ BRIAN K. ALLEN Chief Financial Officer August 28, 2000
-------------------------------------------- (Principal Financial and Accounting
Brian K. Allen Officer)
* Director August 28, 2000
--------------------------------------------
David M. Beirne
* Director August 28, 2000
--------------------------------------------
Robert W. Frick
* Director August 28, 2000
--------------------------------------------
Mark S. Gainey
* Director August 28, 2000
--------------------------------------------
Eric A. Hahn
* Director August 28, 2000
--------------------------------------------
Dr. Charles A. Holloway
* Director August 28, 2000
--------------------------------------------
Steven T. Jurvetson
</TABLE>
* By Michael J. McCloskey as Attorney in Fact
78
