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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
[X]ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2000,
or
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____ to ______
000-26287
(Commission File Number)
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KANA COMMUNICATIONS, INC.
(Exact name of Registrant as specified in its charter)
Delaware 77-0435679
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or Organization)
740 Bay Road, Redwood City, CA 94063
(Address of principal executive offices) (Zip Code)
(650) 298-9282
(Registrant's telephone number, including area code)
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Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.001 par value
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form. [_]
As of February 28, 2001, the aggregate market value of the voting stock held
by non-affiliates of the Registrant was approximately $241,444,076 based upon
the closing sales price of the Common Stock as reported on the Nasdaq Stock
Market on such date. Shares of Common Stock held by officers, directors and
holders of more than ten percent of the outstanding Common Stock have been
excluded from this calculation because such persons may be deemed to be
affiliates. The determination of affiliate status is not necessarily a
conclusive determination for other purposes.
As of February 28, 2001, the Registrant had outstanding 94,345,305 shares of
Common Stock.
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KANA COMMUNICATIONS, INC.
TABLE OF CONTENTS
ANNUAL REPORT ON FORM 10-K
FOR YEAR ENDED DECEMBER 31, 2000
PART I
Page
----
ITEM 1 BUSINESS....................................................... 3
ITEM 2 PROPERTIES..................................................... 14
ITEM 3 LEGAL PROCEEDINGS.............................................. 14
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............ 14
PART II
ITEM 5 MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS........................................... 17
ITEM 6 SELECTED CONSOLIDATED FINANCIAL DATA........................... 18
ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS......................................... 19
ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK..... 42
ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.................... 42
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.......................................... 42
PART III
ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............. 43
ITEM 11 EXECUTIVE COMPENSATION......................................... 44
ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT.................................................... 48
ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................. 49
PART IV
ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-
K............................................................. 51
SIGNATURES.............................................................. 82
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PART I
The following contains forward-looking statements within the meaning of
Section 21e of the Securities Exchange Act of 1934. Our actual results and
timing of certain events could differ materially from those anticipated in
these forward-looking statements as a result of certain factors, including, but
not limited to, those set forth under "Risk Factors," elsewhere in this report
and in our other public filings.
ITEM 1. BUSINESS
Overview
We are a leading provider of enterprise Relationship Management (eRM)
software solutions that deliver integrated communication and business
applications built on a Web-architected platform. Our eRM software solutions
redefine and extend the enterprise to incorporate customers, partners, and
suppliers in collaborative business relationships for greater long-term loyalty
and profitability. At the same time, our eRM solutions enable enterprises to
lower operating and distribution costs as they build relationships. Using our
software products and services, enterprises can:
. offer to customers, partners, and suppliers a consistent, personalized,
and comprehensive view of their business relationship so that they can
learn, buy, and get care that is relevant and targeted to their needs.
. offer customers, partners, and suppliers an integrated business
experience across their service, sales, and marketing activities.
. embrace customers, partners, and suppliers in productive and efficient
relationships through collaborative participation in automated business
processes.
. enhance the effectiveness of both online and offline relationships via
integrated communication channels and interactions methods.
. facilitate integrated information and services via a scalable, flexible,
and adaptable Web-architected platform.
Our customers range from Global 2000 companies pursuing an e-business
strategy to growing Internet companies. The following is a representative list
of our customers:
. eBay . E*Trade
. American Airlines . Kodak
. The Gap . BellSouth
No customer accounted for 10% or more of our total revenues in 1998, 1999 or
2000.
References in this annual report on Form 10-K to "Kana," "we," "our," and
"us" collectively refer to Kana Communications, Inc., a Delaware corporation,
its subsidiary and its California predecessor. Our principal executive offices
are located at 740 Bay Road, Redwood City, California 94063 and our telephone
number is (650) 298-9282.
Recent Developments
On February 28, 2001, we filed a tender offer statement on Schedule TO
announcing our offer to exchange certain eligible options outstanding under our
stock option plans for new options to purchase shares of our common stock to be
granted on or after six months and one day after the tendered options are
accepted and cancelled and for restricted shares of our common stock.
On February 21, 2001, we announced the appointment of Art M. Rodriguez as
our interim chief financial officer, replacing James C. Wood, our chief
executive officer and chairman of the board of directors, who acted as our
interim chief financial officer following the January 2001 resignation of our
former chief financial officer, Brian K. Allen, for personal reasons.
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On January 18, 2001, we announced the appointment of James C. Wood as our
new chief executive officer and chairman of the board, in connection with the
January 2001 resignation of our former chief executive officer and chairman of
the board, Michael J. McCloskey, for health reasons.
Industry Background
In today's economy, customers and partners have a variety of purchasing
options and are only a click away from being able to defect to the competition.
Whether a company is a Global 2000 enterprise, or a newly established Internet-
based business, the ability to provide a high quality interaction and
experience, and thus to establish long-term relationships and loyalty, is
critical to business survival.
Until recently, the relationships with customers and partners were based on
interactions in-person, by telephone or by letter. In order to respond to these
types of inquiries more effectively, many companies invested substantial
resources in expensive call centers and traditional direct marketing
initiatives. Call centers typically served a customer service function,
employed costly technology and did not scale effectively. Traditional direct
marketing is typically expensive and not highly effective in terms of
conversion and response rates. With the advent of the Internet and the
proliferation of electronic communications, the manner through which businesses
communicate has undergone a fundamental change: customers, partners, and
suppliers are now demanding that businesses be accessible anytime and through a
variety of channels, including the Web, wireless, e-mail, telephone, and
storefront.
Given the emerging shift to enhanced customer and partner interaction,
traditional solutions are not addressing the fundamental changes required by
enterprises. Businesses have concluded that, in order to differentiate
themselves from their competitors, they must provide superior customer
service--regardless of the customer contact channel. Therefore, it is no
surprise that according to the Gartner Group, the enterprises that are able to
synchronize customer-facing interactions across channels will outperform
competitors with siloed channels by 20 percent.
There can be negative consequences for a business if it fails to manage
these interactions effectively. These consequences can include loss of
customers, increased difficulty in acquiring new customers and a deterioration
of competitive position. IMT Strategies recently recognized the negative impact
on e-brand loyalty and customer retention associated with inconsistent service
across channels, particularly since customers are now just one click away from
switching their allegiances to a competitor or airing their complaints in
public forums. In addition, businesses face higher operating and information
technology costs without efficient and reliable management of customer and
partner interactions. Perhaps most significantly, businesses may lose the
opportunity to take advantage of new revenue-generating opportunities by
failing to capitalize upon the wealth of information conveyed through these
communications. While addressing these challenges, businesses must also be able
to deploy an enterprise relationship management solution across multiple
departments, to integrate the solution with existing business and legacy
systems and databases and to scale the solution as volumes grow.
The Kana eRM Solution
We believe that in order for companies to be successful in today's rapidly
changing global economy, they must differentiate themselves by enhancing
business relationships while simultaneously decreasing operating costs,
increasing efficiency through business process automation, eliminating
information fragmentation to reduce information technology costs, and adapting
rapidly to changing business requirements. Our products and services are
designed to meet these challenges to generate higher revenue and long-term
customer, partner, and supplier loyalty. We believe our products and services
provide the following business benefits:
. Enhanced Business Relationships and Decreased Operating Costs. Our
products provide customers, partners, suppliers, and enterprise staff
with a complete view of their interactions and activities and deliver
this information via personalized Web portals. All users benefit from a
complete view by receiving relevant information at the right time,
resulting in finer control over their business
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relationships. In addition, with greater access to information, customers,
partners, and suppliers can resolve business issues without assistance,
thus reducing the enterprise's costs for building effective relationships.
Capabilities such as managed self service make enterprise knowledge
available to customers, partners, and suppliers.
Enterprises are able to gain a complete view of business relationships
across departmental functions and communication channels. Our software
provides one-click access to complete customer histories and interactions
so that staff can provide informed, personalized, and consistent answers.
In addition, our software provides enterprises with the ability to
analyze customer information to launch customized initiatives in response
to gathered information. We believe that the resulting improvement in the
business experience enables enterprises to significantly enhance customer
satisfaction, retention, and loyalty.
. Business Process Automation for Increased Efficiency. Our software
enables enterprises to automate communication and business processes
across the organization. Our products use a combination of workflow
automation, business rules for decision-making, artificial intelligence,
analytics and advanced messaging analysis technologies to create
efficient business processes. By extending processes across the
enterprise, all departments can act upon valuable information. For
example, our software can alert a sales department of a potential lead
resulting from a service representative's interaction with a customer to
solve a problem.
Even more importantly, our products enable the enterprise to extend
business process automation outside its walls to embrace customers,
partners, and suppliers in the processes. This "extranet" workflow
capability means that users inside and outside the corporation can
collaborate as one to efficiently resolve business issues.
. Integrated Enterprise Information and Reduced Technology Costs. Our
products and services can reduce enterprise operating and information
technology costs by delivering a suite of business applications for
marketing, sales, and service functions integrated with our broad range
of electronic and traditional communication applications.
Our integrated communication applications enable customers, partners,
suppliers, and enterprise staff to mix and match as many communications
channels as needed to complete a business task, including electronic and
traditional telephone-based communications. Integrated communication
applications have the benefit of lowering operational business costs as
the enterprise can blend scarce resources efficiently to manage all types
of requests across multiple communication channels.
Our suite of business applications enables enterprises to manage the
complete marketing, sales, and service business lifecycle from building
permission-based marketing campaigns, to acquiring and keeping customers,
to managing requests for service. By integrating these applications,
enterprises can easily identify and create additional revenue-generating
opportunities without significant IT effort. For example, our business
applications can convert marketing interactions into sales by attaching
highly personalized and targeted communications in electronic direct
marketing campaigns using information gathered via requests for service
assistance.
Our communication and business applications are built on a Web-
architected foundation designed to integrate not only Kana-delivered
applications, but information and processes residing in legacy systems
and existing enterprise data sources. Our Web-based architecture extends
the useful lives of these diverse and heterogeneous information sources,
helping the enterprise to avoid expensive application redesign and
redevelopment.
Rapid Adaptation to Changing Market Conditions. Our software is built on a
Web-based architecture for rapid application customization and deployment,
network flexibility, and scalability to manage exponential growth. Based on
widely accepted industry standards, our software uses standards such as Java
J2EE, JDBC, JNDI, JMS, World Wide Web Consortium standards, HTML, XML, and
Workflow Management Coalition
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standards to facilitate rapid application customization, efficient development
cycles, and real-time adaptation to changes in business conditions. In
combination with these standards and industry-leading Web, application, and
database servers, our software can help enterprises achieve the scalability,
fault tolerance, application adaptability, and network flexibility required for
today's global business operations.
The Kana Strategy
Our strategy for achieving our goals as the leading provider of eRM software
solutions includes the following objectives:
Extend Market Leadership Position. We intend to extend our position as a
leader in the eRM software market by delivering a broad range of business and
communication applications built on a Web-architected, flexible, and scalable
platform. We intend to take advantage of our technological leadership,
strategic customer base and distribution capabilities to extend our current
position as a market leader. Moreover, we believe that, by broadening our suite
of products and services that enable companies to interact with their
customers, partners, and suppliers in the most cost-effective and efficient
ways possible, we can expand our market opportunities and solidify our position
as a leading provider of comprehensive eRM solutions and services.
Expand Our Suite of Products to Enter New Markets. We intend to expand our
suite of products to include additional marketing, sales and service
capabilities in order to enter new markets. We are working with our customers
and strategic partners to identify the strategic and functional needs of
enterprises that operate in the rapidly changing Web environment. Our focus is
to develop applications and partnerships that address those needs and integrate
them seamlessly with our existing platform to help enterprises establish
broader and deeper business relationships. We believe these applications will
be integrated to merge Web-based marketing, sales, and service transactions
with customer communications to create further revenue opportunities.
Increase Distribution Capabilities. We intend to broaden and increase our
distribution capabilities worldwide by combining the efforts of our direct
sales force and our alliances with leading e-business service and
infrastructure providers, such as Accenture LLP, Aspect, IBM, KPMG Consulting
and Siemens. By expanding existing alliances and aggressively developing new
ones, we can leverage others' sales, marketing and deployment capabilities to
help establish us as a worldwide provider of eRM products and services.
Continue Technology Leadership. We intend to continue our technology
leadership with our Web-based architecture as the leading technology platform
and market standard for eRM products and services. To deliver the high
performance required in the complex and rapidly changing eRM environment, we
have designed our products to be highly scalable, easily customizable and
readily able to integrate with existing enterprise applications and systems.
Our Web-based platform enables a complete view of all people, activities, and
interactions from one location, allowing the enterprise to scale to millions of
daily interactions and to modify automated business process in real time
without disabling the entire system.
Emphasize Customer Satisfaction. We believe that delivering complete
customer satisfaction is vital to growing our business. Our emphasis on
customer satisfaction has provided us with a strong base of customers who can
be referenced. This strategy provides many benefits, including potentially
shortened sales cycles, incremental sales opportunities to our installed-base
of customers, and new and improved products resulting from customer feedback.
We intend to remain focused on providing the highest level of satisfaction to
our customers and to continue designing our solutions to address their
enterprise needs. In addition, we intend to continue to enhance our
professional services group's capabilities, to maintain customer relationships
beyond the implementation phase and provide a superior customer experience.
Products and Services
Our Suite of eRM Software Solutions. Our suite of integrated communication
and business applications built on a Web-based platform create an advanced
technological solution for eRM. The suite consists of Kana
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eBusiness Platform, Kana Service, Kana Connect, Kana Response, Kana I-Mail,
Kana Voice, Kana mBusiness, Kana Classify, and Kana Conduits.
Kana eBusiness Platform. Kana eBusiness Platform is our Web-architected,
standards-based foundation for building, deploying, and modifying software
applications. Kana eBusiness Platform is designed for near linear scalability,
enabling the enterprise to quickly add users to service a growing customer
base. Applications built on Kana eBusiness Platform can be extended to add
features and functionality to accommodate and integrate the enterprise's
specific data and processes, including information residing in legacy systems
and data sources. Kana eBusiness Platform provides the foundation for
integrated, personalized interactions, collaborations, and transactions between
the enterprise and its customers, partners, and suppliers.
Kana Service. Kana Service is a complete customer care application that
enables the enterprise to automate contact center processes and extend those
processes to customers, partners, and suppliers for a global view of their
relationships with the enterprise. By delivering proactive service, self-
service, and assisted service in combination with integrated communication
channels, Kana Service empowers business associates to play an active part in
managing their relationships with the enterprise. At the same time, Kana
Service delivers efficiencies to significantly reduce the costs of providing
superior customer care through extensive service request and knowledge base
management capabilities.
Kana Connect. Kana Connect is our electronic direct marketing application
that enables the enterprise to proactively deliver individually targeted
messages to increase the lifetime value of customers. The application enables
marketers to profile, target and engage customers in one-to-one conversations
through permission-based, e-mail communication.
Kana Response. Kana Response is our e-mail and Web communications management
application that assists enterprises in responding to large numbers of inbound
customer e-mail communications. Kana Response provides rule-based automation,
intelligent workflow, message queuing, specialized user tools and a centralized
knowledge base of issues and responses.
Kana I-Mail. Kana I-Mail lets the enterprise engage in one-to-one real-time
communications with customers. The solution's two-way Web-based instant
messaging between the company and customer provides immediate online assistance
to the customer. Kana I-Mail delivers different service levels to customers
based on a number of factors such as the Web page the customer is browsing, the
value of the items in the customer's shopping cart, or the nature of the
customer's question to determine the appropriate service level for that
individual.
Kana Voice. Kana Voice allows customers to have a voice conversation over
the Internet. Customers simply click on a button and are connected with a live
agent online. Kana Voice also provides collaborative Web browsing, Web history
tracking, prioritization, escalation, knowledge base and agent and
administrator features.
Kana mBusiness. Kana mBusiness provides wireless access to customer and
partner Web portals to support sales and marketing inquiries, personalized
responses, service resolution, transaction confirmation, and contact
management. It uses standards such as WAP and WML so that users can easily
author content across wireless-enabled devices. Kana mBusiness also allows
wireless portals to be customized, enabling users to check and act on
marketing, sales, and service applications.
Kana Classify. Kana Classify is our advanced message classification
technology that drives automated actions. Kana Classify categorizes customer
messages and can automatically respond to customers, suggest responses for user
review or route messages to appropriate queues.
Kana Conduits. Kana Conduits integrate leading third-party applications with
Kana software. Kana Conduits for Computer Teleploy Integration (CTI) provide
integration with leading computer telephony
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applications, providing enterprise agents with a single interface to inquiries
received over various media, including the Web, e-mail and the telephone.
Additional Kana Conduits deliver such capabilities as integration with advanced
Web collaboration vendors and leading Customer Relationship Management (CRM)
vendors.
Kana Online
Kana Online is a Web-based application service that offers our software on a
hosted basis. Kana Online provides e-businesses with access to a customized
version of our software without the need to purchase, install or maintain their
own server or database infrastructure. With Kana Online, we host the back-end
infrastructure and the customer accesses our powerful functionality through a
Web browser or by deploying Kana's Power Client.
The hardware and core technology supporting Kana Online is pre-installed and
managed at Exodus Communications, Inc., a leading provider of Internet server
hosting and management solutions. We believe that Exodus is equipped to provide
the security, reliability and performance required for hosting our solution
through its nationwide network operating centers and high-speed wide area
network backbone.
Services
Professional Services. Our professional services group consists of
consulting services, customer advocacy, technical support and education
services.
Consulting Services. Our consulting services group provides a wide range of
business and technical expertise to support our customers and partners during
the implementation of solutions. This group brings deep functional and industry
knowledge to the market as well as the technical capabilities to deliver
premium consulting services for our customers and partners.
Technical Support. Our technical support group provides global support for
our customers through a number of channels, including phone and e-mail, as well
as access to the Kana Support Website.
Education Services. Our education services group delivers a full set of
training programs for our customers and partners, including a comprehensive set
of learning tracks for end users, business consultants, and developers through
instructor-led, Web-based, and onsite delivery. The group also provides up-to-
date information to our customers and partners through monthly newsletters, Web
site FAQ's, and regional user groups.
Technology
Our software incorporates industry standards, such as Java, HTML, XML, and
the J2EE framework, in order to facilitate customization and to enable
efficient development cycles. Our software offers both Web and Windows-based
interfaces and relies on commercial application servers and database platforms
to provide scalability and redundancy.
Open, Standards-Based Architecture. The architecture of our software is
"open" because it relies upon industry standards that facilitate integration
with customers' e-business and legacy databases and systems and the development
of applications on our platform. These industry standards include:
. Java;
. JDBC (Java DataBase Connectivity);
. Standard relational databases from Oracle, Microsoft, and IBM;
. JSP (Java Server Pages);
. The J2EE (Java 2 Enterprise Edition) framework; and
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. XML, for presentation layers, metadata, and integration.
The use of industry standards also permits our platform to be readily
customized to users' preferences.
Scaleable Web-Based Architecture. Our software relies on a scaleable Web-
based architecture. This architecture separates the different system
components into logical layers, supports multiple hardware and software
platforms, supports browser-based interfaces and enables the system to run on
multiple hardware platforms simultaneously in order to enhance scalability.
The tiers are the presentation, user interface, workflow, business object,
mail delivery, tracking and data layers.
Advanced Message Classification Technologies. We have focused our research
and development of advanced message classification technologies on Bayesian
Network technology. Bayesian Network technology is a classification technology
approach that combines machine learning with human expertise to infer
conclusions about new data. Using machine learning, the system automatically
builds a classification model from existing customer messages, thereby
reducing the cost and time of installation and maintenance and allowing the
system to improve as new issues arise. With human expertise, the system
enables managers to add their knowledge selectively to the system in order to
improve accuracy and adjust the model to anticipate new issues or react to
them in real time. Bayesian Network technology underlies Kana Classify, which
categorizes customer messages and drives system automation.
Ease of Platform Upgrade. Our software may be readily upgraded to new
versions of our system. New versions of the software, when installed, are
designed to recognize the historical data and configurations from the previous
version of the system and automatically convert them to the new data format.
This enables an e-business to upgrade our software without any programming or
advanced technical capability.
Sales and Marketing
Sales. Our sales strategy is to pursue targeted accounts through a
combination of our direct sales force and our strategic alliances. To date, we
have targeted our sales efforts at the e-business divisions of Global 2000
companies and at rapidly growing Internet companies. We maintain direct sales
personnel across the United States and internationally throughout Europe,
Canada, Latin America, Australia, Singapore and Japan. The direct sales force
is organized into regional teams, which include both sales representatives and
systems engineers. As of December 31, 2000, we employed in our sales force 105
persons in our offices outside of North America. Our office in the United
Kingdom is primarily responsible for sales in Europe generally. Sales managers
currently based in the United States handle other international sales and
report to our Vice President, International. Our direct sales force is
complemented by telemarketing representatives based at our headquarters in
Redwood City, California and Manchester, New Hampshire.
We complement our direct sales force with a series of reseller and sales
alliances, such as those with Accenture, Aspect, KPMG Consulting, IBM and
Siemens. Through these alliances we are able to leverage additional sales,
marketing and deployment capabilities. In the future, we intend to expand our
distribution capabilities by increasing the size of our direct sales force,
establishing additional sales offices both domestically and internationally
and broadening our alliance activities.
Marketing. Our marketing programs are targeted at e-businesses and are
currently focused on educating our target market, generating new sales
opportunities and creating awareness for our e-business customer
communications software. We conduct marketing programs worldwide to educate
our target market. In addition, we engage in a variety of marketing
activities, including:
. conducting seminars, including Web Seminars
. hosting regular customer events;
. participating in industry and technology-related conferences and trade
shows;
. establishing and maintaining close relationships with recognized industry
analysts;
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. conducting electronic and traditional direct mailings and ongoing public
relations campaigns;
. managing and maintaining our Web site;
. conducting market research;
. organizing and implementing electronic and traditional direct marketing;
and
. creating sales tools.
Our marketing organization also serves an integral role in acquiring,
organizing and prioritizing industry and customer feedback in order to help
provide product direction to our development organizations. We have a detailed
product management process that surveys customer and market needs to predict
and prioritize future customer requirements, and a product marketing team
dedicated to delivering product positioning and messaging. We also focus on
developing a range of joint marketing strategies and programs in order to
leverage our existing strategic relationships and resources. These alliances
provide collaborative resources to help extend the reach of our presence in the
marketplace. We intend to continue to pursue these alliances in the future.
Strategic Relationships
We have three types of strategic relationships: service relationships,
technology relationships, and reseller and strategic sales relationships, all
designed to expand our market coverage. These relationships are formal or
informal agreements with third parties. We view these relationships as critical
to our success in providing enterprise-wide integrated e-business products and
services.
Recently introduced, the Kana Alliance Program was developed to meet the
increasing demand by companies to partner with us. The program provides
partners with the tools, information and marketing benefits through which they
can develop, promote and sell our products and services. Companies participate
in the program at different levels based on their market presence and on mutual
commitments to establishing successful relationships.
Service Relationships. We collaborate with systems integrators such as
Accenture, CSC Consulting and KPMG Consulting. With the implementation of our
Alliance Program, formal agreements are put into place for these relationships.
These systems integrators are highly trained in our software and provide
integration and implementation services to mutual customers.
Technology Relationships. We have established relationships with technology
partners across a variety of solution areas, including sales force automation,
analytics, content management, telephony systems and IT hardware, that allow us
to provide comprehensive solutions to e-businesses. These technology
relationships are typically formalized in a written agreement and are focused
on technology initiatives and marketing. The agreements are annually renewable,
but generally may be terminated at any time by either party and do not contain
penalties for nonperformance.
Reseller and Strategic Sales Relationships. We complement our direct sales
force with reseller and strategic sales relationships with companies in
targeted geographies and industries. Our agreements with these companies are
typically in the form of value-added reseller agreements.
In 2000, we entered into a global alliance with IBM, which provides for
resale, joint development, joint marketing and other activities. In the future,
we intend to establish additional strategic relationships to further broaden
our product offerings and enhance our distribution channels.
Many of the companies with which we have initiated relationships also work
with competing software companies, and the success of the relationship will
depend on their willingness and ability to devote sufficient resources and
efforts to our products and services. Our arrangements with these parties
typically are in the form of non-exclusive agreements that may be terminated by
either party without cause or penalty and with limited notice. Therefore, we
can provide no guarantee that any of these parties will continue their
relationship with us.
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Customers
Our customers range from Global 2000 companies pursuing an e-business
strategy to growing Internet companies. As of December 31, 2000, we have
licensed our solution to more than 600 customers in a variety of industries
worldwide. The following is a list of customers that we believe are
representative of our overall customer base:
Internet Services Financial Services/Insurance Travel
Alta Vista Aetna American Airlines
eBay Ameritrade British Airways
Hotjobs Capital One Carlson Company
Lycos Chase Manhattan Delta Airlines
priceline.com Cigna Northwest Airlines
QXL E*Trade Rail Europe
National Westminster Travelocity
High-tech Southtrust Bank
Analog Devices
Fujitsu Automotive Consumer Goods
Interwoven Ford Adidas
Microsoft General Motors Avon
Peoplesoft Renault Gateway
SAP Kodak
Sony Computer Entertainment Communications/Media Maytag
Ameritech Nokia
Retail AT&T Broadband
1-800 Flowers BellSouth
Ballard Designs BT Syncordia
Barnes & Noble.com Disney
Federated MTV
Home Depot Sprint ION
J. Crew Qwest
Staples Verizon
The Gap Yahoo!
Williams-Sonoma
No customer accounted for 10% or more of our total revenues in 1998, 1999 or
2000. Although a substantial portion of our license and service revenues in any
given quarter has been, and is expected to continue to be, generated from a
limited number of customers with large financial commitment contracts, we do
not depend on any ongoing commitments from our large customers.
Research and Development
We believe that strong product development capabilities are essential to our
strategy of enhancing our core technology, developing additional applications
incorporating that technology and maintaining the competitiveness of our
product and service offerings. We have invested significant time and resources
in creating a structured process for undertaking all product development. This
process involves several functional groups at all levels within our
organization and is designed to provide a framework for defining and addressing
the activities required to bring product concepts and development projects to
market successfully. In addition, we have recruited key engineers and software
developers with experience in the customer communications and internetworking
markets and have complemented these individuals by hiring senior management
with experience in enterprise application development, sales and deployment.
As of December 31, 2000, 315 of our employees were engaged in research and
development activities. As a result of our recent workforce reductions in the
first quarter of 2001, as of February 28, 2001, 258 of our
11
employees were engaged in research and development activities. Our success
depends, in part, on our ability to enhance our existing customer interactions
solutions and to develop new services, functionality and technology that
address the increasingly sophisticated and varied needs of our prospective
customers. Delays in bringing to market new products or their enhancements, or
the existence of defects in new products or enhancements, could be exploited by
our competitors. If we were to lose market share as a result of lapses in our
product management, our business would suffer.
Competition
The market for our products and services is intensely competitive, evolving
and subject to rapid technological change. We expect the intensity of
competition to increase in the future. We currently face competition for our
products from systems designed by both in-house and third-party development
efforts. We expect that these systems will continue to be a principal source of
competition for the foreseeable future. Our competitors include a number of
companies offering one or more products for the e-business communications and
relationship management market, some of which compete directly with our
products. For example, our competitors include companies providing traditional,
client-server based customer management and communications solutions, such as
Clarify Inc. (which was recently acquired by Nortel), Cisco Systems, Inc.,
Avaya, Inc., Oracle Corporation, Pivotal Corporation, Quintus Corporation,
Siebel Systems, Inc. and Vantive Corporation (which was recently acquired by
PeopleSoft, Inc.). In addition, we compete with companies providing stand-alone
point solutions, including Annuncio, Inc., AskJeeves Inc., Brightware, Inc.
(which was recently acquired by FirePond), Broadbase, Inc. (which recently
acquired another competitor, Servicesoft), Delano Technology, Inc., Digital
Impact, Inc., eGain Communications Corp., E.piphany Inc., Live Person, Inc,
MarketFirst, Inc., Responsys.com, Inc. and Talisma Corporation. Furthermore, we
may face increased competition should we expand our product line, through
acquisition of complementary businesses or otherwise.
We believe that the principal competitive factors affecting our market
include a significant base of referenceable customers, the breadth and depth of
a given solution, product quality and performance, customer service, core
technology, product scalability and reliability, product features, the ability
to implement solutions and the value of a given solution. Although we believe
that our solution currently competes favorably with respect to these factors,
our market is relatively new and is evolving rapidly. We may not be able to
maintain our competitive position against current and potential competitors,
especially those with significantly greater financial, marketing, service,
support, technical and other resources.
Many of our competitors have longer operating histories, significantly
greater financial, technical, marketing and other resources, significantly
greater name recognition and a larger installed base of customers than do we.
In addition, many of our competitors have well-established relationships with
our current and potential customers and have extensive knowledge of our
industry. It is possible that new competitors or alliances among competitors
may emerge and rapidly acquire significant market share. We also expect that
competition will increase as a result of industry consolidations. See "Risk
Factors-We face substantial competition and may not be able to compete
effectively."
Intellectual Property
We rely upon a combination of patent, copyright, trade secret and trademark
laws to protect our intellectual property. We currently have one issued U.S.
patent and eight U.S. patent applications pending. Our pending applications, if
allowed, in conjunction with our issued patent, will cover a material portion
of our products and services. We have also filed international patent
applications corresponding to four of our U.S. applications.
In addition, we have one U.S. trademark registration and seven pending U.S.
trademark registrations, two trademark registrations in the European Union, one
trademark registration in Australia, as well as additional pending trademark
registrations in Australia, Canada, the European Union, India, Japan, South
Korea and Taiwan. Although we rely on patent, copyright, trade secret and
trademark law to protect our technology, we
12
believe that factors such as the technological and creative skills of our
personnel, new product developments, frequent product enhancements and reliable
product maintenance are more essential to establishing and maintaining a
technology leadership position. Others may develop technologies that are
similar or superior to our technology.
We generally enter into confidentiality or license agreements with our
employees, consultants and alliance partners, and generally control access to
and distribution of our software, documentation and other proprietary
information. Despite our efforts to protect our proprietary rights,
unauthorized parties may attempt to copy or otherwise obtain and use our
products or technology or to develop products with the same functionality as
our products. Policing unauthorized use of our products is difficult, and we
cannot be certain that the steps we have taken will prevent misappropriation of
our technology, particularly in foreign countries where the laws may not
protect proprietary rights as fully as do the laws of the United States. In
addition, some of our license agreements require us to place the source code
for our products into escrow. These agreements generally provide that some
parties will have a limited, non-exclusive right to use this code if:
. there is a bankruptcy proceeding instituted by or against us;
. we cease to do business without a successor; or
. we discontinue providing maintenance and support.
Substantial litigation regarding intellectual property rights exists in the
software industry. Our software products may be increasingly subject to third-
party infringement claims as the number of competitors in our industry segment
grows and the functionality of products in different industry segments
overlaps. Some of our competitors in the market for customer communications
software may have filed or may intend to file patent applications covering
aspects of their technology that they may claim our technology infringes. Some
of these competitors may make a claim of infringement against us with respect
to our products and technology. See "Risk Factors--We may become involved in
litigation over proprietary rights, which could be costly and time consuming."
Employees
As of December 31, 2000, we had 1,181 full-time employees, 320 of whom were
in our professional services group, 430 in sales and marketing, 315 in research
and development, and 116 in finance, administration and operations. We recently
restructured our organization in the first quarter of 2001 with workforce
reductions of approximately 300 employees, in order to streamline operations,
reduce costs and bring our staffing and structure in line with industry
standards and current economic conditions.
Our future performance depends in significant part upon the continued
service of our key technical, sales and marketing, and senior management
personnel, none of whom is bound by an employment agreement requiring service
for any defined period of time. The loss of the services of one or more of our
key employees could harm our business.
Our future success also depends on our continuing ability to attract, train
and retain highly qualified technical, sales and managerial personnel.
Competition for these personnel is intense, particularly in the San Francisco
Bay Area where we are headquartered. Due to the limited number of people
available with the necessary technical skills and understanding of the
Internet, we may not be able to retain or attract these key personnel in the
future. None of our employees are represented by a labor union. We have not
experienced any work stoppages and consider our relations with our employees to
be good. See "Risk Factors--We may be unable to hire and retain the skilled
personnel necessary to develop our engineering, professional services and
support capabilities in order to continue to grow," "--We may face difficulties
in hiring and retaining qualified sales personnel to sell our products and
services, which could harm our ability to increase our revenues in the future,"
and "--Our workforce reduction and financial performance may adversely affect
the morale and performance of our personnel and our ability to hire new
personnel."
13
ITEM 2. PROPERTIES
Our corporate offices are located in Redwood City, California, where we
lease approximately 60,861 square feet under a lease that expires in October
2006. As of December 31, 2000, the annual base rent for this facility was
approximately $1.9 million. Also, we lease approximately 88,094 square feet of
space in two office buildings in Manchester, New Hampshire. The lease expires
in April 2005, and we have an option to extend the lease for two additional
five-year terms. In addition, we lease facilities and offices in several cities
throughout the United States, and internationally throughout Europe, Australia,
Japan, Singapore and Latin America. The terms of these leases began to expire
in August 2000, but automatically renewed unless earlier terminated. On
February 11, 2000, we entered into an agreement to lease approximately 62,500
additional square feet in Redwood City, California under a lease that expires
in December 2010. The annual base rent for this facility for the first year is
approximately $2.4 million. We believe that our corporate office space in
Redwood City and the other facilities we currently lease will be sufficient to
meet our needs through at least the next 12 months.
ITEM 3. LEGAL PROCEEDINGS
On October 8, 1999, Genesys Telecommunications Laboratories, Inc. filed a
complaint against us in the United States District Court for the District of
Delaware. Genesys subsequently amended its complaint to allege that our
Customer Messaging System 3.0 infringes one or more claims of two Genesys
patents. In connection with the license agreement and reseller agreement that
we entered into with Genesys on December 29, 2000, the complaint was dismissed
with prejudice. We are not currently a party to any other material legal
proceedings. See "Risk Factors--We may become involved in litigation over
proprietary rights, which could be costly and time consuming."
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's annual meeting of stockholders was held on October 4, 2000
(the "Annual Meeting"). The following matters were considered and voted upon at
the Annual Meeting:
The first matter related to the election of three directors, David M.
Beirne, Robert W. Frick and Steven T. Jurvetson, to serve for a three-year term
ending in the year 2003 and until their successors are duly elected and
qualified. The votes cast and withheld for such nominees were as follows:
Name For Withheld
---- --- --------
David M. Beirne.......................................... 59,576,795 130,824
Robert W. Frick.......................................... 59,482,922 224,697
Steven T. Jurvetson...................................... 59,437,318 270,301
The second matter related to the ratification of the appointment of
PricewaterhouseCoopers LLP as our independent auditors for the year ending
December 31, 2000. The votes cast for and against this action were 56,842,368
and 2,855,773, respectively, with 9,478 votes abstaining.
Based on these voting results, each of the directors nominated was elected
and the second matter was approved.
14
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth information regarding our current executive
officers and directors (with ages as of December 31, 2000):
Name Age Position
---- --- --------
James C. Wood........... 44 Chief Executive Officer and Chairman of the Board of Directors
David B. Fowler......... 47 President
Nigel K. Donovan........ 45 Chief Operating Officer
Art M. Rodriguez........ 45 Interim Chief Financial Officer
Toya A. Rico............ 40 Chief Personnel Officer
David M. Beirne......... 36 Director
Robert W. Frick......... 63 Director
Mark S. Gainey.......... 32 Director
Eric A. Hahn............ 40 Director
Charles A. Holloway,
Ph.D................... 64 Director
Steven T. Jurvetson..... 33 Director
James C. Wood. Mr. Wood joined us in April 2000 as a director in connection
with our acquisition of Silknet Software, Inc. and served as our President from
May 2000 until he was appointed as our Chief Executive Officer and Chairman of
the Board of Directors in January 2001. Mr. Wood founded Silknet in March 1995
and served as its Chairman of the Board, President and Chief Executive Officer.
From January 1988 until November 1994, Mr. Wood served as President and Chief
Executive Officer of CODA Incorporated, a subsidiary of CODA Limited, a
financial accounting software company. Mr. Wood also served as a director of
CODA Limited from November 1988 until November 1994. Mr. Wood holds a B.S. in
Electrical Engineering from Villanova University.
David B. Fowler. Mr. Fowler joined us in connection with our acquisition of
Silknet Software, Inc. and served as our Vice President, Corporate Marketing
from April 2000 until he was appointed as our President in January 2001. Prior
to joining us, from April 1999 to April 2000, Mr. Fowler served as Vice
President--Marketing of Silknet. From April 1995 to March 1999, Mr. Fowler
served as Vice President--Sales and Marketing for Gradient Technologies, a
software company. From December 1993 to March 1995, Mr. Fowler served as Vice
President--Sales and Marketing for FTP Software. Mr. Fowler holds a B.S. in
Computer Science from Worcester Polytechnic Institute and an M.B.A. from New
York University.
Nigel K. Donovan. Mr. Donovan joined us in connection with our acquisition
of Silknet Software, Inc. and served as our Vice President, Development from
April 2000 until he was appointed as our Chief Operating Officer in January
2001. Prior to joining us, from February 1999 to April 2000, Mr. Donovan served
as Senior Vice President and Chief Operating Officer of Silknet. From November
1995 to February 1999 Mr. Donovan served as Silknet's Vice President--
Professional Services. From November 1996 to October 1998, he also served as
Silknet's Treasurer and from May 1997 to October 1998 as its Chief Financial
Officer. In addition, Mr. Donovan served as director of Silknet from October
1996 to February 1999. From March 1988 until October 1995, Mr. Donovan served
as Vice President--Professional Services of CODA Incorporated. Mr. Donovan
holds a B.A. in Accounting and Finance from the London School of Business
Studies.
Art M. Rodriguez. Mr. Rodriguez joined us in July 2000 as our Vice President
of Finance and currently serves as the interim Chief Financial Officer. Prior
to joining us, Mr. Rodriguez spent 15 years in various financial positions at
Hewlett Packard Co., most recently as the controller for the Customer Service &
Support Group. Before his work at Hewlett Packard, Mr. Rodriguez served as a
Captain in the United States Marine Corps. Mr. Rodriguez has an M.B.A. from the
University of California at Los Angeles.
Toya A. Rico. Ms. Rico joined us in January 2000 as Vice President, Human
Resources and was appointed as our Chief Personnel Officer in January 2001.
Prior to joining us, from October 1996 through May
15
1999, Ms. Rico served as Director, Human Resources at Adaptec, Inc., a
bandwidth management company. From May 1988 through September 1996, Ms. Rico
served in a variety of human resources management positions at 3Com
Corporation, a computer networking company. Ms. Rico holds a B.A. in
Communications from California State University, San Francisco.
David M. Beirne. Mr. Beirne has served as one of our directors since
September 1997. Mr. Beirne has been a Managing Member of Benchmark Capital, a
venture capital firm, since June 1997. Prior to joining Benchmark Capital, Mr.
Beirne founded Ramsey/Beirne Associates, an executive search firm, and served
as its Chief Executive Officer from October 1987 to June 1997. Mr. Beirne
serves on the board of directors of Scient Corporation, PlanetRx.com, Inc.,
Webvan Group, Inc., 1-800-FLOWERS.COM, Inc., and several private companies. Mr.
Beirne holds a B.S. in Management from Bryant College.
Robert W. Frick. Mr. Frick has served as one of our directors since August
1999. Mr. Frick previously served as the Vice Chairman of the Board, Chief
Financial Officer and head of the World Banking Group for Bank of America, as
Managing Director of BankAmerica International, and as President of Bank of
America's venture capital subsidiary. He is now retired. Mr. Frick previously
served as a director of Connectify, Inc. from its founding to its acquisition
by us, and he currently serves on the board of directors of six private
companies. Mr. Frick holds a B.S. in Civil Engineering and an M.B.A. from
Washington University in St. Louis, Missouri.
Eric A. Hahn. Mr. Hahn has served as one of our directors since June 1998.
Mr. Hahn is a founding partner of Inventures Group, a venture capital firm.
From November 1996 to June 1998, Mr. Hahn served as the Executive Vice
President and later as the Chief Technical Officer of Netscape Communications
Corporation and served as a member of Netscape's Executive Committee. Mr. Hahn
also served as General Manager of Netscape's Server Products Division,
overseeing Netscape's product development and marketing activities for
enterprise Internet, intranet and extranet servers, from November 1995 to
November 1996. Prior to joining Netscape, from February 1993 to November 1995,
Mr. Hahn was founder and Chief Executive Officer of Collabra Software, Inc., a
groupware provider that was acquired by Netscape. Mr. Hahn holds a B.S. and
Ph.D. in Computer Science from the Worcester Polytechnic Institute.
Dr. Charles A. Holloway. Dr. Holloway has served as one of our directors
since December 1996. Dr. Holloway holds the Kleiner, Perkins, Caufield & Byers
Professorship in Management at the Stanford Graduate School of Business and has
been a faculty member of the Stanford Graduate School of Business since 1968.
Dr. Holloway is also currently co-director of the Stanford Center for
Entrepreneurial Studies at the Graduate School of Business. Dr. Holloway was
the founding co-chair of the Stanford Integrated Manufacturing Association, a
cooperative effort between the Graduate School of Business and the School of
Engineering, which focuses on research and curriculum development in
manufacturing and technology. Dr. Holloway serves on the board of directors of
several private companies. Dr. Holloway holds a B.S. in Electrical Engineering
from the University of California at Berkeley and an M.S. in Nuclear
Engineering and Ph.D. in Business Administration from the University of
California, Los Angeles.
Steven T. Jurvetson. Mr. Jurvetson has served as one of our directors since
April 1997. Mr. Jurvetson has been a Managing Director of Draper Fisher
Jurvetson, a venture capital firm, since June 1995. Prior to joining Draper
Fisher Jurvetson, from July 1990 to September 1993, Mr. Jurvetson served as a
consultant with Bain & Company, a management consulting firm. Mr. Jurvetson
served as a research and development engineer at Hewlett-Packard during the
summer months from June 1987 to August 1989. Mr. Jurvetson serves on the boards
of directors of Cognigine Corporation, FastParts, Inc., iTv Corp., Tacit
Knowledge Corporation, Third Voice, Inc., ReleaseNow.com Corporation, Everdream
Corporation and Vivaldi Networks, Inc. Mr. Jurvetson holds a B.S. and an M.S.
in Electrical Engineering from Stanford University and an M.B.A. from the
Stanford Graduate School of Business.
16
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Our common stock is listed on the Nasdaq Stock Market under the Symbol
"KANA".
The following table sets forth the range of high and low closing sales
prices for each period indicated, adjusted for the two-for-three reverse stock
split effective September 1999 and the two-for-one forward stock split
effective February 2000:
High Low
------- ------
Fiscal 1999
Third Quarter (from September 22, 1999)...................... $ 26.13 $22.78
Quarter Ended December 31, 1999.............................. 122.50 24.03
Fiscal 2000
First Quarter................................................ 169.81 68.00
Second Quarter............................................... 61.88 29.63
Third Quarter................................................ 72.25 22.00
Fourth Quarter............................................... 28.36 8.84
There were approximately 712 stockholders of record as of February 28, 2001.
This number does not include stockholders whose shares are held in trust by
other entities. The actual number of stockholders is greater than this number
of holders of record. We estimate that the beneficial stockholders of the
shares of our common stock as of February 14, 2001 was approximately 86,564.
We have not paid any cash dividends on our capital stock. We currently
intend to retain our earnings to fund the development and growth of our
business and, therefore, do not anticipate paying any cash dividends in the
foreseeable future. In addition, our existing credit facilities prohibit the
payment of cash or stock dividends on our capital stock without the lender's
prior written consent. See Item 7--"Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital
Resources."
17
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the consolidated financial statements of Kana
Communications, Inc. and the notes to consolidated financial statements
included elsewhere in this annual report on Form 10-K.
The consolidated statement of operations data for each of the years in the
four-year period ended December 31, 2000, and the consolidated balance sheet
data at December 31, 1999 and 2000 are derived from our consolidated financial
statements. The diluted net loss per share computation excludes potential
shares of common stock (preferred stock, options to purchase common stock and
common stock subject to repurchase rights held by us), since their effect would
be antidilutive. See Note 1 of Notes to Consolidated Financial Statements for a
detailed explanation of the determination of the shares used to compute actual
basic and diluted net loss per share and goodwill impairment in the year ended
December 31, 2000. The historical results are not necessarily indicative of
results to be expected for any future period. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
Years Ended December 31,
-----------------------------------------
2000 1999 1998 1997
----------- --------- -------- -------
(in thousands, except per share
amounts)
Consolidated Statement of
Operations Data:
Revenues:
License........................... $ 75,360 $ 10,536 $ 2,014 $ --
Service........................... 43,887 3,528 333 617
----------- --------- -------- -------
Total revenues.................... 119,247 14,064 2,347 617
----------- --------- -------- -------
Cost of revenues:
License........................... 2,856 271 54 --
Service........................... 56,201 6,610 666 253
----------- --------- -------- -------
Total cost of revenues............. 59,057 6,881 720 253
----------- --------- -------- -------
Gross profit....................... 60,190 7,183 1,627 364
----------- --------- -------- -------
Operating expenses:
Sales and marketing............... 88,186 21,199 5,504 512
Research and development.......... 42,724 12,854 5,669 971
General and administrative........ 18,945 5,018 1,826 378
Amortization of stock-based
compensation..................... 14,715 80,476 1,456 113
Amortization of goodwill and
identifiable intangibles......... 873,022 -- -- --
In process research and
development...................... 6,900 -- -- --
Acquisition related costs......... 6,564 5,635 -- --
Goodwill impairment............... 2,084,841 -- -- --
----------- --------- -------- -------
Total operating expenses.......... 3,135,897 125,182 14,455 1,974
----------- --------- -------- -------
Operating loss..................... (3,075,707) (117,999) (12,828) (1,610)
Other income (expense), net........ 4,834 (744) 227 57
----------- --------- -------- -------
Net loss.......................... $(3,070,873) $(118,743) $(12,601) $(1,553)
=========== ========= ======== =======
Basic and diluted net loss per
share............................. $ (39.57) $ (4.61) $ (2.01) $ (0.37)
=========== ========= ======== =======
Shares used in computing basic and
diluted net loss per share
amounts........................... 77,610 25,772 6,258 4,152
=========== ========= ======== =======
December 31,
-----------------------------------------
2000 1999 1998 1997
----------- --------- -------- -------
(in thousands)
Consolidated Balance Sheet Data:
Cash, cash equivalents and short-
term investments.................. $ 76,499 $ 53,217 $ 14,035 $ 5,594
Working capital.................... 54,234 38,591 11,833 5,364
Total assets....................... 980,124 70,229 16,876 6,158
Total stockholders' equity......... $ 899,452 $ 48,500 $ 12,951 $ 5,684
18
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of the Financial Condition and Results of
Operations contains forward-looking statements within the meaning of Section
21e of the Securities Exchange Act of 1934. Our actual results and timing of
certain events could differ materially from those anticipated in these forward-
looking statements as a result of certain factors, including, but not limited
to, those set forth under "Risk Factors," elsewhere in this report and in our
other public filings.
Overview
We are a leading provider of enterprise Relationship Management (eRM)
software solutions that deliver integrated communication and business
applications built on a Web-architectured platform. We were incorporated in
July 1996 in California and were reincorporated in Delaware in September 1999.
We had no significant operations until 1997. In February 1998, we released the
first commercially available version of the Kana platform. To date, we have
derived substantially all of our revenues from licensing our software and
related services, and we have sold our products worldwide primarily through our
direct sales force.
On August 13, 1999, we completed a merger with Connectify pursuant to which
Connectify became our wholly-owned subsidiary. In connection with the merger,
we issued approximately 6,982,542 shares of our common stock in exchange for
all outstanding shares of Connectify capital stock and reserved 416,690 shares
of common stock for issuance upon the exercise of Connectify options and
warrants we assumed in connection with the merger. The merger was accounted for
as a pooling of interests.
On December 3, 1999, we completed a merger with Business Evolution pursuant
to which Business Evolution became our wholly-owned subsidiary. In connection
with the acquisition of Business Evolution, 1,890,200 shares of our common
stock were issued for all outstanding shares and warrants of Business
Evolution. This transaction was accounted for as a pooling of interests.
On December 3, 1999, we completed a merger with netDialog pursuant to which
netDialog became our wholly-owned subsidiary. In connection with the
acquisition of netDialog, 1,120,286 shares of our common stock were issued for
all outstanding shares, warrants and convertible notes of netDialog. This
transaction was accounted for as a pooling of interests.
On April 19, 2000, we completed a merger with Silknet under which Silknet
became our wholly-owned subsidiary. In connection with the Silknet merger, each
share of Silknet common stock outstanding immediately prior to the completion
of the merger was converted into the right to receive 1.66 shares of our common
stock and we assumed Silknet's outstanding stock options and warrants based on
the exchange ratio, issuing approximately 29.2 million shares of our common
stock and reserving 4.0 million shares of common stock for issuance upon the
exercise of Silknet options and warrants we assumed in connection with the
merger. The transaction was accounted for using the purchase method of
accounting. In connection with the merger, we have recorded goodwill and
intangible assets of approximately $3.8 billion, which we were amortizing over
a period of three years.
During the quarter ended December 31, 2000, we performed an impairment
assessment of the identifiable intangibles and goodwill recorded in connection
with the acquisition of Silknet. As a result of our review, we recorded a $2.1
billion impairment charge to reduce our goodwill. The remaining goodwill and
identifiable intangibles balance of approximately $800.0 million will be
amortized over the remaining useful life.
On June 12, 2000, we sold 2,500,000 shares of our common stock for gross
proceeds of $125.0 million (net proceeds of approximately $120.0 million) in a
private placement transaction.
We derive our revenues from the sale of software product licenses and from
professional services including implementation, consulting, hosting and
maintenance. License revenue is recognized when persuasive
19
evidence of an agreement exists, the product has been delivered, the
arrangement does not involve significant customization of the software,
acceptance has occurred, the license fee is fixed and determinable and
collection of the fee is probable. If the arrangement involves significant
customization of the software, the fee, excluding the portion attributable to
maintenance, is recognized using the percentage-of-completion method. Service
revenue includes revenues from maintenance contracts, implementation,
consulting and hosting services. Revenue from maintenance contracts is
recognized ratably over the term of the contract. Revenue from implementation,
consulting and hosting services is recognized as the services are provided.
Revenue under arrangements where multiple products or services are sold
together is allocated to each element based on their relative fair values.
Our cost of license revenue includes royalties due to third parties for
technology integrated into some of our products, the cost of product
documentation, the cost of the media used to deliver our products and shipping
costs. Cost of service revenue consists primarily of personnel-related
expenses, subcontracted consultants, travel costs, equipment costs and overhead
associated with delivering professional services to our customers.
Our operating expenses are classified into three general categories: sales
and marketing, research and development, and general and administrative. We
classify all charges to these operating expense categories based on the nature
of the expenditures. Although each category includes expenses that are unique
to the category, some expenditures, such as compensation, employee benefits,
recruiting costs, equipment costs, travel and entertainment costs, facilities
costs and third-party professional services fees, occur in each of these
categories.
We allocate the total costs for information services and facilities to each
functional area that uses the information services and facilities based on its
relative headcount. These allocated costs include rent and other facility-
related costs, communication charges and depreciation expense for furniture and
equipment.
Since 1997, we have incurred substantial costs to develop our products and
to recruit, train and compensate personnel for our engineering, sales,
marketing, client services and administration departments. As a result, we have
incurred substantial losses since inception and, for the twelve months ended
December 31, 2000, incurred a net loss of $3.1 billion. As of December 31,
2000, we had an accumulated deficit of $3.2 billion. We believe our future
success is contingent upon providing superior customer service, increasing our
customer base and developing our products. We expect to decrease our operating
losses for the foreseeable future.
As of December 31, 2000, we had 1,181 full-time employees. We recently
restructured our organization in the first quarter of 2001 with workforce
reductions of approximately 300 employees, in order to streamline operations,
reduce costs and bring our staffing and structure in line with industry
standards. We may reduce our workforce again in the near future.
We believe that our prospects must be considered in light of the risks,
expenses and difficulties frequently experienced by companies in early stages
of development, particularly companies in new and rapidly evolving markets like
ours. Although we have experienced significant revenue growth recently, this
trend may not continue, particularly in light of increasing competition in our
markets, the worsening economic outlook and declining expenditures on
enterprise software products. Furthermore, we may not achieve or maintain
profitability in the future.
20
QUARTERLY RESULTS OF OPERATIONS
The following tables set forth a summary of our unaudited quarterly
operating results for each of the eight quarters in the period ended December
31, 2000. The information has been derived from our unaudited consolidated
financial statements that, in management's opinion, have been prepared on a
basis consistent with the audited consolidated financial statements contained
elsewhere in this annual report and include all adjustments, consisting of only
normal recurring adjustments, necessary for a fair presentation of this
information when read in conjunction with our audited consolidated financial
statements and notes thereto. The operating results for any quarter are not
necessarily indicative of results for any future period.
Quarter Ended
-------------------------------------------------------------------------------------
Mar. 31, June 30, Sept. 30, Dec. 31, March 31, June 30, Sept. 30, Dec. 31,
1999 1999 1999 1999 2000 2000 2000 2000
-------- -------- --------- -------- --------- --------- --------- -----------
(in thousands)
Consolidated Statement
of Operations Data:
Revenues:
License................ $ 1,209 $ 1,821 $ 2,781 $ 4,725 $ 7,329 $ 15,574 $ 23,730 $ 28,727
Service................ 280 517 998 1,733 3,361 9,909 16,913 13,704
------- ------- -------- -------- -------- --------- --------- -----------
Total revenues........ 1,489 2,338 3,779 6,458 10,690 25,483 40,643 42,431
------- ------- -------- -------- -------- --------- --------- -----------
Cost of revenues:
License................ 34 38 52 147 143 658 918 1,137
Service................ 498 851 2,191 3,070 4,032 10,772 16,354 25,043
------- ------- -------- -------- -------- --------- --------- -----------
Total cost of
revenues............. 532 889 2,243 3,217 4,175 11,430 17,272 26,180
------- ------- -------- -------- -------- --------- --------- -----------
Gross profit............ 957 1,449 1,536 3,241 6,515 14,053 23,371 16,251
------- ------- -------- -------- -------- --------- --------- -----------
Operating expenses:
Sales and marketing.... 2,479 4,180 5,482 9,058 11,210 21,338 25,749 29,889
Research and
development........... 2,329 2,732 3,384 4,409 5,239 11,059 12,993 13,433
General and
administrative........ 725 1,086 1,402 1,805 1,835 3,747 6,347 7,016
Amortization of stock-
based compensation.... 520 2,734 3,377 73,845 3,320 3,593 3,790 4,012
Amortization of
goodwill and
identifiable
intangibles........... -- -- -- -- -- 247,043 312,865 313,114
In process research and
development........... -- -- -- -- -- 6,900 -- --
Acquisition related
costs................. -- -- 910 4,725 -- 6,564 -- --
Goodwill impairment.... -- -- -- -- -- -- -- 2,084,841
------- ------- -------- -------- -------- --------- --------- -----------
Total operating
expenses............. 6,053 10,732 14,555 93,842 21,604 300,244 361,744 2,452,305
------- ------- -------- -------- -------- --------- --------- -----------
Operating loss.......... (5,096) (9,283) (13,019) (90,601) (15,089) (286,191) (338,373) (2,436,054)
Other income (expense),
net.................... (125) (394) (231) 6 644 1,247 2,039 904
------- ------- -------- -------- -------- --------- --------- -----------
Net loss................ $(5,221) $(9,677) $(13,250) $(90,595) $(14,445) $(284,944) $(336,334) $(2,435,150)
======= ======= ======== ======== ======== ========= ========= ===========
As a Percentage of Total
Revenues:
Revenues:
License................ 81.2% 77.9% 73.6% 73.2% 68.6% 61.1% 58.4% 67.7%
Service................ 18.8 22.1 26.4 26.8 31.4 38.9 41.6 32.3
------- ------- -------- -------- -------- --------- --------- -----------
Total revenues........ 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
------- ------- -------- -------- -------- --------- --------- -----------
Cost of revenues:
License................ 2.3 1.6 1.4 2.3 1.3 2.6 2.3 2.7
Service................ 33.4 36.4 58.0 47.5 37.7 42.3 40.2 59.0
------- ------- -------- -------- -------- --------- --------- -----------
Total cost of
revenues............. 35.7 38.0 59.4 49.8 39.0 44.9 42.5 61.7
------- ------- -------- -------- -------- --------- --------- -----------
Gross profit............ 64.3 62.0 40.6 50.2 61.0 55.1 57.5 38.3
------- ------- -------- -------- -------- --------- --------- -----------
Selected operating
expenses:
Sales and marketing.... 166.5 178.8 145.1 140.3 104.9 83.7 63.4 70.4
Research and
development........... 156.4 116.9 89.5 68.3 49.0 43.4 32.0 31.7
General and
administrative........ 48.7 46.4 37.1 27.9 17.2 14.7 15.6 16.5
21
The amount and timing of our operating expenses generally will vary from
quarter to quarter depending on our level of actual and anticipated business
activities. Our revenues and operating results are difficult to forecast and
will fluctuate, and we believe that period-to-period comparisons of our
operating results will not necessarily be meaningful. As a result, you should
not rely upon them as an indication of future performance.
Results of Operations
The following table sets forth selected data for the periods presented
expressed as a percentage of total revenues.
Years Ended
December 31,
-------------------
2000 1999 1998
----- ----- -----
Revenues:
License................................................ 63.2% 74.9% 85.8%
Service................................................ 36.8 25.1 14.2
----- ----- -----
Total revenues........................................ 100.0 100.0 100.0
----- ----- -----
Cost of revenues:
License................................................ 2.4 1.9 2.3
Service................................................ 47.1 47.0 28.4
----- ----- -----
Total cost of revenues................................ 49.5 48.9 30.7
----- ----- -----
Gross profit............................................ 50.5 51.1 69.3
Selected operating expenses:
Sales and marketing.................................... 74.0 150.7 234.5
Research and development............................... 35.8 91.4 241.5
General and administrative............................. 15.9 35.7 77.8
COMPARISON OF THE YEARS ENDED DECEMBER 31, 2000 AND 1999
Revenues
Total revenues increased by 748% to $119.2 million for the year ended
December 31, 2000 from $14.1 million for the year ended December 31, 1999
primarily as a result of increased license revenue. License revenues increased
by 615% to $75.4 million for the year ended December 31, 2000 from $10.5
million for 1999. This increase in license revenue was due primarily to
increased market acceptance of our products, expansion of our product line and
increased sales generated by our expanded sales force and the acquisition of
Silknet. License revenue represented 63% of total revenues for the year ended
December 31, 2000 and 75% of total revenues for 1999.
Service revenues increased by 1,144% to $43.9 million for the year ended
December 31, 2000 from $3.5 million for 1999. Service revenue increased
primarily due to increased licensing activity described above, resulting in
increased revenue from customer implementations, system integration projects,
maintenance contracts and hosted service. Service revenue represented 37% of
total revenues for the year ended December 31, 2000 and 25% of total revenues
for 1999.
Revenues from international sales were $19.5 million and $1.4 million in the
years ended December 31, 2000 and 1999. Our international revenues were derived
from sales in Europe, Canada, Asia Pacific and Latin America.
Cost of Revenues
Total cost of revenues increased by 758% to $59.1 million for the year ended
December 31, 2000 from $6.9 million for the year ended December 31, 1999,
primarily due to increased cost of service revenues. Cost
22
of license revenues increased by 954% to $2.9 million for the year ended
December 31, 2000 from $271,000 for the year ended December 31, 1999, the
increase mainly associated with increased license revenues and new third party
software royalties. As a percentage of license revenues, cost of license
revenues was 4% for the year ended December 31, 2000 and 3% for the year ended
December 31, 1999. Cost of license revenues includes third party software
royalties, product packaging, documentation, production and delivery costs for
shipments to customers.
Cost of service revenues consists primarily of salaries and related expenses
for our customer support, implementation and training services organization and
allocation of facility costs and system costs incurred in providing customer
support. Cost of service revenues increased by 750% to $56.2 million for the
year ended December 31, 2000 from $6.6 million for the year ended December 31,
1999. The growth in cost of service revenues was attributable to an increase in
personnel dedicated to support our growing number of customers and related
recruiting, travel, related facility and system costs and third party
consulting expenses. Additional increases are attributable to our acquisition
of Silknet and the inclusion of its cost of service revenues from the effective
date of the merger. As a percentage of service revenues, cost of service
revenues was 128% in 2000 and 187% in 1999. We anticipate that cost of service
revenue will be relatively stable in absolute dollars in future periods.
Operating Expenses
Sales and Marketing. Sales and marketing expenses consist primarily of
compensation and related costs for sales and marketing personnel and
promotional expenditures, including public relations, advertising, trade shows,
and marketing collateral materials. Sales and marketing expenses increased by
316% to $88.2 million for the year ended December 31, 2000 from $21.2 million
for the year ended December 31, 1999. This increase was attributable primarily
to the addition of sales and marketing personnel from internal growth and the
Silknet acquisition, the expansion of our international sales offices, an
increase in sales commissions associated with increased revenues and higher
marketing costs due to expanded advertising and promotional activities. As a
percentage of total revenues, sales and marketing expenses were 74% for the
year ended December 31, 2000 and 151% for the year ended December 31, 1999.
This decrease in sales and marketing expense as a percent of total revenues was
due primarily to the increase in total revenues over the prior period. We
anticipate that sales and marketing expenses will be relatively stable in
absolute dollars, but will vary as a percentage of total revenues from period
to period.
Research and Development. Research and development expenses consist
primarily of compensation and related costs for research and development
employees and contractors and enhancement of existing products and quality
assurance activities. Research and development expenses increased by 232% to
$42.7 million for the year ended December 31, 2000 from $12.9 million for the
year ended December 31, 1999. This increase was attributable primarily to the
addition of personnel, due to internal growth and the Silknet acquisition,
product development and related benefits, and consulting expenses. As a
percentage of total revenues, research and development expenses were 36% for
the year ended December 31, 2000 and 91% for the year ended December 31, 1999.
This decrease in research and development expense as a percent of total
revenues was due primarily to the increase in total revenues over the prior
period. We expect to continue to make investments in research and development,
but anticipate that research and development expenses will be relatively stable
in absolute dollars, but will vary as a percentage of total revenues from
period to period.
General and Administrative. General and administrative expenses increased by
278% to $18.9 million for the year ended December 31, 2000 from $5.0 million
for the year ended December 31, 1999, due primarily to increased personnel from
internal growth and the Silknet acquisition, increase in allowance for doubtful
accounts, increase in legal and other professional service provider fees. As a
percentage of total revenues, general and administrative expenses were 16% for
the year ended December 31, 2000 and 36% for the year ended December 31, 1999.
This decrease in general and administrative expenses as a percent of total
revenues was due primarily to the proportionately greater increase in total
revenues than general and administrative expenses over the prior period. We
expect that general and administrative expenses will be relatively stable in
absolute dollars. However, we expect that these expenses will vary as a
percentage of total revenues from period to period.
23
Amortization of Stock-Based Compensation
In connection with the granting of stock options to our employees, we
recorded unearned stock-based compensation totaling approximately $101.0
million through December 31, 2000. This amount represents the total difference
between the exercise prices of stock options and the deemed fair market value
of the underlying common stock for accounting purposes on the date these stock
options were granted. This amount is included as a component of stockholders'
equity and is being amortized on an accelerated basis by charges to operations
over the vesting period of the options, consistent with the method described
in FASB Interpretation No. 28.
On September 6, 2000, we issued to Accenture 400,000 shares of common stock
and a warrant to purchase up to 725,000 shares of common stock pursuant to a
stock and warrant purchase agreement in connection with our global strategic
alliance. The shares of the common stock issued were fully vested, and we have
recorded a charge of approximately $14.8 million to be amortized over the
four-year term of the agreement. The portion of the warrant to purchase
125,000 shares of common stock is fully vested with the remainder becoming
vested upon the achievement of certain performance goals. The vested warrants
were valued using the Black-Scholes model resulting in a charge of $1.0
million to be amortized over the four-year term of the agreement. We will
incur a charge to stock-based compensation for the unvested portion of the
warrant when performance goals are achieved.
On December 31, 2000, Accenture earned and vested in a portion of the
warrant to purchase 121,628 shares of common stock. This vesting of shares
resulted in a stock-based charge to operations of $968,000 during the quarter
ended December 31, 2000. As of December 31, 2000, shares of common stock under
the warrant which were unvested had a fair value of approximately $5.0 million
based upon the fair market value of our common stock at such date.
On February 28, 2001, we filed a tender offer statement on Schedule TO
announcing our offer to exchange certain eligible options outstanding under
the stock option plans for new options to purchase shares of our common stock
and for restricted shares of our common stock. The new options will be granted
on or after six months and one day after the date the tendered options are
accepted and cancelled. There are options to purchase approximately 18,000,000
shares of our common stock that could be exchanged if all the options eligible
under stock option plans were tendered by the employees. We will incur a
charge to compensation expense in connection with the issuance of the
restricted shares of common stock, based upon the fair market value of the
common stock at the time of the exchange. The charge to compensation expense
will be amortized over the six month vesting term of the restricted stock. Had
the compensation cost related to the maximum number of restricted shares
issuable under the offer been determined based upon the fair market value of
$3.0625 per share at the date of the tender offer, the total compensation
charge would have approximated $6.9 million.
As of December 31, 2000, there was approximately $21.6 million of total
unearned deferred stock-based compensation remaining to be amortized.
The amortization of stock-based compensation by operating expense is
detailed as follows (in thousands):
Years ended, December
31,
----------------------
2000 1999 1998
------- ------- ------
Cost of service...................................... $ 2,816 $19,752 $ 143
Sales and marketing.................................. 8,078 34,000 564
Research and development............................. 2,831 19,864 438
General and administrative........................... 990 6,860 311
------- ------- ------
Total............................................... $14,715 $80,476 $1,456
======= ======= ======
24
Amortization of Goodwill and Identifiable Intangibles
On April 19, 2000, we completed a merger with Silknet. As a result of the
merger, $3.8 billion was allocated to goodwill and identifiable intangibles.
This amount is being amortized on a straight-line basis over a period of three
years from the date of acquisition. We recorded $873.0 million in amortization
for the year ended December 31, 2000.
In Process Research and Development
In connection with the merger of Silknet, net intangibles of $6.9 million
were allocated to in process research and development. The fair value
allocation to in-process research and development was determined by identifying
the research projects for which technological feasibility has not been achieved
and which have no alternative future use at the merger date, assessing the
stage and expected date of completion of the research and development effort at
the merger date, and calculating the net present value of the cash flows
expected to result from the successful deployment of the new technology
resulting from the in-process research and development effort.
The stages of completion were determined by estimating the costs and time
incurred to date relative to the costs and time incurred to develop the in-
process technology into a commercially viable technology or product, while
considering the relative difficulty of completing the various tasks and
obstacles necessary to attain technological feasibility. As of the date of the
acquisition, Silknet had two projects in process that were 90% complete.
The estimated net present value of cash flows was based on incremental
future cash flows from revenues expected to be generated by the technologies in
the process of development, taking into account the characteristics and
applications of the technologies, the size and growth rate of existing and
future markets and an evaluation of past and anticipated technology and product
life cycles. Estimated net future cash flows included allocations of operating
expenses and income taxes but excluded the expected completion costs of the in-
process projects, and were discounted at a rate of 20% to arrive at a net
present value. The discount rate included a factor that took into account the
uncertainty surrounding the successful deployment of in-process technology
projects. This net present value was allocated to in-process research and
development based on the percentage of completion at the merger date.
Acquisition Related Costs
In connection with the Silknet merger, we recorded $6.6 million of
transaction costs and merger-related integration expenses. These amounts
consisted primarily of merger-related advertising and announcements of $4.5
million and duplicate facility costs of $1.0 million.
Goodwill Impairment
We performed an impairment assessment of the identifiable intangibles and
goodwill recorded in connection with the acquisition of Silknet. The assessment
was performed primarily due to the significant sustained decline in our stock
price since the valuation date of the shares issued in the Silknet acquisition
resulting in our net book value of our assets prior to the impairment charge
significantly exceeding our market capitalization, the overall decline in the
industry growth rates, and our lower fourth quarter of 2000 actual and
projected operating results. As a result of our review, we recorded a $2.1
billion impairment charge to reduce goodwill. The charge was determined based
upon our estimated discounted cash flows over the remaining estimated useful
life of the goodwill using a discount rate of 20%. The assumptions supporting
the cash flows including the discount rate were determined using our best
estimates as of such date. The remaining goodwill balance of approximately
$800.0 million will be amortized over its remaining useful life. We will
continue to assess the recoverability of the remaining goodwill and intangibles
periodically in accordance with our policy.
25
Other Income (Expense), net
Other income (expense), net in 2000 consists primarily of interest earned on
cash and short-term investments and in 1999, interest expense related to
warrants issued to convertible debt holders offset by interest income. Other
income (expense), net was income of $4.8 million for the year ended December
31, 2000 and expense of $744,000 for the year ended December 31, 1999. The
increase in other income (expense), net was primarily interest income earned on
higher average cash balances and lower interest expense paid on debt.
Provision for Income Taxes
We have incurred operating losses for all periods from inception through
December 31, 2000, and therefore have not recorded a provision for income
taxes. We have recorded a valuation allowance for the full amount of our gross
deferred tax assets, as the future realization of the tax benefit is not
currently likely.
As of December 31, 2000 and December 31, 1999, we had net operating loss
carryforwards for federal and state tax purposes of approximately $122.8
million and $53.6 million, respectively. These federal and state loss
carryforwards are available to reduce future taxable income. The federal loss
carryforwards expire at various dates into the year 2020. Under the provisions
of the Internal Revenue Code of 1986, as amended, substantial changes in
ownership may limit the amount of net operating loss carryforwards that could
be utilized annually in the future to offset taxable income.
Net Loss
Our net loss was $3.1 billion and $118.7 million for the years ended
December 31, 2000, and 1999 respectively. We have experienced substantial
increases in our expenditures since our inception consistent with growth in our
operations and personnel. In addition, goodwill impairment, amortization of
goodwill and identifiable intangibles and stock based compensation charges have
contributed to the significant increase in net loss during 2000. We anticipate
that our expenditures will continue to increase in the future. Although our
revenue has grown in recent quarters, we cannot be certain that we can sustain
this growth or that we will generate sufficient revenue to attain
profitability.
COMPARISON OF THE YEARS ENDED DECEMBER 31, 1999 AND 1998
Revenue
Total revenues increased by 500% to $14.1 million for the year ended
December 31, 1999 from $2.3 million for the year ended December 31, 1998.
License revenues increased by 423% to $10.5 million for the year ended December
31, 1999 from $2.0 million for 1998. This increase in license revenue was due
primarily to increased market acceptance of our products, expansion of our
product line and increased sales generated by our expanded sales force.
Service revenues increased by 960% to $3.5 million for the year ended
December 31, 1999 from $333,000 for 1998. Service revenue increased primarily
due to increased licensing activity, resulting in increased revenue from
maintenance contracts, customer implementations and hosted service. Service
revenue represented 25% of total revenues for the year ended December 31, 1999
and 14% of total revenues for 1998.
Cost of Revenues
Total cost of revenues increased by 856% to $6.9 million for the year ended
December 31, 1999 from $720,000 for the year ended December 31, 1998, primarily
due to increased cost of service revenues. Cost of service revenues increased
by 892% to $6.6 million for the year ended December 31, 1999 from $666,000 for
the year ended December 31, 1998. The growth in cost of service revenues was
attributable primarily to an increase in personnel dedicated to support our
growing number of customers and related recruiting and travel expenses as well
as facility expenses and system costs.
26
Operating Expenses
Sales and Marketing. Sales and marketing expenses increased by 285% to $21.2
million for the year ended December 31, 1999 from $5.5 million for the year
ended December 31, 1998. This increase was attributable primarily to the
addition of sales and marketing personnel, an increase in sales commissions and
higher marketing costs due to expanded promotional activities including
advertising and trade show participation.
Research and Development. Research and development expenses increased by
127% to $12.9 million for the year ended December 31, 1999 from $5.7 million
for the year ended December 31, 1998. This increase was attributable primarily
to the addition of personnel associated with product development and related
benefits and recruiting costs and related consulting expenses.
General and Administrative. General and administrative expenses consist
primarily of compensation and related costs for administrative personnel,
legal, accounting and other general corporate expenses. General and
administrative expenses increased by 175% to $5.0 million for the year ended
December 31, 1999 from $1.8 million for the year ended December 31, 1998, due
primarily to increased personnel, consultants, facilities expenses and outside
services necessary to support our growth.
Amortization of Stock-Based Compensation
In connection with the granting of stock options to employees, we recorded
stock-based compensation totaling approximately $97.0 million through December
31, 1999. Subsequent to the mergers with Business Evolution and netDialog, we
granted options to certain employees hired from the acquired companies for an
exercise price below the fair market value of the common stock. These options
immediately vested on the date of grant. The difference between the market
value of the underlying common stock and the exercise price of the options was
recorded as compensation expense in the fourth quarter of 1999 in the amount of
approximately $60.4 million.
Acquisition Related Costs
In connection with the merger with Connectify, we recorded a nonrecurring
charge for merger integration costs of $1.2 million consisting primarily of
transaction fees for attorneys and accountants of approximately $390,000 and
employee severance benefits and facility related costs of $780,000 in 1999.
In connection with the mergers with Business Evolution and netDialog, we
recorded a nonrecurring charge for merger integration costs of $4.5 million,
consisting primarily of transaction fees for attorneys and accountants of
approximately $1.5 million, advertising and announcements of $1.7 million
incurred as of December 31, 1999, charges for the elimination of duplicate
facilities of approximately $840,000 and severance costs and certain other
related costs of approximately $433,000.
Other Income (Expense), net
Other income (expense), net consists primarily of interest earned on cash
and short-term investments, offset by interest expense related to warrants
issued to convertible debt holders. Other income, net decreased by 428% to an
expense of $744,000 for the year ended December 31, 1999 from income of
$227,000 for 1998. The decrease in other income (expense), net was due
primarily to interest expense associated with warrants issued to convertible
debt holders offset by increased interest income earned on higher average cash
balances.
Liquidity and Capital Resources
In June 2000, we completed the private placement of 2,500,000 shares of our
common stock, raising net proceeds of approximately $120.0 million.
In September 1999, we completed the initial public offering of our common
stock and realized net proceeds from the offering of approximately $51.1
million. Prior to the initial public offering, we had financed
27
our operations primarily from private sales of convertible preferred and common
stock totaling $40.8 million and, to a lesser extent, from bank borrowings and
lease financing.
As of December 31, 2000, we had $76.5 million in cash, cash equivalents and
short-term investments and $54.2 million in working capital. We estimate that
we will have approximately $20.0 million in cash, cash equivalents and short-
term investments as of March 31, 2001.
Our operating activities used $90.7 million of cash for the year ended
December 31, 2000. These uses are primarily attributable to net losses
experienced during these periods as we invested in the development of our
products, expansion of our sales force and expansion of our infrastructure to
support our growth and increase in sales leading to an increase in accounts
receivable. Our operating activities used $25.7 million of cash for the year
ended December 31, 1999.
Our investing activities consisting primarily of net sales of short-term
investments, cash acquired from the acquisition of Silknet, offset by purchases
of computer equipment, furniture, fixtures and leasehold improvements to
support our growing number of employees, provided $22.4 million of cash for the
year ended December 31, 2000. Our investing activities used $44.4 million of
cash for the year ended December 31, 1999, which is primarily due to purchases
of short-term investments and computer equipment, furniture, fixtures and
leasehold improvements.
Our financing activities provided $126.2 million in cash for the year ended
December 31, 2000, primarily due to proceeds from the private placement in June
2000 of 2,500,000 shares of our common stock, raising net proceeds of
approximately $120.0 million. Our financing activities provided $75.0 million
for the year ended December 31, 1999, primarily from the net proceeds from our
initial public offering and proceeds from notes payable and issuance of
convertible preferred stock.
We have a line of credit totaling $10.0 million, which is secured by all of
our assets, bears interest at the bank's prime rate (9.5% as of December 31,
2000), and expires on July 31, 2001. The line of credit contains certain
financial covenants including: a quick asset ratio of at least 1.75 and a
tangible net worth of at least $60,000,000. We were in compliance with all debt
covenants as of December 31, 2000. Total borrowings as of December 31, 2000 and
1999 were $1,187,000 under this line of credit. The entire balance under this
line of credit is due on the expiration date, July 31, 2001. Our total bank
debt, including the borrowings under the line of credit, was $1.6 million at
December 31, 2000.
Our capital requirements depend on numerous factors. We expect to devote
resources to continue our research and development efforts, and expand our
sales, support, marketing and product development organizations. In addition,
although we have curtailed capital expenditures, we have made commitments to
establish additional facilities and infrastructure growth, which we will need
to fund.
We have experienced substantial increases in expenditures since our
inception consistent with growth in our operations and personnel, and we
anticipate that our expenditures will continue to increase in the future. To
reduce our expenditures, we recently restructured in several areas, including
reduced staffing, expense management and curtailed capital spending. For
example, in the first quarter of 2001, we reduced our workforce by
approximately 25%, in order to streamline operations, reduce costs and bring
our staffing and structure in line with industry standards. However, these
actions will not be sufficient for us to obtain a positive cash flow.
Therefore, we plan to further reduce our expenditures. Our auditors have
included a paragraph in their report indicating that substantial doubt exists
as to our ability to continue as a going concern. We are uncertain whether our
cash balance, collections on our accounts receivable and funding from projected
operations will be sufficient to meet our working capital and operating
resource expenditure requirements for the next 12 months and believe it will be
necessary for us to substantially increase revenues and reduce expenditures. If
we are unable to substantially increase revenues, reduce expenditures and
collect upon accounts receivable or if we incur unexpected expenditures, then
we will need to raise additional funds in order to continue as a going concern.
Especially in light of our declining stock price and the extreme volatility in
the technology capital markets, additional funding may not be available on
favorable terms or at all. In addition, although there are no present
understandings, commitments or agreements with respect to any acquisition of
28
other businesses, products or technologies, we may, from time to time, evaluate
potential acquisitions of other businesses, products and technologies. In order
to consummate potential acquisitions, we may issue additional securities or
need additional equity or debt financing and any financing may be dilutive to
existing investors.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 133 "Accounting for Derivative Instruments
and Hedging Activities." SFAS 133 establishes accounting and reporting
standards for derivative instruments and for hedging activities which is
effective in the first quarter of 2001. The adoption of SFAS 133 did not have
any material effect on our results of operations, financial position or cash
flows.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements." SAB
101 provides guidance for revenue recognition under certain circumstances. SAB
101 became effective in the quarter beginning October 1, 2000. The adoption of
SAB 101 did not have a material impact on our results of operations, financial
position or cash flows.
RISK FACTORS
Our future operating results may vary substantially from period to period.
The price of our common stock will fluctuate in the future, and an investment
in our common stock is subject to a variety of risks, including but not limited
to the specific risks identified below. Inevitably, some investors in our
securities will experience gains while others will experience losses depending
on the prices at which they purchase and sell securities. Prospective and
existing investors are strongly urged to carefully consider the various
cautionary statements and risks set forth in this report and our other public
filings.
This report contains forward-looking statements that are not historical
facts but rather are based on current expectations, estimates and projections
about our business and industry, our beliefs and assumptions. Words such as
"anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates"
and variations of these words and similar expressions are intended to identify
forward-looking statements. These statements are not guarantees of future
performance and are subject to risks, uncertainties and other factors, some of
which are beyond our control, are difficult to predict and could cause actual
results to differ materially from" those expressed or forecasted in the
forward-looking statements. These risks and uncertainties include those
described in "Risks Related to Our Business,""Risks Related to Our Industry"
and elsewhere in this report. Forward-looking statements that were true at the
time made may ultimately prove to be incorrect or false. Readers are cautioned
not to place undue reliance on forward-looking statements, which reflect our
management's view only as of the date of this report. Except as required by
law, we undertake no obligation to update any forward-looking statement,
whether as a result of new information, future events or otherwise.
Risks Related to Our Business
Because we have a limited operating history, there is limited information upon
which you can evaluate our business
We are still in the early stages of our development, and our limited
operating history makes it difficult to evaluate our business and prospects. We
were incorporated in July 1996 and first recorded revenue in February 1998.
Thus, we have a limited operating history upon which you can evaluate our
business and prospects. Due to our limited operating history, it is difficult
or impossible to predict future results of operations. For example, we cannot
forecast operating expenses based on our historical results because they are
limited, and we are required to forecast expenses in part on future revenue
projections. Moreover, due to our limited operating history, any evaluation of
our business and prospects must be made in light of the risks and uncertainties
often encountered by early-stage companies in Internet-related markets. Many of
these risks are discussed in the subheadings below, and include our ability to:
. attract more customers;
. implement our sales, marketing and after-sales service initiatives, both
domestically and internationally;