<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarter Ended June 30, 2000
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
---------- ----------
Commission File number 000-26287
Kana Communications, Inc.
(Exact Name of Registrant as Specified in Its Charter)
Delaware 77-0435679
--------- ----------
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
740 Bay Road
Redwood City, California 94063
-------------------------------------------
(Address of Principal Executive Offices)
Registrant's Telephone Number, Including Area Code: (650) 298-9282
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
On July 31, 2000, approximately 93,228,000 shares of the Registrant's Common
Stock, $0.001 par value, were outstanding.
<PAGE>
Kana Communications, Inc.
Form 10-Q
Quarter Ended June 30, 2000
Index
<TABLE>
<S><C>
Part I: Financial Information
Item 1: Financial Statements
Unaudited Condensed Consolidated Balance Sheets at June 30, 2000 3
and December 31, 1999
Unaudited Condensed Consolidated Statement of Operations for the 4
Three months and Six months ended June 30, 2000 and 1999
Unaudited Condensed Consolidated Statements of Cash Flows for the 5
Six months ended June 30, 2000 and 1999
Notes to the Unaudited Condensed Consolidated Financial Statements 6
Item 2: Management's Discussion and Analysis of Financial Condition and 10
Results of Operations
Item 3: Quantitative and Qualitative Disclosures About Market Risk 30
Part II: Other Information
Item 1. Legal Proceedings 31
Item 2. Changes in Securities and Use of Proceeds 31
Item 4. Submission of Matters to a Vote of Security Holders 32
Item 6. Exhibits and Reports on Form 8-K 32
</TABLE>
Signatures
Exhibit Index
2
<PAGE>
PART I: FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
KANA COMMUNICATIONS, INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
---- ----
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 159,760 $ 18,695
Short-term investments 3,082 34,522
Accounts receivable, net 31,719 4,655
Prepaid expenses and other current assets 5,202 2,036
---------- ----------
Total current assets 199,763 59,908
Property and equipment, net 22,249 8,360
Goodwill and identifiable intangibles 3,510,792 -
Other assets 8,640 1,961
----------- ----------
Total assets $ 3,741,444 $ 70,229
=========== ==========
LIABILITIES AND STOCKHOLDERS'
EQUITY
Current liabilities:
Current portion of notes payable $ 1,462 $ 4,224
Accounts payable 5,243 2,766
Accrued payroll and related expenses 11,987 3,623
Accrued liabilities 11,883 1,303
Accrued acquisition related costs 30,868 3,148
Deferred revenue 21,908 6,253
----------- ----------
Total current liabilities 83,351 21,317
Notes payable, less current portion 262 412
----------- ----------
Total liabilities 83,613 21,729
----------- ----------
Stockholders' equity:
Common stock 93 61
Additional paid-in capital 4,109,094 202,473
Deferred stock-based compensation (13,000) (14,962)
Notes receivable from stockholders (5,974) (6,380)
Accumulated other comprehensive losses (376) (75)
Accumulated deficit (432,006) (132,617)
----------- ----------
Total Stockholders' Equity 3,657,831 48,500
----------- ----------
Total liabilities and stockholders' equity $ 3,741,444 $ 70,229
=========== ==========
</TABLE>
See accompanying notes to unaudited condensed consolidated
financial statements.
3
<PAGE>
KANA COMMUNICATIONS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(In thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
JUNE 30, JUNE 30,
-------- --------
2000 1999 2000 1999
----------- ----------- ----------- ----------
<S> <C> <C> <C> <C>
Revenue:
License $ 15,574 $ 1,821 $ 22,903 $ 3,030
Service 9,909 517 13,270 797
----------- ----------- ----------- ----------
Total revenue 25,483 2,338 36,173 3,827
----------- ----------- ----------- ----------
Cost of revenue:
License 658 38 801 72
Service (excluding stock-based
compensation of $875, $671, $1,690
and $799, respectively) 10,772 851 14,804 1,349
----------- ----------- ----------- ----------
Total cost of revenue 11,430 889 15,605 1,421
----------- ----------- ----------- ----------
Gross profit 14,053 1,449 20,568 2,406
----------- ----------- ----------- ----------
Operating expenses:
Sales and marketing (excluding stock-
based compensation of $1,522, $1,155,
$2,925 and $1,375, respectively) 21,338 4,180 32,548 6,659
Research and development (excluding
stock-based compensation of $880,
$675, $1,699 and $803, respectively) 11,059 2,732 16,298 5,061
General and administrative (excluding
stock-based compensation of $316,
$233, $599 and $277, respectively) 3,747 1,086 5,582 1,811
Amortization of goodwill and identifiable
intangibles 247,043 - 247,043 -
Amortization of deferred stock-based
compensation 3,593 2,734 6,913 3,254
In process research and development 6,900 - 6,900 -
Acquisition related costs 6,564 - 6,564 -
----------- ----------- ----------- ----------
Total operating expenses 300,244 10,732 321,848 16,785
----------- ----------- ----------- ----------
Operating loss (286,191) (9,283) (301,280) (14,379)
Other income & expense, net 1,247 (394) 1,891 (519)
----------- ----------- ----------- ----------
Net loss $ (284,944) $ (9,677) $ (299,389) $ (14,898)
============ ============== ============== ==========
Basic and diluted net loss per share $ (3.58) $ (1.55) $ (4.53) $ (2.51)
============ =========== =========== ===========
Shares used in computing basic and diluted
net loss per share 79,509 6,232 66,030 5,944
============ =========== =========== ===========
</TABLE>
See accompanying notes to unaudited condensed consolidated
financial statements.
4
<PAGE>
KANA COMMUNICATIONS, INC.
UNAUDITED CONDENSED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
2000 1999
------------------ -----------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (299,389) $ (14,898)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation 2,968 373
Noncash charges 260,856 3,793
Changes in operating assets and liabilities:
Accounts receivable (17,944) (801)
Prepaid and other current assets (7,136) (646)
Accounts payable and accrued liabilities 6,294 2,109
Deferred revenue 12,164 1,419
------------------ -----------------
Net cash used in operating activities (42,187) (8,651)
------------------ -----------------
Cash flows from investing activities:
Sales (purchases) of short-term investments 31,433 (2,091)
Property and equipment purchases (11,742) (1,344)
Cash acquired from acquisition 43,135 -
------------------ -----------------
Net cash provided by (used in) investing activities 62,826 (3,435)
------------------ -----------------
Cash flows from financing activities:
Payments on notes payable (3,034) (65)
Proceeds from notes payable and convertible notes
payable - 4,461
Proceeds from issuance of common stock and
warrants 123,355 310
Payments on stockholders' notes receivable 406 -
------------------ -----------------
Net cash provided by financing activities 120,727 4,706
------------------ -----------------
Effect of exchange rate changes on cash and cash
equivalents (301) (37)
------------------ ----------------
Net increase (decrease) in cash and cash equivalents 141,065 (7,417)
Cash and cash equivalents at beginning of period 18,695 13,875
------------------ ----------------
Cash and cash equivalents at end of period $ 159,760 $ 6,458
================== =================
Supplemental disclosure of cash flow information:
Cash paid during the year for interest $ 130 $ 27
================== =================
Issuance of common stock in exchange for notes
receivable from stockholders $ - 1,041
================== =================
</TABLE>
See accompanying notes to unaudited condensed consolidated
financial statements.
5
<PAGE>
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
The unaudited condensed consolidated financial statements have been
prepared by Kana Communications, Inc. ("Kana" or the "Company") and reflect all
adjustments (all of which are normal and recurring in nature) that, in the
opinion of management, are necessary for a fair presentation of the interim
financial information. The results of operations for the interim periods
presented are not necessarily indicative of the results to be expected for any
subsequent quarter or for the entire year ending December 31, 2000. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted under the Securities and Exchange Commission's ("SEC")
rules and regulations. These unaudited condensed consolidated financial
statements and notes included herein should be read in conjunction with Kana's
audited consolidated financial statements and notes included in Kana's annual
report on Form 10-K for the year ended December 31, 1999.
NOTE 2. NET LOSS PER SHARE
Basic net loss per share is computed using the weighted-average number of
outstanding shares of common stock, excluding common stock subject to
repurchase. Diluted net loss per share is computed using the weighted-average
number of outstanding shares of common stock and, when dilutive, potential
common shares from options and warrants to purchase common stock and common
stock subject to repurchase using the treasury stock method, and convertible
securities using the as-if converted basis. The following table presents the
calculation of basic and diluted net loss per share (in thousands), except per
share amounts.
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
JUNE 30, JUNE 30,
-------- --------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net loss $ (284,944) $ (9,677) $(299,389) $ (14,898)
=========== ========= ========= =========
Basic and diluted:
Weighted-average shares of common stock
outstanding 85,420 8,044 72,185 8,164
Less weighted-average shares subject to
repurchase 5,911 1,812 6,155 2,220
---------- --------- --------- ---------
Weighted-average shares used in computing basic
and diluted net loss per common share 79,509 6,232 66,030 5,944
---------- --------- --------- ---------
Basic and diluted net loss per common share $ (3.58) $ (1.55) $ (4.53) $ (2.51)
=========== ========= ========= =========
</TABLE>
All convertible preferred stock, warrants, outstanding stock options and
shares subject to repurchase by Kana have been excluded from the calculation of
diluted net loss per share because all such securities are anti-dilutive for all
periods presented. The total number of shares excluded from the calculation of
diluted loss per share are as follows (in thousands):
Six Months Ended
JUNE 30,
--------
2000 1999
---- ----
Stock options and warrants 14,623,607 421,156
Common stock subject to repurchase 5,644,931 8,418,674
Convertible preferred stock - 25,025,282
----------- ----------
20,268,538 33,868,112
=========== ==========
The weighted average exercise price of stock options outstanding was
$58.33 and $0.43 as of June 30, 2000 and 1999, respectively.
6
<PAGE>
NOTE 3. COMPREHENSIVE LOSS
The components of comprehensive loss for the three months and six months
ended June 30, 2000 and 1999 were as follows (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
JUNE 30, JUNE 30,
-------- --------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net loss $ (284,944) $ (9,677) $(299,389) $ (14,898)
Foreign currency translation adjustments (266) (18) (301) (37)
---------- --------- --------- ---------
$ (285,210) $ (9,695) $(299,690) $ (14,935)
=========== ========= ========= =========
</TABLE>
Tax effects of foreign currency translation adjustments are not material.
NOTE 4. STOCK-BASED COMPENSATION
Kana uses the intrinsic value method of accounting for its employee
stock-based compensation plans. Accordingly, compensation cost is recognized for
stock options when the exercise price of an option is less than the fair value
of the underlying common stock as of the grant date for each stock option. Kana
recorded approximately $1.5 million and $11.6 million of deferred stock-based
compensation for the three months ended June 30, 2000 and 1999, respectively,
and $5.0 million and $14.4 million for the six months ended June 30, 2000 and
1999, respectively. As of June 30, 2000, there was approximately $13.0 million
of deferred stock-based compensation remaining to be amortized. This amount is
being amortized in accordance with Financial Accounting Standards Board (FASB)
Interpretation No. 28 over the vesting period of the individual options,
generally 4 years.
NOTE 5. LEGAL PROCEEDINGS
On October 8, 1999, Genesys Telecommunications Laboratories, Inc.
("Genesys") filed a complaint against Kana in the United States District Court
for the District of Delaware. Genesys has amended its complaint to allege that
Kana's 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 documentation. Kana intends to defend itself
from this claim vigorously and does not expect it to materially impact our
results from operations. Kana is not currently a party to any other material
legal proceedings.
NOTE 6. SEGMENT INFORMATION
Kana's chief operating decision maker reviews financial information
presented on a consolidated basis, accompanied by disaggregated information
about revenues by geographic region for purposes of making operating decisions
and assessing financial performance. Accordingly, Kana considers itself to be in
a single industry segment, specifically the license, implementation and support
of its software applications. Kana's long-lived assets are primarily in the
United States. Geographic information on revenue for the three months and six
months ended June 30, 2000 and 1999 are as follows (in thousands):
Three Months Ended Six Months Ended
JUNE 30, JUNE 30,
------- --------
2000 1999 2000 1999
---- ---- ---- ----
United States $22,550 $2,031 $32,155 $3,483
International 2,933 307 4,018 344
--------- -------- --------- --------
$25,483 $2,338 $36,173 $3,827
========= ======== ========= ========
During the three months and six months ended June 30, 2000 and 1999, no
customer represented more than 10% of total revenues.
7
<PAGE>
NOTE 7. ACQUISITION OF SILKNET SOFTWARE, INC.
On April 19, 2000, the Company finalized the acquisition of Silknet
Software, Inc. ("Silknet"). In connection with the merger, each share of Silknet
common stock outstanding immediately prior to the consummation of the merger was
converted into the right to receive 1.66 shares of Kana common stock (the
"Exchange Ratio") and Kana assumed Silknet's outstanding stock options and
warrants based on the Exchange Ratio, issuing approximately 29.2 million shares
of Kana common stock and assuming options and warrants to acquire approximately
4.0 million shares of Kana common stock. The transaction is accounted for using
the purchase method of accounting.
The Company has accounted for the merger as a purchase. As a result, Kana
recorded on its balance sheet the fair market value of Silknet's assets and
liabilities, acquisition-related costs of $32.9 million, and goodwill and
identifiable intangibles of approximately $3.8 billion. Goodwill and intangible
assets acquired in connection with the merger will be amortized over a
three-year period, resulting in an approximate $1.3 billion charge per year. The
preliminary allocation of the purchase price to assets acquired and liabilities
assumed is presented in the table that follows (in thousands).
Tangible assets acquired.......................................... $ 60,074
Identifiable intangibles acquired:
In-process research and development............................... 6,900
Existing technology............................................... 14,400
In-place workforce................................................ 6,600
Goodwill.......................................................... 3,736,835
Liabilities assumed............................................... (13,562)
-----------
Net assets acquired............................................ $ 3,811,247
============
The estimated purchase price was approximately $3.8 billion, measured as
the average fair market value of Kana's outstanding common stock from January
31, to February 14, 2000, five trading days before and after the merger
agreement was announced plus the Black-Scholes calculated value of the options
and warrants of Silknet assumed by Kana in the merger, and other costs directly
related to the merger as follows (in thousands):
Fair market value of Kana's common stock............................$ 3,373,425
Fair market value of Silknet options and warrants assumed........... 404,922
Acquisition-related costs........................................... 32,900
------------
Total...............................................................$ 3,811,247
============
The following unaudited pro forma net revenues, net loss and net loss
per share data for the six months ended June 30, 2000 and 1999 are based on the
respective historical financial statements of the Company and Silknet. The pro
forma data reflects the consolidated results of operations as if the merger with
Silknet occurred at the beginning of each of the periods indicated and includes
the amortization of the resulting goodwill and other intangible assets. The pro
forma financial data presented are not necessarily indicative of the Company's
results of operations that might have occurred had the transaction been
completed at the beginning of the periods specified, and do not purport to
represent what the Company's consolidated results of operations might be for any
future period.
<TABLE>
<CAPTION>
(Unaudited Pro Forma)
Six Months Ended
JUNE 30,
2000 1999
---- ----
(In thousands, except per share data)
<S> <C> <C>
Net revenue $ 49,497 $ 12,309
Net loss $(682,179) $(647,733)
Basic and diluted net loss per share $ (8.21) $ (22.78)
Shares used in basic and diluted net loss per share
calculation 83,134 28,439
</TABLE>
8
<PAGE>
NOTE 8. PRIVATE PLACEMENT FUNDING
On June 12, 2000, the Company sold 2,500,000 shares of common stock
in a private placement at $50.00 per share for net proceeds of approximately
$120.0 million. The shares of common stock sold were registered under the
Securities Act of 1933, as amended, on a registration statement on Form S-1
(Reg. No. 333-40338) that was declared effective by the SEC on July 11, 2000.
NOTE 9. RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 133 "Accounting for Derivative Instruments and
Hedging Activities" ("SFAS 133"). SFAS 133 establishes accounting and reporting
standards for derivative instruments and for hedging activities. This statement
becomes effective for all fiscal quarters of fiscal years beginning after June
15, 1999. In June 1999, the FASB issued Statement of Financial Accounting
Standard No. 137 "Accounting for Derivative Instruments - Deferral of the Effect
Date of SFAS Statement No. 133" ("SFAS 137"). SFAS 137 defers the effective date
of SFAS 133 until June 15, 2000. Kana will adopt SFAS 133 in 2001. Kana expects
that the adoption of SFAS 133 will not affect results of operations.
In December 1998, the American Institute of Certified Public Accountants
issued Statement of Position (SOP) 98-9, Modification of SOP 97-2, Software
Revenue Recognition with Respect to Certain Transactions. SOP 98-9 amends SOP
97-2 to require the entity to recognize revenue for multiple element
arrangements by means of the "residual method" when: (1) there is
vendor-specific evidence of the fair values of all of the undelivered elements;
(2) vendor-specific evidence of fair value does not exist for one or more of the
delivered elements; and (3) the revenue recognition criteria of SOP 97-2 are
satisfied. SOP 98-9 became effective January 1, 2000. Kana adopted SOP 98-9 on
January 1, 2000 without any material effect on its results of operations,
financial position or cash flows.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements". SAB 101 provides guidance for revenue recognition under certain
circumstances. SAB 101 is effective in the quarter beginning October 1, 2000.
Kana does not believe SAB 101 will have a material impact on the financial
statements.
In March 2000, the Financial Accounting Standards Board ("FASB") issued
FASB Interpretation No. 44 "Accounting for Certain Transactions Involving Stock
Compensation - an interpretation of APB Opinion No. 25". This interpretation has
provisions that are effective on staggered dates, some of which began after
December 15, 1998 and others that become effective after June 30, 2000. The
adoption of this interpretation did not have a material impact on the Company's
historical financial statements.
9
<PAGE>
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
EXCEPT FOR HISTORICAL INFORMATION CONTAINED OR INCORPORATED BY REFERENCE IN THIS
SECTION, THE FOLLOWING DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS THAT
INVOLVE RISKS AND UNCERTAINTIES. KANA'S ACTUAL RESULTS COULD DIFFER
SIGNIFICANTLY FROM THOSE DISCUSSED HEREIN. FACTORS THAT COULD CAUSE OR
CONTRIBUTE TO THESE DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED
HEREIN WITH THIS QUARTERLY REPORT ON FORM 10-Q, THE COMPANY'S ANNUAL REPORT ON
FORM 10-K, AND THE COMPANY'S REGISTRATION STATEMENTS ON FORM S-4 AND FORM S-1
FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. ANY FORWARD-LOOKING
STATEMENTS SPEAK ONLY AS OF THE DATE SUCH STATEMENTS ARE MADE.
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.
10
<PAGE>
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
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 their relative fair values.
Our cost of license revenue includes royalties due to third parties for
technology integrated into some of our products, the cost of product
documentation, the cost of the media used to deliver our products and shipping
costs. Cost of service revenue consists primarily of personnel-related expenses,
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 unearned stock-based compensation totaling approximately $102.0 million
through June 30, 2000. This amount represents the total difference between the
exercise prices of stock options and the deemed fair market value of the
underlying common stock for accounting purposes on the date these stock options
were granted. This amount is included as a component of stockholders' equity and
is being amortized on an accelerated basis by charges to operations over the
vesting period of the options, consistent with the method described in Financial
Accounting Standards Board (FASB) Interpretation No. 28. We recorded
approximately $6.9 million of unearned stock-based compensation for the six
months ended June 30, 2000, approximately $93.2 million of unearned stock-based
compensation for the year ended December 31, 1999 and approximately $3.0 million
of unearned stock-based compensation for the year ended December 31, 1998. The
amortization of stock-based compensation is classified as a separate component
of operating expenses in our consolidated statements of operations.
11
<PAGE>
Since the beginning of 1997, we have incurred substantial costs to
develop our products and to recruit, train and compensate personnel for our
engineering, sales, marketing, client services and administration departments.
As a result, we have incurred substantial losses since inception and, for the
six months ended June 30, 2000, incurred a net loss of $299.4 million. As of
June 30, 2000, we had an accumulated deficit of $432.0 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 had 889 full-time employees as of June 30, 2000 and intend to hire a
significant number of employees in the future. This expansion places significant
demands on our management and operational resources. To manage this rapid
growth, we must invest in and implement scaleable operational systems,
procedures and controls. We expect future expansion to continue to challenge our
ability to hire, train, manage and retain employees.
We believe that our prospects must be considered in light of the risks,
expenses and difficulties frequently experienced by companies in early stages of
development, particularly companies in new and rapidly evolving markets like
ours. Although we have experienced significant revenue growth recently, this
trend may not continue. Furthermore, we may not achieve or maintain
profitability in the future.
RECENT DEVELOPMENTS
On April 19, 2000, we completed a merger with Silknet Software, Inc
under which Silknet became our wholly-owned subsidiary. Silknet provides
enterprise 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 the enterprise.
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.
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. The shares of common
stock sold in the private placement were registered under the Securities Act of
1933, as amended, on a registration statement on Form S-1 (Reg. No. 333-40338)
that was declared effective by the SEC on July 11, 2000.
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<PAGE>
RESULTS OF SELECTED OPERATIONS
The following table sets forth selected data for periods indicated
expressed as a percentage of total revenues.
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------ ----------- -----------------------
2000 1999 2000 1999
------------ ----------- -------- ---------
<S> <C> <C> <C> <C>
Revenues:
License............................................... 61.0% 78.0% 63.3% 79.2%
Service............................................... 39.0 22.0 36.7 20.8
----------- ----------- -------- ---------
Total revenues.................................... 100.0 100.0 100.0 100.0
----------- ----------- -------- ---------
Cost of revenues:
License............................................... 3.0 2.0 2.2 1.9
Service............................................... 42.0 36.0 40.9 35.2
----------- ----------- -------- ---------
Total cost of revenues............................ 45.0 38.0 43.1 37.1
----------- ----------- -------- ---------
Gross profit............................................... 55.0 62.0 56.9 62.9
Selected operating expenses:
Sales and marketing................................... 84.0 179.0 90.0 174.0
Research and development.............................. 43.0 117.0 45.0 132.2
General and administrative............................ 15.0% 46.0% 15.4% 47.4%
</TABLE>
THREE AND SIX MONTHS ENDED JUNE 30, 2000 AND 1999
REVENUES
Total revenues increased to $25.5 million for the three months ended June
30, 2000 from $2.3 million for the three months ended June 30, 1999. License
revenue increased to $15.6 million for the three months ended June 30, 2000 from
$1.8 million for the three months ended June 30, 1999. Total revenues increased
to $36.2 million for the six months ended June 30, 2000 from $3.8 million for
the six months ended June 30, 1999. License revenue increased to $22.9 million
for the six months ended June 30, 2000 from $3.0 million for the six months
ended June 30, 1999. The increase in license revenue was due primarily to
increased market acceptance of our products, expansion of our product line and
increased sales generated by our expanded sales force. Total sales personnel
increased to 219 people at June 30, 2000 from 39 people at June 30, 1999. Much
of this expansion and related increases is attributable to our acquisition of
Silknet and the inclusion of its revenues from the effective date of the merger.
License revenue represented 61% of total revenues for the three months
ended June 30, 2000 and 78% of total revenues for the three months ended June
30, 1999. License revenue represented 63% of total revenues for the six months
ended June 30, 2000 and 79% of total revenues for the six months ended June 30,
1999.
Service revenue increased to $9.9 million for the three months ended June
30, 2000 from $517,000 for the three months ended June 30, 1999. Service revenue
increased to $13.3 million for the six months ended June 30, 2000 from $797,000
for the six months ended June 30, 1999. This increase in service revenue was due
primarily to the increased licensing activity described above, resulting in
increased revenue from customer implementations, system integration projects,
maintenance contracts and hosted service. Much of this expansion and related
increases is attributable to our acquisition of Silknet from the effective date
of the merger.
Service revenue represented 39% of total revenues for the three months
ended June 30, 2000 and 22% of total revenues for the three months ended June
30, 1999. Service revenue represented 37% of total revenues for the six months
ended June 30, 2000 and 21% of total revenues for the six months ended June 30,
1999. Revenue from international sales for the six months ended June 30, 2000
was 11%, and 9% for the six months ended June 30, 1999.
COST OF REVENUES
Cost of license revenue includes third parties' software royalties,
product packaging, documentation and production. Cost of license revenue
increased to $658,000 for the three months ended June 30, 2000 from $38,000 for
the three months ended June 30, 1999. As a
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percentage of license revenue, cost of license revenue was 4% for the three
months ended June 30, 2000 and 2% for the three months ended June 30, 1999. Cost
of license revenue increased to $801,000 for the six months ended June 30, 2000
from $72,000 for the six months ended June 30, 1999. The absolute dollar
increase in the cost of license revenue was due principally to royalties. As a
percentage of license revenue, cost of license revenue was 3% for the six months
ended June 30, 2000 and 2% for the six months ended June 30, 1999. We anticipate
that the cost of license revenue will increase in absolute dollars as we license
additional technologies. Cost of license revenue as a percentage of license
revenue has varied in the past due to the timing and volume of product sales and
the nature of royalty agreements in place at the time.
Cost of service revenue consists primarily of salaries and related
expenses for our customer support, implementations and training services
organization and allocation of facility costs and system costs incurred in
providing customer support. Cost of service revenue increased to $10.8 million
for the three months ended June 30, 2000 from $851,000 for the three months
ended June 30, 1999. Cost of service revenue as a percent of service revenue was
109% for the three months ended June 30, 2000 and 165% for the three months
ended June 30, 1999. Cost of service revenue increased to $14.8 million for the
six months ended June 30, 2000 from $1.3 million for the six months ended June
30, 1999. The growth in cost of service revenue was attributable primarily to an
increase in personnel and related costs associated with an increased number of
customers and recruiting fees. Much of this growth and related increases is
attributable to our acquisition of Silknet from the effective date of the
merger. Cost of service revenue as a percent of service revenue was 112% for the
six months ended June 30, 2000 and 169% for the six months ended June 30,1999.
The decrease in cost of service revenue as a percent of service revenue was due
primarily to the increase in service revenue over the period. We anticipate that
cost of service revenue will increase in absolute dollars, but will decrease as
a percentage of service revenue.
Cost of license and service revenue excludes amortization of deferred
stock based amortization and amortization of acquired technology.
OPERATING EXPENSES
SALES AND MARKETING. Sales and marketing expenses consist primarily of
compensation and related costs for sales and marketing personnel and promotional
expenditures, including public relations, advertising, trade shows, and
marketing collateral materials. Sales and marketing expenses increased to $21.3
million for the three months ended June 30, 2000 from $4.2 million for the three
months ended June 30, 1999. As a percentage of total revenues, sales and
marketing expenses were 84% for the three months ended June 30, 2000 and 179%
for the three months ended June 30, 1999. Sales and marketing expenses increased
to $32.5 million for the six months ended June 30, 2000 from $6.7 million for
the six months ended June 30, 1999. This increase was attributable primarily to
the addition of sales and marketing personnel, an increase in sales commissions
associated with increased revenues and higher marketing costs due to expanded
advertising and promotional activities. Much of this growth and related
increases is attributable to our acquisition of Silknet from the effective date
of the merger. As a percentage of total revenues, sales and marketing expenses
were 90% for the six months ended June 30, 2000 and 174% for the six months
ended June 30, 1999. This decrease in sales and marketing expense as a percent
of total revenues was due primarily to the increase in total revenues over the
period. We expect to continue to increase our marketing and promotional efforts
and hire additional sales personnel. We further expect our sales and marketing
expenses to increase due to our recent mergers. Accordingly, we anticipate that
sales and marketing expenses will increase in absolute dollars, but will vary as
a percentage of total revenues from period to period.
RESEARCH AND DEVELOPMENT. Research and development expenses consist
primarily of compensation and related costs for engineering employees and
contractors responsible for new product development and for enhancement of
existing products and quality assurance activities. Research and development
expenses increased to $11.1 million for the three months ended June 30, 2000
from $2.7 million for the three months ended June 30, 1999. As a percentage of
total revenues, research and development expenses were 43% for the three months
ended June 30, 2000 and 117% for the six months ended June 30, 1999. Research
and development expenses increased to $16.3 million for the six months ended
June 30, 2000 from $5.1 million for the six months ended June 30, 1999. This
increase was attributable primarily to the addition of personnel associated with
product development and related benefits, consulting and recruiting costs. Much
of this growth and related increases is attributable to our acquisition of
Silknet from the effective
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<PAGE>
date of the merger. As a percentage of total revenues, research and development
expenses were 45% for the six months ended June 30, 2000 and 132% for the six
months ended June 30, 1999. This decrease in research and development expense as
a percent of total revenues was due primarily to the increase in total revenues
over the period. We expect to continue to make substantial investments in
research and development and anticipate that research and development expenses
will continue to increase in absolute dollars, but will vary as a percentage of
total revenues from period to period. We further expect our research and
development expenses to increase due to our recent mergers.
GENERAL AND ADMINISTRATIVE. General and administrative expenses consist
primarily of compensation and related costs for administrative personnel, legal,
accounting and other general corporate expenses. General and administrative
expenses increased to $3.7 million for the three months ended June 30, 2000 from
$1.1 million for the three months ended June 30, 1999. As a percentage of total
revenues, general and administrative expenses were 15% for the three months
ended June 30, 2000 and 46% for the three months ended June 30, 1999. General
and administrative expenses increased to $5.6 million for the six months ended
June 30, 2000 from $1.8 million for the six months ended June 30, 1999, due
primarily to increased personnel, legal and professional fees, facilities and
other related costs necessary to support our growth. Much of this growth and
related increases is attributable to our acquisition of Silknet from the
effective date of the merger. As a percentage of total revenues, general and
administrative expenses were 15% for the six months ended June 30, 2000 and 47%
for the six months ended June 30, 1999. This decrease in general and
administrative expenses as a percent of total revenues was due primarily to the
increase in total revenues over the period. We expect that general and
administrative expenses will increase in absolute dollars as we add personnel
and incur additional costs related to the anticipated growth of our business and
operation as a public company. However, we expect that these expenses will vary
as a percentage of total revenues from period to period.
AMORTIZATION OF GOODWILL AND IDENTIFIABLE INTANGIBLES. On April 19, 2000,
Kana consummated its merger with Silknet. As a result of the merger, $3.8
billion was allocated to goodwill and identifiable intangibles. This amount is
being amortized on a straight-line basis over a period of three years from the
date of acquisition. For the three months and six months ended June 30, 2000, we
recorded $247.0 million in amortization.
AMORTIZATION OF DEFERRED STOCK-BASED COMPENSATION. In connection with the
granting of stock options to our employees, we recorded deferred stock-based
compensation of which $13.0 million remains unamortized at June 30, 2000. This
amount represents the total difference between the exercise prices of stock
options and the deemed fair value of the underlying common stock for accounting
purposes on the date these stock options were granted. This amount is included
as a component of stockholders' equity and is being amortized on an accelerated
basis by charges to operations over the vesting period of the options,
consistent with the method described in FASB Interpretation No. 28.
The amortization of stock-based compensation by operating expense is
detailed as follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------------- --------------------
2000 1999 2000 1999
-------- ------- -------- ---------
<S> <C> <C> <C> <C>
Cost of service..................................... $ 875 $ 671 $ 1,690 $ 799
Sales and marketing................................. 1,522 1,155 2,925 1,375
Research and development............................ 880 675 1,699 803
General and administrative.......................... 316 233 599 277
-------- ------- ------ ---------
Total.......................................... $ 3,593 $ 2,734 $ 6,913 $3,254
======== ======= ====== =========
</TABLE>
IN PROCESS RESEARCH AND DEVELOPMENT. In connection with the merger of
Silknet, net intangibles of $6.9 million were allocated to in process research
and development. The fair value allocation to in-process research and
development was determined by identifying the research projects for which
technological feasibility has not been achieved and which have no alternative
future use at the merger date, assessing the stage and expected date of
completion of the research and development effort at the merger date, and
calculating the net present value of the cash flows expected to result from the
successful deployment of the new technology resulting from the in-process
research and development effort.
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<PAGE>
The stages of completion were determined by estimating the costs and
time incurred to date relative to the costs and time incurred to develop the
in-process technology into a commercially viable technology or product, while
considering the relative difficulty of completing the various tasks and
obstacles necessary to attain technological feasibility. As of the date of the
acquisition, Silknet had two projects in process that were 90% complete.
The estimated net present value of cash flows was based on incremental
future cash flows from revenues expected to be generated by the technologies in
the process of development, taking into account the characteristics and
applications of the technologies, the size and growth rate of existing and
future markets and an evaluation of past and anticipated technology and product
life cycles. Estimated net future cash flows included allocations of operating
expenses and income taxes but excluded the expected completion costs of the
in-process projects, and were discounted at a rate of 20% to arrive at a net
present value. The discount rate included a factor that took into account the
uncertainty surrounding the successful deployment of in-process technology
projects. This net present value was allocated to in-process research and
development based on the percentage of completion at the merger date.
ACQUISITION RELATED COSTS. In connection with the Silknet merger, we
recorded $6.6 million of transaction costs and merger-related integration
expenses. These amounts consisted primarily of merger-related advertising and
announcements of $4.5 million and duplicate facility costs of $1.0 million.
OTHER INCOME (EXPENSE), NET. Other income (expense), net consists
primarily of interest earned on cash and short-term investments, offset by
interest expense related to a note. Other income (expense), net was $2.0 million
for the six months ended June 30, 2000 and $(519,000) for the six months ended
June 30, 1999. The increase was due primarily to increased interest income
earned on higher cash balances offset by interest expense.
PROVISION FOR INCOME TAXES. We have incurred operating losses for all
periods from inception through June 30, 2000. We have recorded a valuation
allowance for the full amount of our gross deferred tax assets, as the future
realization of the tax benefit is not currently likely.
NET LOSS. Our net loss increased to $299.4 million for the six months
ended June 30, 2000 from $14.9 million for the six months ended June 30, 1999.
We have experienced substantial costs related to our recent acquisition of
Silknet, and substantial increases in our expenditures since our inception
consistent with growth in our operations and personnel. We anticipate that our
expenditures will continue to increase in the future. Although our revenue has
grown in recent quarters, we cannot be certain that we can sustain this growth
or that we will generate sufficient revenue for profitability.
LIQUIDITY AND CAPITAL RESOURCES
In June 2000, we completed the private placement of 2,500,000 shares of
our common stock, raising net proceeds of approximately $120.0 million. In
September 1999, we completed the initial public offering of our common stock and
realized net proceeds from the offering of approximately $51.1 million. Prior to
the initial public offering, we had financed 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 $42.2 million of cash for the six months
ended June 30, 2000 and $25.7 million of cash for the year ended December 31,
1999. Such uses are primarily attributable to net losses experienced during
these periods as we invested in the development of our products, expanded our
sales force and expanded our infrastructure to support our growth and increase
in sales, leading to an increase in accounts receivable. Our operating
activities used $8.7 million of cash for the six months ended June 30, 1999 and
$10.1 million of cash for the year ended December 31, 1998, which is primarily
attributable to net losses experienced during this period.
Our investing activities consisted primarily of the acquisition of
Silknet, net sales of short-term investments, purchases of computer equipment,
furniture, fixtures and leasehold improvements to support our growing number of
employees, and provided $62.8 million of cash for the six months ended June 30,
2000 and used $44.4 million of cash for the year ended December 31, 1999. Our
investing activities used $3.4 million of cash for the six months ended
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<PAGE>
June 30, 1999 and $1.4 million of cash for the year ended December 31, 1998,
which is primarily due to purchases of short-term investments and computer
equipment, furniture, fixtures and leasehold improvements.
Our financing activities provided $120.7 million in cash for the six
months ended June 30, 2000, primarily due to proceeds from the private
placement. For the year ended December 31, 1999, our financing activities
generated $75.0 million in cash 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. For the six months ended June 30, 1999,
our financing activities generated $4.7 million in cash, primarily from the net
proceeds from bank borrowings. For the year ended December 31, 1998, our
financing activities generated $20.0 million in cash primarily from the net
proceeds from private sales of preferred stock.
At June 30, 2000, we had cash and cash equivalents aggregating $159.8
million and short-term investments totaling $3.1 million. We have a line of
credit totaling $3.0 million, which is secured by all of our assets, bears
interest at the bank's prime rate (9.5% as of June 30, 2000), and is in the
process of being extended at June 30, 2000. Our total bank debt was $1.7 million
at June 30, 2000.
Our capital requirements depend on numerous factors. We expect to devote
substantial resources to continue our research and development efforts, expand
our sales, support, marketing and product development organizations, establish
additional facilities worldwide and build the infrastructure necessary to
support our growth. We have experienced substantial increases in our
expenditures since our inception consistent with growth in our operations and
personnel, and we anticipate that our expenditures will continue to increase in
the future. We believe that the net proceeds from the sale of the common stock
in our initial public offering, the private placement of our common stock and
collections on our accounts receivable will be sufficient to meet our working
capital and operating resource expenditure requirements for the next 18 months.
However, we may need to raise additional funds in order to fund more rapid
expansion, including significant increases in personnel and office facilities,
to develop new or enhance existing services or products, to respond to
competitive pressures, or to acquire or invest in complementary businesses,
technologies, services or products. Additional funding may not be available on
favorable terms or at all. In addition, although there are no present
understandings, commitments or agreements with respect to any acquisition of
other businesses, products or technologies, we may, from time to time, evaluate
potential acquisitions of other businesses, products and technologies. In order
to consummate potential acquisitions, we may issue additional securities or need
additional equity or debt financing and any financing may be dilutive to
existing investors.
17
<PAGE>
RISK FACTORS ASSOCIATED WITH KANA'S BUSINESS AND FUTURE OPERATING
RESULTS
OUR FUTURE OPERATING RESULTS MAY VARY SUBSTANTIALLY FROM PERIOD TO
PERIOD. THE PRICE OF OUR COMMON STOCK WILL FLUCTUATE IN THE FUTURE, AND AN
INVESTMENT IN OUR COMMON STOCK IS SUBJECT TO A VARIETY OF RISKS, INCLUDING BUT
NOT LIMITED TO THE SPECIFIC RISKS IDENTIFIED BELOW. INEVITABLY, SOME INVESTORS
IN OUR SECURITIES WILL EXPERIENCE GAINS WHILE OTHERS WILL EXPERIENCE LOSSES
DEPENDING ON THE PRICES AT WHICH THEY PURCHASE AND SELL SECURITIES. PROSPECTIVE
AND EXISTING INVESTORS ARE STRONGLY URGED TO CAREFULLY CONSIDER THE VARIOUS
CAUTIONARY STATEMENTS AND RISKS SET FORTH IN THIS REPORT 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 THIS "RISKS ASSOCIATED WITH KANA'S BUSINESS AND FUTURE OPERATING
RESULTS" AND ELSEWHERE IN THIS REPORT. FORWARD-LOOKING STATEMENTS THAT WERE TRUE
AT THE TIME MADE MAY ULTIMATELY PROVE TO BE INCORRECT OR FALSE. READERS ARE
CAUTIONED NOT TO PLACE UNDUE RELIANCE ON FORWARD-LOOKING STATEMENT, WHICH
REFLECT OUR MANAGEMENT'S VIEW ONLY AS OF THE DATE OF THIS REPORT. 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;
18
<PAGE>
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.
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
19
<PAGE>
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;
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 TWELVE 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
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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.
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
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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.
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 will become eligible for sale under Rule 144. Also in
July 2000, we filed a registration statement to allow 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.
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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 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.
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THE INTEGRATION OF OUR NEW PRESIDENT, VICE PRESIDENT OF PRODUCT 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.
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
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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;
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
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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 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
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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
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.
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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.
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.
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IF WE FAIL TO RESPOND TO CHANGING CUSTOMER PREFERENCES IN OUR MARKET, DEMAND FOR
OUR PRODUCTS AND OUR ABILITY TO ENHANCE OUR REVENUES WILL SUFFER
We must continually improve the performance, features and reliability of
our products, particularly in response to competitive offerings. Our success
depends, in part, on our ability to enhance our existing software and to develop
new services, functionality and technology that address the increasingly
sophisticated and varied needs of our prospective customers. If we do not
properly identify the feature preferences of prospective customers, or if we
fail to deliver features that meet the requirements of these customers, our
ability to market our products successfully and to increase our revenues could
be impaired. The development of proprietary technology and necessary service
enhancements entails significant technical and business risks and requires
substantial expenditures and lead time.
IF THE INTERNET AND 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.
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ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We develop products in the United States and sell these products in North
America, Europe, Asia and Australia. Generally, our sales are made in local
currency. As a result, our financial results could be affected by factors such
as changes in foreign currency exchange rates or weak economic conditions in
foreign markets. We do not currently use derivative instruments to hedge our
foreign exchange risk.
Our exposure to market rate risk for changes in interest rates relates
primarily to our investment portfolio. Our investments consist primarily of
short-term municipals, which have an average fixed yield rate of 6.7%. These all
mature within three months. Kana does not consider its cash equivalents to be
subject to interest rate risk due to their short maturities.
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PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
On October 8, 1999, Genesys Telecommunications Laboratories, Inc.
("Genesys") filed a complaint against Kana in the United States District Court
for the District of Delaware. Genesys has amended its complaint to allege that
Kana's 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 documentation. Kana intends to defend itself
from this claim vigorously and does not expect it to materially impact our
results from operations. Kana is not currently a party to any other material
legal proceedings.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
On September 21, 1999, we consummated our initial public offering of common
stock, $0.001 par value. The managing underwriters in the offering were Goldman
Sachs & Co, Hambrecht & Quist LLC and Wit Capital Corporation. The shares of
common stock sold in the offering were registered under the Securities Act of
1933, as amended, on a registration statement on Form S-1 (Reg. No. 333-82587)
that was declared effective by the SEC on September 21, 1999. All 7,590,000
shares of common stock registered under the registration statement, including
shares covered by an over-allotment option that was exercised, were sold at a
price to the public of $7.50 per share. The aggregate offering amount registered
was $56,925,000. In connection with the offering, Kana paid an aggregate of
$3,985,000 in underwriting discounts to the underwriters. In addition, the
following table sets forth an approximation of all expenses incurred in
connection with the offering, other than underwriting discounts. All amounts
shown are approximations except for the registration fees of the SEC and the
National Association of Securities Dealers, Inc.
SEC Registration Fee.................................... $ 28,130
NASD Filing Fee......................................... 5,500
Nasdaq National Market Listing Fee...................... 91,000
Printing and Engraving Expenses......................... 440,000
Legal Fees and Expenses................................. 700,000
Accounting Fees and Expenses............................ 300,000
Blue Sky Fees and Expenses.............................. 15,000
Transfer Agent Fees..................................... 30,000
Miscellaneous........................................... 264,370
--------------------
Total Expenses.......................................... $ 1,874,000
====================
All of such expenses were direct or indirect payments to others.
The net offering proceeds to us after deducting the total expenses above
were approximately $51,066,000. From September 21, 1999 to December 31, 1999, we
used such net offering proceeds from our initial public offering of common stock
to invest in short-term, interest bearing, investment grade securities and used
proceeds for working capital and other corporate purposes. This use of proceeds
does not represent a material change in the use of proceeds described in the
prospectus of the registration statement. We used its existing cash balances to
fund Kana's general operations.
We currently estimate that we will use the remaining net proceeds as
follows: 45% for marketing and distribution activities; 20% for various product
development initiatives; 10% for working capital and other general corporate
purposes.
On June 12, 2000, we sold 2,500,000 shares of our common stock in a private
placement transaction with entities affiliated with Putnam Investment
Management, Inc., entities affiliated with The Putnam Advisory Company, Inc.,
entities affiliated with The Galleon Group, DWS Investments and Metzler
Investments for an aggregate purchase price of $125,000,000. This private
placement transaction did not involve any underwriters, any underwriting
discounts or commissions, or any public offering, and we believe that the
transaction was exempt from the
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registration requirements of the Securities Act by virtue of Section 4(2). The
shares of common stock sold in the private placement were registered under the
Securities Act of 1933, as amended, on a registration statement on Form S-1
(Reg. No. 333-40338) that was declared effective by the SEC on July 11, 2000.
Upon resale of the common stock sold in the private placement transaction and
registered under the registration statement, the selling stockholders will
receive all of the proceeds from such sale. We will not receive any of the
proceeds from sales by the selling stockholders.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
A Special Meeting of Stockholders was held on April 18, 2000 to act on the
following matters:
1. To approve the issuance of common stock as part of the merger
agreement among the Company, Silknet Software, Inc. ("Silknet")
and Pitsol Acquisition Corporation. The votes cast for and
against this action were 47,166,669 and 900, respectively, with
1,450 votes abstaining.
2. To approve an amendment to increase the Company's authorized
shares from 100,000,000 to 1,000,000,000. The votes cast for and
against this action were 46,625,693 and 1,426,972, respectively,
with 36,170 votes abstaining.
3. To approve an amendment to the Company's 1999 Stock Incentive
Plan to increase the plan by an additional 10,000,000 shares and
to increase the limitation on the maximum number of shares by
which the share reserve under the plan is to increase each year
pursuant to the automatic share increase provisions of the plan
from 4,000,000 to 6,000,000 shares. The votes cast for and
against this action were 45,438,591 and 1,398,371, respectively,
with 25,588 votes abstaining.
Based on these voting results, the issuance of common stock for the
acquisition of Silknet, the amendment to increase the Company's authorized
shares from 100,000,000 to 1,000,000,000 and the amendment to the Company's
1999 Stock Incentive Plan to increase the plan by an additional 10,000,000
shares and to increase the limitation on the maximum number of shares by
which the share reserve under the plan is to increase each year pursuant to
the automatic share increase provisions of the plan from 4,000,000 to
6,000,000 shares, were approved.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
27 Financial Data Schedule
(b) Reports on Form 8-K:
(1) On April 20, 2000, we filed a report on Form 8-K,
Item 4 regarding the engagement of new independent
accountants.
(2) On May 4, 2000, we filed a report on Form 8-K,
Items 2, 5 and 7 regarding the acquisition of Silknet
Software, Inc.
(3) On June 15, 2000, we filed a report on Form 8-K,
Items 5 and 7 regarding the sale of our common stock
in a private placement transaction.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
August 14, 2000 Kana Communications, Inc.
/S/ MICHAEL J. MCCLOSKEY
------------------------------------
Michael J. McCloskey
Chief Executive Officer and Director
/S/ BRIAN K. ALLEN
------------------------------------
Brian K. Allen
Chief Financial Officer
(Principal Financial and Accounting Officer)
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EXHIBIT INDEX TO KANA COMMUNICATIONS, INC.
Quarterly Report on Form 10-Q
For the Quarter Ended June 30, 2000
Exhibit Number Description
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27 Financial Data Schedule
