We are a leading provider of enterprise Customer Relationship Management (eCRM) software solutions that deliver integrated communication and business applications built on a Web-architectured platform. Our software helps our customers to better service, market to, and understand their customers and partners, while improving results and decreasing costs in contact centers and marketing departments. We offer a multi-channel customer relationship management solution that combines our KANA eCRM Architecture with customer-focused service, marketing and commerce software applications. These applications enable organizations to improve customer and partner relationships by allowing them to interact with their customers and partners through web contact, web collaboration, e-mail and telephone.

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.

Our customers range from Global 2000 companies pursuing an e-business strategy to growing companies.

References in this annual report on Form 10-K to "KANA," "we," "our," and "us" collectively refer to KANA Software, Inc., a Delaware corporation, and its predecessor, and its subsidiaries and their predecessors. Our principal executive offices are located at 181 Constitution Drive, Menlo Park, California 94025 and our telephone number is (650) 614-8300.

At a special meeting held on February 1, 2002, our stockholders voted against the proposed issuance of up to $45 million of a Series A convertible preferred stock to two investment funds. Immediately following the stockholder vote, we elected to terminate the share purchase agreement with the investment funds. The stockholder vote followed an announcement on January 14, 2002 of the decision by our Board of Directors to withdraw its recommendation that our stockholders vote in favor of the proposed preferred stock transaction. In connection with the proposed transaction and its termination, the investment funds have received two-year warrants to purchase a total of approximately 386,000 shares of KANA's common stock at an exercise price of $10.00 per share. The issuance of these warrants will result in approximately $4.7 million of stock-based compensation expense in the first quarter of 2002. The warrants were valued using the Black-Scholes model.

On February 12, 2002, we completed the sale of an aggregate of approximately 2,910,000 shares of our common stock to institutional investors in a private placement, for gross proceeds of approximately $34.5 million, before transaction-related costs.

In today's economy, Global 2000 organizations must find a way to increase customer retention and loyalty while decreasing operating expenses. 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, 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 have invested substantial resources in expensive call centers and traditional direct marketing initiatives. Call centers typically employ costly technology and do not scale effectively. Traditional direct marketing usually involves poorly targeted communications and substantial administrative effort and is therefore expensive and inefficient in conversion and response rates. With the advent of the Internet and the proliferation of electronic communications, the manner through which businesses communicate is undergoing 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 devices, e-mail, telephone, and storefronts.

Global 2000 organizations have concluded that, in order to retain high-value customers they must provide superior customer service - regardless of the customer contact channel. By utilizing online channels for customer support, Global 2000 organizations have been successfully increasing customer interactions while decreasing costs in contact centers and marketing departments.

Businesses that fail to manage customer interactions effectively often face negative consequences, which can include loss of customers, increased difficulty in acquiring new customers and a deterioration of competitive position. In addition, without efficient and reliable management of customer and partner interactions, businesses face higher operating and information technology costs. 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 interactions. While addressing these challenges, businesses must also be able to deploy an enterprise eCRM solution across multiple departments, to integrate the solution with existing business and legacy systems and databases and to scale the solution as they add new contact channels and increase their volume of customer interactions.

KANA iCARE (Intelligent Customer Acquisition and Retention for the Enterprise) is a comprehensive eCRM solution that provides Global 2000 organizations with the ability to create intelligent, more effective interactions that lead to loyal and lasting customer relationships.

Built with KANA's flexible and scalable, web-architected J2EE (Java Two Enterprise Edition platform) and COM (Common Object Model) applications, KANA iCARE is an integrated solution that spans across multiple channels. KANA iCARE provides the critical link between contact centers and marketing departments, allowing organizations to have effective, efficient interactions with customers at all points of contact (web collaboration, the phone, e-mail, live chat) and throughout the enterprise. The KANA iCARE suite leverages intelligence about both the customer and the enterprise to give contact center representatives and marketing departments the information they need to deliver effective customer interactions. KANA iCARE also employs robust analytics across its entire product family to allow companies to continually analyze and improve their customer and partner relationships. These features enable Global 2000 organizations to lower the cost of information access for their employees, customers and partners while creating profitable relationships.

Our customers can deploy KANA's iCARE applications as complete solution suites or as components that include:

• KANA Contact Center - KANA Contact Center is a multi-channel customer service application for contact centers that provides request management, solution publishing, self-service capabilities, and extranet workflow.

• KANA IQ - Bringing together a self-service solution for customers along with an assisted-service solution for contact center agents, KANA IQ is a robust knowledge base that enables customers and agents alike to quickly and accurately locate the information they need, resulting in increased customer satisfaction and agent productivity -- all while reducing queue times and low- value interactions.

• KANA ResponseIQ - KANA ResponseIQ provides Global 2000 organizations with an intelligent e-mail management suite that enables companies to better manage e-mail responses to customer inquiries by leveraging a common knowledge base that responds to requests through all communications channels. ResponseIQ automatically responds to customers' requests with answers to their questions, and forwards requests to the most qualified agents based on the rules set by the organization.

• KANA Response - KANA Response is a high performance email management system that provides agent-assisted service with fast, high volume, intelligent, automated e-mail, Web and instant messaging request management.

• KANA Marketing - A multi-channel marketing automation solution, KANA Marketing provides marketing organizations with more tools to build lasting relationships with their customers, including rapid segmentation and recurring campaign functionality.

• KANA iCARE Analytics - KANA iCare Analytics enhances the functionality of other iCARE applications to enable companies to measure and continuously improve customer service, marketing and commerce operations across all touch points.

We believe that our technology provides a competitive advantage. Our applications are designed to easily integrate with other enterprise software systems. Our iCARE architecture supports both Unix and Microsoft Windows NT operating systems, providing customers with capabilities for personalization, customer profile management, inquiry management, universal business rules, knowledge management and extranet workflow. It links with customers' legacy systems and provides a design environment to preserve their investments and speed deployments. Recent versions of our products have been built using the J2EE (Java 2 Platform, Enterprise Edition") standard, enabling these applications to provide enterprises with a secure, reliable infrastructure that facilitates fast deployment and cost-effective maintenance. By late 2002, we anticipate that J2EE versions of all of our products will be available. In addition, KANA is focusing development resources and working with Microsoft to develop versions of applications that comply with Microsoft's .Net standard. Our iCARE Architecture uses data modeling to make data located in external systems available in a our application without requiring the data to be moved or replicated. Some of our products are built using Microsoft's COM framework, which is a set of programming tools for Web-architectured software applications.

We partner with leading systems integrators that have developed significant expertise with our web-architected eCRM solutions and provide our customers with a wide range of consulting, implementation, and systems integration services. Our systems integrator partners are involved in an increasing number of our customer's deployments, and by the fourth quarter of 2001, a substantial majority of our new customers were relying on systems integrators in their deployment of our products. We believe that the support of these systems integrators for our products is increasingly important in influencing new customers' decisions to license our products. In addition, systems integrators are increasingly playing an important role as resellers of our products. KANA partners, including both systems integrator partners and resellers, include Accenture, Aspect, BEA Systems, Broadvision, Cisco, CSC, Deloitte Consulting, Hewlett-Packard, IBM, KPMG Consulting, Microsoft, Sun Microsystems and WorldCom.

Consulting Services. Our consulting services group provides a wide range of business and technical expertise to support our partners and customers. With the release of the iCARE suite of products in September 2001, we streamlined our internal professional services organization and began working more closely with strategic systems integrator partners for the implementation, integration, service and maintenance of our products. Our consulting services group works closely with partners during implementations to provide deep functional and industry knowledge as well as technical capabilities that assist our partners in providing high-quality, successful enterprise-wide eCRM implementations and customer satisfaction.

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 Web site.

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.

Our sales strategy is to pursue Global 2000 companies through a combination of our strategic alliances and our direct sales force. We maintain direct sales personnel across the United States and internationally throughout Europe, Canada, Singapore and Japan. Our direct sales force complements our system integrator and reseller alliances. As of December 31, 2001, 136 of our employees were employed in sales and marketing activities.

Our customers range from Global 2000 companies pursuing an e-business strategy to growing companies. As of December 31, 2001, we have licensed our solution to more than 1,200 customers in a variety of industries worldwide. The following is a list of customers that we believe are representative of our overall customer base:

No customer accounted for 10% or more of our total revenues in 2001, 2000 or 1999. However, 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.

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, 2001, 136 of our employees were engaged in research and development activities. We restructured our organization throughout 2001, in order to streamline operations, eliminate redundant positions after the merger with Broadbase, reduce costs and bring our staffing and structure in line with industry standards and current economic conditions. In connection with this restructuring, we had a net reduction of 179 employees engaged in research and development activities. These net reductions have been significant, particularly in light of the personnel added with our merger with Broadbase Software in June 2001.

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.

The market for our products and services is intensely competitive, evolving and subject to rapid technological change. Our primary competitors are Siebel Systems, Inc., PeopleSoft, Inc., and E.piphany, Inc. Furthermore, we may face increased competition should we expand our product line through acquisition of complementary businesses or otherwise.

We believe that the principal competitive factors affecting our market include having 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, and the ability to implement solutions. We believe that our solution currently competes favorably with respect to these factors, and that KANA's Web-based architecture provides it with a competitive advantage. However, 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."

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 a number of 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 some of our U.S. applications.

In addition, we have several trademarks that are registered or pending registration in the U.S. or abroad. Although we rely on patent, copyright, trade secret and trademark law to protect our technology, we believe that factors such as the technological and creative skills of our personnel, new product developments, frequent product enhancements and reliable product maintenance are more essential to establishing and maintaining a technology leadership position. 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:

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. For example, we have been contacted by a company that has asked us to evaluate the need for a license of certain patents that this company holds, relating to certain call-center applications. See "Risk Factors-We may become involved in litigation over proprietary rights, which could be costly and time consuming."

As of December 31, 2001, we had 409 full-time employees, 78 of whom were in our services and support group, 136 in sales and marketing, 136 in research and development, and 59 in finance, administration and operations. We have restructured our organization throughout 2001, with net workforce reductions of approximately 772 employees, in order to streamline operations, eliminate redundant positions after the merger with Broadbase, and reduce costs and bring our staffing and structure in line with industry standards and current economic conditions. These reductions have been significant, particularly in light of the increase of approximately 896 employees upon our merger with Broadbase in June 2001.

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 and grow," "-We may face difficulties in hiring and retaining qualified sales personnel to sell our products and services, which could impair our growth," and "-Our cost reduction initiatives may adversely affect the morale and performance of our personnel and our ability to hire new personnel."

Our corporate offices are located in Menlo Park, California, where we lease approximately 80,000 square feet under 3 leases that expire in July 2002 and April 2007. As of December 31, 2001, the annual base rent for these facilities totaled approximately $1.7 million. Also, we lease approximately 35,000 square feet of space 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. The annual base rent for the New Hampshire lease totals approximately $451,000.

In addition, we lease smaller facilities and offices in several cities throughout the United States, and internationally throughout Europe, Australia, Japan, and Singapore. The terms of these leases renew semi-annually unless terminated. We believe that our office space will be sufficient to meet our needs through at least the next 12 months.

In addition, we have a total of approximately 161,000 square feet of excess space available for disposition. Locations of the excess space include Menlo Park and San Francisco, California, Natick, Massachusetts, Princeton, New Jersey and Marlow in the United Kingdom. Remaining lease commitment terms on these leases vary from three to eight years. We are seeking to dispose of the excess space. We have $27.4 million in accrued restructuring and merger costs as of December 31, 2001 which is our estimate, as of that date, of the disposition costs of these excess facilities. However, if we determine that any of these real estate markets continues to deteriorate, additional adjustments to this accrual may be required, which would result in additional restructuring costs in the period in which such determination is made. Likewise, if any of these real estate markets strengthen, and we are able to sublease the properties earlier or at more favorable rates than projected, adjustments to the accrual may be required that would increase income in the period in which such determination is made.

In April 2001, Office Depot, Inc. filed a complaint against KANA claiming that KANA has breached its license agreement with Office Depot. Office Depot is seeking relief in the form of a refund of license fees and maintenance fees paid to KANA, attorneys' fees and costs. The litigation is currently in its early stages. We intend to defend this claim vigorously and do not expect it to have a material impact on our results of operations. However, the ultimate outcome of any litigation is uncertain, and either unfavorable or favorable outcomes could have a material negative impact on our results from operations, consolidated balance sheet and cash flows, due to defense costs, diversion of management resources and other factors.

The underwriters for our initial public offering, Goldman Sachs & Co., Lehman Bros, Hambrecht & Quist LLC, Wit Capital Corp as well as KANA and certain current and former officers of KANA have been named as defendants in federal securities class action lawsuits filed in the United States District Court for the Southern District of New York. The cases allege violations of Section 11, 12(a)(2) and Section 15 of the Securities Act of 1933 and violations of Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934, on behalf of a class of plaintiffs who purchased KANA's stock between September 21, 1999 and December 6, 2000 in connection with KANA's initial public offering. Specifically, the complaints alleged that the underwriter defendants engaged in a scheme concerning sales of KANA's securities in the initial public offering and in the aftermarket. Discovery against the issuers such as KANA and against the individuals such as the current and former officers of KANA has been stayed by order of the Court pending further developments with respect to the claims against the underwriters. We believe we have good defenses to these claims and intend to defend the action vigorously.

On December 11, 2001, we held a special stockholders' meeting to vote on an amendment to our Certificate of Incorporation to authorize our board of directors to effect a reverse split of our outstanding common stock at an exchange ratio of one-for-ten. The votes cast for and against this action were 14,104,502 and 559,227, respectively, with 18,358 votes abstaining.

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-one forward stock split effective February 2000, and the one-for-ten reverse split effective December 2001:

There were approximately 1,557 stockholders of record as of February 28, 2002. 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 28, 2002 was approximately 60,000.

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."

The following table provides information about our unregistered sales of KANA securities since January 1, 2001.

___________

All sales were made in reliance on Section 4(2) of the Securities Act and/or Regulation D promulgated under the Securities Act. The securities were sold to a limited number of people with no general solicitation or advertising. The purchasers were sophisticated investors with access to all relevant information necessary to evaluate the investment and who represented to the issuer that the shares were being acquired for investment.

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 Software, 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 five-year period ended December 31, 2001, and the consolidated balance sheet data at December 31, 2001, 2000, 1999, 1998 and 1997 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 basic and diluted net loss per share. The historical results are not necessarily indicative of results to be expected for any future period. See "Management's Discussion and Analysis of Financial Condition and Results of Operations."

                                                            Years Ended December 31,
                                               -------------------------------------------------------
                                                 2001        2000        1999       1998       1997
                                               ---------  -----------  ---------  ---------  ---------
                                                        (in thousands, except per share amounts)
Consolidated Statement of
 Operations Data:
Revenues:
 License..................................... $  37,963  $    75,360  $  10,536  $   2,014  $      --
 Service.....................................    48,907       37,657      2,966        333        617
                                               ---------  -----------  ---------  ---------  ---------
 Total revenues..............................    86,870      113,017     13,502      2,347        617
                                               ---------  -----------  ---------  ---------  ---------
Cost of revenues:
 License.....................................     2,536        2,856        271         54         --
 Service.....................................    48,074       51,144      6,383        666        253
                                               ---------  -----------  ---------  ---------  ---------
Total cost of revenues.......................    50,610       54,000      6,654        720        253
                                               ---------  -----------  ---------  ---------  ---------
Gross profit.................................    36,260       59,017      6,848      1,627        364
                                               ---------  -----------  ---------  ---------  ---------
Operating expenses:
 Sales and marketing.........................    69,635       88,186     21,199      5,504        512
 Research and development....................    35,558       42,724     12,854      5,669        971
 General and administrative..................    21,215       18,945      5,018      1,826        378
 Amortization of stock-based compensation....    15,880       14,715     80,476      1,456        113
 Amortization of goodwill and
  identifiable intangibles...................   127,660      873,022         --         --         --
 Merger and transition related costs.........    13,443        6,564      5,635         --         --
 Restructuring costs.........................    89,047           --         --
 In process research and development.........        --        6,900         --         --         --
 Goodwill impairment.........................   603,446    2,084,841         --         --         --
                                               ---------  -----------  ---------  ---------  ---------
 Total operating expenses....................   975,884    3,135,897    125,182     14,455      1,974
                                               ---------  -----------  ---------  ---------  ---------
Operating loss...............................  (939,624)  (3,076,880)  (118,334)   (12,828)    (1,610)
Impairment of investment.....................    (1,000)          --         --         --         --
Other income (expense), net..................     1,521        4,834       (744)       227         57
                                               ---------  -----------  ---------  ---------  ---------
Loss from continuing operations..............  (939,103) $(3,072,046) $(119,078) $ (12,601) $  (1,553)
Discontinued operation:
 Income (loss) from operations of
   discontinued operation....................      (125)       1,173        335         --         --
 Loss on disposal, including provision of
   $1.1 million for operating losses
   during phase-out period...................    (3,667)          --         --         --         --
                                               ---------  -----------  ---------  ---------  ---------
         Net loss............................ $(942,895)  (3,070,873)  (118,743)   (12,601)    (1,553)
                                               =========  ===========  =========  =========  =========
Basic and diluted net loss per share:
  Loss from continuing operations ........... $  (68.33) $   (395.83) $  (46.21) $  (20.13) $   (3.74)
  Income (loss) from discontinued operation..     (0.28)        0.15       0.13         --         --
                                               ---------  -----------  ---------  ---------  ---------
  Net loss .................................. $  (68.61) $   (395.68) $  (46.08) $  (20.13) $   (3.74)
                                               =========  ===========  =========  =========  =========
Shares used in computing basic and
  diluted net loss per share amounts.........    13,743        7,761      2,577        626        415
                                               =========  ===========  =========  =========  =========

                                                                      December 31,
                                               -------------------------------------------------------
                                                 2001        2000        1999       1998       1997
                                               ---------  -----------  ---------  ---------  ---------
                                                                      (in thousands)
Consolidated Balance Sheet Data:
Cash, cash equivalents and
 Short-term investments...................... $  40,130  $    76,499  $  53,217  $  14,035  $   5,594
Working capital..............................   (13,697)      52,753     38,591     11,833      5,364
Total assets.................................   160,672      980,124     70,229     16,876      6,158
Total stockholders' equity................... $  66,839  $   899,452  $  48,500  $  12,951  $   5,684

We are a leading provider of enterprise Customer Relationship Management (eCRM) software solutions that deliver integrated communication and business applications built on a Web-architectured platform. Our software helps our customers to better service, market to, and understand their customers and partners, while improving results and decreasing costs in contact centers and marketing departments. We offer multi-channel customer relationship management that combines our KANA eCRM Architecture with several enterprise applications. Our customer-focused service and marketing software applications enable organizations to improve customer and partner relationships by allowing them to interact with their customers and partners through web contact, web collaboration, e-mail and telephone.

In 1999, we completed mergers with Connectify, Business Evolution and netDialog pursuant to which these companies became our wholly-owned subsidiaries. We issued an aggregate of approximately 999,303 shares of our common stock in exchange for all outstanding shares and warrants of the acquired companies and reserved 41,669 shares of common stock for issuance upon the exercise of Connectify options and warrants. The mergers were each 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. The transaction was accounted for using the purchase method of accounting. The purchase price approximated $3.8 billion. In connection with the merger, we recorded goodwill and intangible assets of approximately $3.8 billion, which we were amortizing over a period of three years. During the quarters ended March 31, 2001 and 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 impairment charges of $603.4 million and $2.1 billion, respectively, relating to goodwill.

On June 29, 2001, we completed a merger with Broadbase. This transaction was accounted for using the purchase method of accounting. The purchase price approximated $101.4 million.

In December 2001, our Board of Directors recommended and our stockholders approved a one-for-ten reverse stock split of the common stock for stockholders of record on December 13, 2001. All share and per share amounts have been retroactively restated to reflect the effect of this stock split.

In 1999, we initiated our KANA Online business. Our KANA Online business provided a hosted environment of our software to customers. Our servers for this business are maintained by a third-party service provider. In the second quarter of 2001, we adopted a plan to discontinue the KANA Online business. We have accounted for our KANA Online business as a discontinued operation.

We derive our revenues from the sale of software product licenses and from professional services including implementation, consulting, training and maintenance. License revenue is recognized when persuasive evidence of an agreement exists, the product has been delivered, the arrangement does not involve significant customization of the software by us, the license fee is fixed or determinable and collection of the fee is reasonably assured. If the arrangement involves significant customization of the software by us, the fee, excluding the portion attributable to maintenance, is recognized using the percentage-of-completion method. Service revenue includes revenues from maintenance contracts, implementation, training and consulting services. Revenue from maintenance contracts is recognized ratably over the term of the contract. Revenue from implementation, training, and consulting services is recognized as the services are provided.

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. For the twelve months ended December 31, 2001, we incurred a net loss of $942.9 million. Included in the net loss is approximately $603.4 million related to the impairment of goodwill in 2001. As of December 31, 2001, we had an accumulated deficit of $4.1 billion. We expect to decrease our operating losses in 2002.

As of December 31, 2001, we had 409 full-time employees. We have restructured our organization throughout 2001, with net workforce reductions of approximately 772 employees, in order to streamline operations, eliminate redundant positions after the merger with Broadbase, reduce costs and bring our staffing and structure in line with industry standards and current economic conditions. These reductions have been significant, particularly in light of the increase of approximately 896 employees upon our merger with Broadbase in June of 2001.

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 revenue growth in the past, our revenues have declined in recent periods, and we may not be able to achieve revenue growth in the future, particularly in light of increasing competition in our markets, the weak economy, and declining expenditures on enterprise software products. Furthermore, we may not achieve or maintain profitability in the future.

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect our reported assets, liabilities, revenues and expenses, and our related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to revenue recognition, collectibility of receivables, goodwill and intangible assets, contract loss reserve, product warranties, income taxes, and restructuring. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. This forms the basis of judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We believe the following critical accounting policies and the related judgments and estimates significantly affect the preparation of our consolidated financial statements:

Revenue Recognition. In addition to determining our results of operations for a given period, our revenue recognition determines the timing of certain expenses, such as commissions and royalties. Revenue recognition rules for software companies are very complex, and certain judgments affect the application of our revenue policy. The amount and timing of our revenue is difficult to predict, and any shortfall in revenue or delay in recognizing revenue could cause our operating results to vary significantly from quarter to quarter and could result in future operating losses.

License revenue is recognized when there is persuasive evidence of an arrangement, delivery to the customer has occurred, provided the arrangement does not require significant customization of the software, the fee is fixed or determinable and collectibility is reasonably assured.

In software arrangements that include rights to multiple software products and/or services, we allocate the total arrangement fee among each of the deliverables using the residual method, under which revenue is allocated to undelivered elements based on vendor-specific objective evidence of fair value of such undelivered elements and the residual amounts of revenue are allocated to delivered elements. Elements included in multiple element arrangements could consist of software products, maintenance (which includes customer support services and unspecified upgrades), or consulting services. Vendor-specific objective evidence is based on the price charged when an element is sold separately or, in the case of an element not yet sold separately, the price established by authorized management, if it is probable that the price, once established, will not change before market introduction. Determining whether vendor-specific objective evidence exists is subject to judgment, and resulting fair values used in determining the value of undelivered elements is also subject to judgment and estimates.

Probability of collection is based upon the assessment of the customer's financial condition through the review of their current financial statements or credit reports. For follow-on sales to existing customers, prior payment history is also used to evaluate probability of collection.

Revenues from customer support services are recognized ratably over the term of the contract, typically one year. Consulting revenues are primarily related to implementation services performed on a time-and-materials basis or, in certain situations, on a fixed-fee basis, under separate service arrangements. Implementation services are periodically performed under fixed-fee arrangements and in such cases, consulting revenues are recognized on a percentage-of- completion basis. Revenues from consulting and training services are recognized as services are performed.

Reserve for Loss Contract. We are party to a contract with a customer that involves a fixed fee as payment for services upon meeting certain milestone criteria. We estimate the total expected costs of providing services necessary to complete the contract and compare these costs to the fees expected to be received under the contract. As a result of our recent restructuring in 2001, substantially all of the remaining services are being provided by a third party. Since the costs are expected to exceed the associated fees received, loss reserves are recorded and expensed in cost of service revenues. Estimates of applicable costs are subject to revision and could vary materially from estimates, resulting in either increases or decreases in the estimated loss reserve which could have a material impact on cost of service revenues in future periods.

Collectibility of Receivables. A considerable amount of judgment is required to assess the ultimate realization of receivables, including assessing the probability of collection and the current credit-worthiness of each customer. We have recorded significant increases in the allowance for doubtful accounts in fiscal 2001 due to the rapid downturn in the economy, and in the technology sector in particular. There is no assurance that we will not need to record increases to the allowance in the future.

Accounting for Internal Use Software. Software development costs, including costs incurred to purchase third party software are capitalized beginning when we have determined factors are present, including among others, that technology exists to achieve the performance requirements, buy versus internal development decisions have been made and the we have authorized the funding for the project. Capitalization of software costs ceases when the software is substantially complete and is ready for its intended use and is amortized over its estimated useful life of generally three years using the straight-line method. As of December 31, 2001, we had $4.8 million of capitalized costs of internal use software.

When events or circumstances indicate the carrying value of internal use software might not be recoverable, we will assess the recoverability of these assets by determining whether the amortization of the asset balance over its remaining life can be recovered through undiscounted future operating cash flows. The amount of impairment, if any, is recognized to the extent that the carrying value exceeds the projected discounted future operating cash flows and is recognized as a write down of the asset. In addition, if it is no longer probable that computer software being developed will be placed in service, the asset will be adjusted to the lower of its carrying value or fair value, if any, less direct selling costs. Any such adjustment would result in an expense in the period recorded, which could have a material adverse effect on our consolidated statement of operations.

Restructuring. During 2001, we recorded significant reserves in connection with our restructuring program. These reserves include estimates pertaining to contractual obligations related to excess leased facilities. We have worked with external real estate advisors in each of the markets where the properties are located so that we may estimate the amount of the accrual. This process involves significant judgments regarding these markets. If the real estate market continues to worsen, additional adjustments to the reserve may be required, which would result in additional restructuring expenses in the period in which such determination is made. Likewise, if the real estate market strengthens, and we are able to sublease the properties earlier or at more favorable rates than projected, adjustments to the reserve may be required that would increase income in the period in which such determination is made.

Goodwill and Intangible Assets. Consideration paid in connection with acquisitions is required to be allocated to the acquired assets, including identifiable intangible assets, and liabilities acquired. Acquired assets and liabilities are recorded based on our estimate of fair value, which requires significant judgment with respect to future cash flows and discount rates. For intangible assets, we are required to estimate the useful life of the asset and recognize its cost as an expense over the useful life. We use the straight-line method to expense long-lived assets, which results in an equal amount of expense in each period. We regularly evaluate acquired businesses for potential indicators of impairment of goodwill and intangible assets. Our judgments regarding the existence of impairment indicators are based on market conditions, operational performance of our acquired businesses and identification of reporting units. Future events could cause us to conclude that impairment indicators exist and that goodwill and other intangible assets associated with our acquired businesses are impaired. Beginning in fiscal 2002, the methodology for assessing potential impairments of intangibles changed based on new accounting rules issued by the Financial Accounting Standards Board. Any resulting impairment loss could have a material adverse impact on our financial condition and results of operations.

Warranty Allowance. We must make estimates of potential warranty obligations. We actively monitor and evaluate the quality of our software and analyze any historical warranty costs when we evaluate the adequacy of our warranty allowance. Significant management judgments and estimates must be made and used in connection with establishing the warranty allowance in any accounting period. Material differences may result in the amount and timing of our expenses for any period if management made different judgments or utilized different estimates. To date our provisions for warranty allowance have been immaterial.

Income taxes. We are required to estimate our income taxes in each of the jurisdictions in which we operate as part of the process of preparing our consolidated financial statements. This process involves us estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as deferred revenue, for tax and accounting purposes. These differences result in deferred tax assets and liabilities. We must then assess the likelihood that our net deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not likely, we must establish a valuation allowance. While we have considered future taxable income in assessing the need for the valuation allowance, in the event we were to determine that we would be able to realize our deferred tax assets in the future in excess of its net recorded amount, an adjustment to the deferred tax asset would be made, increasing income in the period in which such determination was made.

Contingencies and Litigation. We are subject to proceedings, lawsuits and other claims. We assess the likelihood of any adverse judgments or outcomes to these matters as well as ranges of probable losses. A determination of the amount of loss contingency required, if any, for these matters are made after careful analysis of each individual matter. The required loss contingencies may change in the future as the facts and circumstances of each matter changes.

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, 2001. 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,    Mar. 31,   June 30,   Sept. 30,   Dec 31,
                                     2000       2000       2000        2000        2001       2001       2001       2001
                                   ---------  ---------  ---------  -----------  ---------  ---------  ---------  ---------
                                                                    (in thousands)
Consolidated Statement
 of Operations Data:
Revenues:
 License......................... $   7,329  $  15,574  $  23,730  $    28,727  $  11,857  $   9,587  $   2,891  $  13,628
 Service.........................     2,505      8,280     15,312       11,560     10,656     12,542     14,507     11,202
                                   ---------  ---------  ---------  -----------  ---------  ---------  ---------  ---------
  Total revenues.................     9,834     23,854     39,042       40,287     22,513     22,129     17,398     24,830
                                   ---------  ---------  ---------  -----------  ---------  ---------  ---------  ---------
Cost of revenues:
 License.........................       143        658        918        1,137        633        653        503        747
 Service.........................     3,413      9,438     14,824       23,469     15,445      7,378     20,224      5,027
                                   ---------  ---------  ---------  -----------  ---------  ---------  ---------  ---------
  Total cost of
   revenues......................     3,556     10,096     15,742       24,606     16,078      8,031     20,727      5,774
                                   ---------  ---------  ---------  -----------  ---------  ---------  ---------  ---------
Gross profit (loss)..............     6,278     13,758     23,300       15,681      6,435     14,098     (3,329)    19,056
                                   ---------  ---------  ---------  -----------  ---------  ---------  ---------  ---------
Operating expenses:
 Sales and marketing.............    11,210     21,338     25,749       29,889     26,534     13,789     19,205     10,107
 Research and
  development....................     5,239     11,059     12,993       13,433     12,949      6,273     10,236      6,100
 General and
  administrative.................     1,835      3,747      6,347        7,016      6,068      2,523      9,500      3,124
 Amortization of stock-
  based compensation.............     3,320      3,593      3,790        4,012      4,112      2,250      4,177      5,341
 Amortization of goodwill
  and identifiable
  intangibles....................        --    247,043    312,865      313,114     86,852     13,730     13,551     13,527
 Merger and transition
  related costs..................        --      6,564         --           --         --      6,676      4,841      1,926
 Restructuring costs.............        --         --         --           --     19,930     34,327     32,081      2,709
 In process research and
  development....................        --      6,900         --           --         --         --         --         --
 Goodwill impairment.............        --         --         --    2,084,841    603,446         --         --         --
                                   ---------  ---------  ---------  -----------  ---------  ---------  ---------  ---------
  Total operating expenses.......    21,604    300,244    361,744    2,452,305    759,891     79,568     93,591     42,834
                                   ---------  ---------  ---------  -----------  ---------  ---------  ---------  ---------
Operating loss...................   (15,326)  (286,486)  (338,444)  (2,436,624)  (753,456)   (65,470)   (96,920)   (23,778)
Impairment of investment.........        --         --         --           --         --         --         --     (1,000)
Other income (expense), net......       644      1,247      2,039          904        302       (252)       858        613
                                   ---------  ---------  ---------  -----------  ---------  ---------  ---------  ---------
Loss from continuing operations .   (14,682)  (285,239)  (336,405)  (2,435,720)  (753,154)   (65,722)   (96,062)   (24,165)
Discontinued operation:
 Income (loss) from operations
   of discontinued operation.....       237        295         71          570        258       (383)        --         --
 Loss on disposal, including
   provision of $1.1 million
   for operating losses during
   phase-out period..............        --         --         --           --         --     (3,667)        --         --
                                   ---------  ---------  ---------  -----------  ---------  ---------  ---------  ---------
         Net loss................ $ (14,445) $(284,944) $(336,334) $(2,435,150) $(752,896) $ (69,772) $ (96,062) $ (24,165)
                                   =========  =========  =========  ===========  =========  =========  =========  =========

As a Percentage of Total
 Revenues:
Revenues:
 License.........................      74.5 %     65.3 %     60.8 %       71.3 %     52.7 %     43.3 %     16.6 %     54.9 %
 Service.........................      25.5       34.7       39.2         28.7       47.3       56.7       83.4       45.1
                                   ---------  ---------  ---------  -----------  ---------  ---------  ---------  ---------
  Total revenues.................     100.0      100.0      100.0        100.0      100.0      100.0      100.0      100.0
                                   ---------  ---------  ---------  -----------  ---------  ---------  ---------  ---------
Cost of revenues:
 License.........................       1.5        2.8        2.4          2.8        2.8        3.0        2.9        3.0
 Service.........................      34.7       39.6       38.0         58.3       68.6       33.3      116.2       20.2
                                   ---------  ---------  ---------  -----------  ---------  ---------  ---------  ---------
  Total cost of
   revenues......................      36.2       42.3       40.3         61.1       71.4       36.3      119.1       23.3
                                   ---------  ---------  ---------  -----------  ---------  ---------  ---------  ---------
Gross profit (loss)..............      63.8       57.7       59.7         38.9       28.6       63.7      (19.1)      76.7
                                   ---------  ---------  ---------  -----------  ---------  ---------  ---------  ---------
Selected operating
 expenses:
 Sales and marketing.............     114.0       89.5       66.0         74.2      117.9       62.3      110.4       40.7
 Research and
  development....................      53.3       46.4       33.3         33.3       57.5       28.3       58.8       24.6
 General and
  administrative.................      18.7 %     15.7 %     16.3 %       17.4 %     27.0 %     11.4 %     54.6 %     12.6 %

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.

The following table sets forth selected data for the periods presented expressed as a percentage of total revenues.

                                                               Years Ended December 31,
                                                          -----------------------------------
                                                             2001        2000         1999
                                                          ----------  -----------  ----------
Revenues:
 License................................................       43.7 %       66.7 %      78.0 %
 Service................................................       56.3         33.3        22.0
                                                          ----------  -----------  ----------
   Total revenues.......................................      100.0        100.0       100.0
                                                          ----------  -----------  ----------
Cost of revenues:
 License................................................        2.9          2.5         2.0
 Service................................................       55.4         45.3        47.3
                                                          ----------  -----------  ----------
   Total cost of revenues...............................       58.3         47.8        49.3
                                                          ----------  -----------  ----------
Gross profit............................................       41.7         52.2        50.7

Selected operating expenses:
 Sales and marketing....................................       80.2         78.0       157.0
 Research and development...............................       40.9         37.8        95.2
 General and administrative.............................       24.4         16.8        37.2

Total revenues decreased by 23% to $86.9 million for the year ended December 31, 2001 from $113.0 million for the year ended December 31, 2000 primarily as a result of decreased license revenue as discussed below.

License revenues decreased by 50% to $38.0 million for the year ended December 31, 2001 from $75.4 million for 2000. This decrease in license revenue was primarily due to a decrease in the number of license transactions, resulting from the weakness in the economy throughout 2001, and particularly in the third quarter of 2001 following the events of September 11, 2001. This decrease was partially offset in the fourth quarter by sales of products formerly offered by Broadbase, which were not included in our revenues prior to the June 2001 merger. License revenues represented 44% of total revenues in 2001 and 67% in 2000. We anticipate license revenue will increase as a percentage of total revenue in the future due to the reduction in our professional services as a result of our shift during the fourth quarter of 2001 to increase our use of third party integrators for providing implementation services to our customers. We expect license revenues to increase in absolute dollars in 2002 from 2001. However, the market for our products in unpredictable and intensely competitive, and sales of our products are subject to fluctuations in the economy and the corresponding effect on corporate purchasing habits.

Service revenues increased by 30% to $48.9 million for the year ended December 31, 2001 from $37.7 million for 2000. Service revenues increased primarily due to service engagements in quarters following increased licensing activity. Given the increase in licensing activity in 2000 compared to 1999, as well as the first quarter of 2001 compared to the first quarter of 2000, service revenue in 2001 increased from 2000. However, during the third and fourth quarters of 2001, service revenues began to decline slightly from the same periods in 2000. We expect that service revenues in 2002 will be lower than the comparative periods in 2001 due to the shift in the fourth quarter of 2001 to increase the use of third party integrators for providing implementation services to our customers. Service revenues represented 56% of total revenues for the year ended December 31, 2001 and 33% of total revenues for 2000.

Revenues from international sales were $13.8 million in the year ended December 31, 2001 and $19.5 million in the year ended December 31, 2000. Our international revenues were derived from sales in Europe, Canada, Asia Pacific and Latin America.

Total cost of revenues decreased by 6% to $50.6 million for the year ended December 31, 2001 from $54.0 million for the year ended December 31, 2000, primarily due to decreased cost of service revenues as discussed below.

Cost of license revenue consists primarily of third party software royalties, product packaging, documentation, and production and delivery costs for shipments to customers. Cost of license revenue as a percentage of license revenue for 2001 was 7% compared to 4% in 2000. The increase was due to the reduced license revenue and fixed nature of some of the license costs, as well as an increase in royalties from 2000. We expect that our cost of license revenue as a percentage of sales in 2002 will be approximately the same as in 2001.

Cost of service revenue 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 revenue decreased to 98% of service revenue for 2001 compared to 136% for the same period in the prior year. This was primarily due to more consistent utilization of our professional services personnel in revenue-generating services during the first half of 2001, offset by an increase of the estimated costs to complete a fixed fee contract recorded in the third quarter of 2001. During the fourth quarter of 2001, service margins improved due to the shift in service revenue mix following the shift to increase use of third party integrators to provide implementation services to our customers. As a result, support revenues comprised a larger percentage of service revenues, which have yielded better margins than training and consulting revenues.

We anticipate that cost of service revenue will decrease in absolute dollars in the future due to reductions in services personnel because of the shift to increase use of third party integrators made in the third and fourth quarters of 2001. As a percentage of revenue, we expect cost of services to be lower in 2002 than in 2001 due to an increase in the support portion of service revenues, which realizes higher gross margins than our professional services. Our support revenues relate to providing telephone support and product maintenance and updates. Our professional services revenues relate to providing consulting and implementation services.

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 decreased by 21% to $69.6 million for the year ended December 31, 2001 from $88.2 million for the year ended December 31, 2000. This decrease was attributable primarily to reductions in sales and marketing personnel, and to a lesser extent, decreases in sales commissions associated with decreased revenues and decreases in marketing costs, primarily in advertising and promotional activities. As a percentage of total revenues, sales and marketing expenses were 80% for the year ended December 31, 2001 and 78% for the year ended December 31, 2000. We anticipate that sales and marketing expenses will be lower in absolute dollars and as a percentage of revenue in 2002 than in 2001 due to decreased personnel and promotional expenditures.

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 decreased by 17% to $35.6 million for the year ended December 31, 2001 from $42.7 million for the year ended December 31, 2000. This decrease was attributable primarily to the reduction of personnel and related benefits and facility costs. As a percentage of total revenues, research and development expenses were 41% for the year ended December 31, 2001 and 38% for the year ended December 31, 2000. We anticipate that research and development expenses will be slightly lower in absolute dollars in 2002 than in 2001, and will fluctuate as a percentage of revenue depending on the timing and amount of revenue.

General and Administrative. General and administrative expenses increased by 12% to $21.2 million for the year ended December 31, 2001 from $18.9 million for the year ended December 31, 2000. The increase resulted from higher overall general and administrative costs in the first quarter of 2001 compared to the same period in 2000 due to internal growth, the acquisition and integration of Broadbase, as well as higher bad debt expense throughout 2001 compared to 2000. As a percentage of total revenues, general and administrative expenses were 24% for the year ended December 31, 2001 and 17% for the year ended December 31, 2000. We anticipate that general and administrative costs will be lower in absolute dollars in 2002 compared to 2001 due to general and administrative staff reductions in the second half of 2001. We anticipate general and administrative expenses will be lower in 2002 as a percentage of revenue compared to 2001, and will fluctuate as a percentage of revenue depending on the timing and amount of revenue.

Amortization of Stock-Based Compensation. In connection with the granting of stock options to our employees, we recorded unearned stock-based compensation charges. These charges represent 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. The majority of these charges relate to grants made prior to our initial public offering. In 2001, options granted with an exercise price below the fair market value resulted in a charge of $2.6 million, and cancellations of grants with previous associated charges resulted in a reversal of $3.0 million. In connection with the merger with Broadbase, we recorded unearned stock-based compensation totaling approximately $15.5 million during the year ended December 31, 2001. These amounts are included as a component of stockholders' equity and are 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.

In September 2000, we issued to Accenture 40,000 shares of common stock and a warrant to purchase up to 72,500 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 recorded a charge of approximately $14.8 million to be amortized over the four-year term of the agreement. As of December 31, 2001, 33,077 shares of common stock subject to the warrant were fully vested and 19,423 shares had been forfeited, with the remainder to become vested upon the achievement of certain performance goals. The vested portion of the warrant was valued using the Black-Scholes model resulting in charges totaling $2.0 million of which $1.0 million is being amortized over the remaining term of the agreement and $1.0 million was immediately expensed in the fourth quarter of 2000. We will incur a charge to stock-based compensation for the unvested portion of the warrant when performance goals are achieved. As of December 31, 2001, unvested shares of common stock under the warrant had a fair value of approximately $389,000 based upon the fair market value of our common stock at such date.

In June 2001, we entered into an agreement to issue to a customer a fully vested and exercisable warrant to purchase up to 25,000 shares of common stock pursuant to a warrant purchase agreement. We have recorded deferred stock-based compensation of $330,000 for the warrant using the Black-Scholes model. This amount is being amortized as a reduction to revenue.

In September 2001, we issued to a customer a warrant to purchase up to 5,000 shares of common stock pursuant to a warrant purchase agreement. The warrant fully vests in September 2006 and has a provision for acceleration of vesting 1,250 shares annually over four years if certain marketing criteria are met by the customer. The warrant was valued using the Black-Scholes model, resulting in a charge of approximately $29,000 which is being amortized over the five-year term of the agreement.

In September 2001, we issued to Accenture an additional warrant to purchase up to 150,000 shares of common stock pursuant to a warrant purchase agreement in connection with our global strategic alliance. The warrant is fully vested and exercisable as of September 2001. The warrant was valued using the Black-Scholes model resulting in a charge of approximately $946,000 which is being amortized over the remaining term of the agreement.

As of December 31, 2001, approximately $22.2 million of total unearned deferred stock-based compensation remained to be amortized.

At a special meeting held on February 1, 2002, our stockholders voted against the proposed issuance of up to $45 million of a Series A convertible preferred stock to two investment funds. Immediately following the stockholder vote, we elected to terminate the share purchase agreement with the investment funds. The stockholder vote followed an announcement on January 14, 2002 of the decision by our Board of Directors to withdraw its recommendation that our stockholders vote in favor of the proposed preferred stock transaction. In connection with the proposed transaction and its termination, the investment funds have received two-year warrants to purchase a total of approximately 386,000 shares of KANA's common stock at an exercise price of $10.00 per share. The issuance of these warrants will result in approximately $4.7 million of stock-based compensation expense in the first quarter of 2002. The warrants were valued using the Black- Scholes model.

The amortization of stock-based compensation by operating expense is detailed as follows (in thousands):

                                      Year Ended December 31,
                                      ------------------------
                                         2001         2000
                                      -----------  -----------
Cost of service..................... $     1,417  $     2,816
Sales and marketing.................       7,230        8,078
Research and development............       4,226        2,831
General and administrative..........       3,007          990
                                      -----------  -----------
 Total.............................. $    15,880  $    14,715
                                      ===========  ===========

We are required to adopt SFAS No. 142 effective January 1, 2002, which will result in us no longer amortizing our existing goodwill. In addition, we will be required to measure goodwill for impairment effective January 1, 2002 as part of the transition provisions. Any impairment resulting from the transition provisions will be recorded as of January 1, 2002 and will be recognized as the effect of a change in accounting principle. We will not be able to determine if an impairment will be required until completion of such impairment test. In addition, at December 31, 2001, negative goodwill approximated $3.9 million. We will be required as part of the adoption of SFAS No. 142 to immediately recognize the unamortized negative goodwill that exists on January 1, 2002. This adjustment will be recognized as the effect of a change in accounting principle.

Merger and Transition Related Cost. In connection with the merger with Broadbase, we recorded $13.4 million of transition costs and merger-related integration expenses in 2001. The merger costs include transitional personnel costs of $5.6 million, and $7.8 million relating to duplicate facility and insurance costs, redundant assets, and professional fees associated with the merger. As of December 31, 2001, $10.3 million remains in accrued merger- related costs on the consolidated balance sheet in accrued restructuring and merger costs.

In connection with the Silknet merger, we recorded $6.6 million of transaction costs and merger-related integration expenses in 2000. These amounts consisted primarily of merger-related advertising and announcements of $4.5 million and duplicate facility costs of $1.0 million.

Restructuring Costs. For the year ended December 31, 2001, we incurred restructuring charges of approximately $89.0 million primarily related to reductions in our workforce and costs associated with certain excess leased facilities and asset impairments. The restructuring charge included $26.4 million for assets disposed of or removed from operations. Assets disposed of or removed from operations consisted primarily of leasehold improvements, computer equipment and related software, office equipment, furniture and fixtures.

The restructuring charge also included $24.4 million for severance, benefits and related costs due to reductions in our workforce. As of December 31, 2001, we had 409 full-time employees. We restructured our organization throughout 2001, with net workforce reductions of approximately 772 employees, or 65% from December 31, 2000, in order to streamline operations, eliminate redundant positions after the merger with Broadbase, reduce costs and bring our staffing and structure in line with industry standards and current economic conditions.

The restructuring charge also included $38.2 million resulting from our decision to exit and reduce certain facilities. The estimated facility costs were based on our contractual obligations, net of assumed sublease income based on current comparable rates for leases in the respective markets. Should facilities operating lease rental rates continue to decrease in these markets or should it take longer than expected to find a suitable tenant to sublease these facilities, the actual loss could exceed this estimate. Future cash outlays are anticipated through December 2010 unless we negotiate to exit the leases at an earlier date.

A summary of restructuring expenses, payments, and liabilities for the year ended and as at December 31, 2001 is as follows (in thousands):

                                                                     Restructuring
                           Expense      Non-cash       Payments        Accrual
                          ---------   ------------   -------------   ------------
      Severance......... $  24,426   $      1,858   $      21,655   $        913
      Facilities........    38,168             --          10,750         27,418
      Asset disposals...    26,453         26,453              --             --
                          ---------   ------------   -------------   ------------
      Total ............ $  89,047   $     28,311   $      32,405   $     28,331
                          =========   ============   =============   ============

In Process Research and Development. In connection with the Silknet merger, net intangibles of $6.9 million were allocated to in-process research and development in 2000. The fair value allocation to in-process research and development was determined by identifying the research projects for which technological feasibility had not been achieved and which had 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. These projects have since been completed.

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.

Goodwill Impairment. We performed impairment assessments of the identifiable intangibles and goodwill recorded in connection with the Silknet merger. The assessments were 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 than projected operating results. As a result, we recorded impairment charges of approximately $603.4 million in the first quarter of 2001 and $2.1 billion in the fourth quarter of 2000 to reduce our goodwill. The charges were based upon the estimated discounted cash flows over the remaining useful life of the goodwill using a discount rate of 20%.

The remaining goodwill balance, excluding negative goodwill recorded in connection with the merger with Broadbase, was approximately $68.7 million at December 31, 2001.

In connection with the merger with Silknet, we assumed a $1.5 million investment in preferred stock of a privately held company. We recorded a $1.0 million impairment charge in order to reduce the carrying value of the investment to $500,000. The impairment charge was based on a substantial decline in the estimated fair value of the investment based, in part, on the terms of a recent proposed financing. This investment is included in other assets in the consolidated balance sheet at December 31, 2001.

Other income (expense), net in 2001 and 2000 consisted primarily of interest earned on cash and short-term investments offset by interest expense and other expenses. Other income (expense), net was $1.5 million for the year ended December 31, 2001 and $4.8 million for the year ended December 31, 2000. The decrease in other income (expense), net related to lower amounts of interest income earned due to lower average cash balances in 2001 than in 2000.

We have incurred operating losses for all periods from inception through December 31, 2001, 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, 2001, we had net operating loss carryforwards for federal tax purposes of approximately $408.2 million. The federal net operating loss carryforwards, if not offset against future taxable income, will expire from 2011 through 2021. 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.

During the second quarter of 2001, we adopted a plan to discontinue the KANA Online business. We will no longer seek new business but will continue to service all ongoing contractual obligations we have to our existing customers. Accordingly, KANA Online is reported as a discontinued operation. Net assets of the discontinued operation at December 31, 2001, consisted primarily of computers and servers. The estimated loss on the disposal of KANA Online recorded during the second quarter of 2001 was $3.7 million, consisting of an estimated loss on disposal of the business of $2.6 million and a provision of $1.1 million for the anticipated operating losses during the phase-out period. Revenues from our discontinued operation for the year ended December 31, 2001 were $3.2 million compared to $6.2 million in 2000.

Our net loss was $942.9 million and $3.1 billion for the years ended December 31, 2001, and 2000, respectively. In the past, we have experienced substantial increases in our expenditures since our inception consistent with growth in our operations and personnel through the first quarter of 2001 and expenses related to merger and transition costs and restructuring costs. In addition, goodwill impairment, amortization of goodwill and identifiable intangibles and stock-based compensation charges have contributed to the significant net loss during 2001 and 2000. Although we anticipate that our expenditures will decrease in the future due to our cost reduction initiatives, we cannot be certain that we will attain profitability.

Total revenues increased by 737% to $113.0 million for the year ended December 31, 2000 from $13.5 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 67% of total revenues for the year ended December 31, 2000 and 78% of total revenues for 1999.

Service revenues increased by 1,170% to $37.7 million for the year ended December 31, 2000 from $3.0 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 33% of total revenues for the year ended December 31, 2000 and 22% 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.

Total cost of revenues increased by 712% to $54.0 million for the year ended December 31, 2000 from $6.7 million for the year ended December 31, 1999, primarily due to increased cost of service revenues. Cost 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 701% to $51.1 million for the year ended December 31, 2000 from $6.4 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 136% in 2000 and 215% in 1999.

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 78% for the year ended December 31, 2000 and 157% 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.

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 38% for the year ended December 31, 2000 and 95% 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.

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 17% for the year ended December 31, 2000 and 37% 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.

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.

In September 2000, we issued to Accenture 40,000 shares of common stock and a warrant to purchase up to 72,500 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 warrant to purchase up to 72,500 shares of common stock was immediately vested and exercisable with respect to 12,500 shares of common stock, with the remainder becoming vested upon the achievement of certain performance goals. The vested shares 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 became vested in an additional 12,163 shares of common stock subject to the warrant. This vesting of shares resulted in a stock-based charge to operations of $968,000 during the quarter ended December 31, 2000.

The amortization of stock-based compensation by operating expense is detailed as follows (in thousands):

                                      Years Ended December 31,
                                      ------------------------
                                         2000         1999
                                      -----------  -----------
Cost of service..................... $     2,816  $    19,752
Sales and marketing.................       8,078       34,000
Research and development............       2,831       19,864
General and administrative..........         990        6,860
                                      -----------  -----------
 Total.............................. $    14,715  $    80,476
                                      ===========  ===========

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 in 2000. 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.

Acquisition Related Costs. In connection with the Silknet merger, we recorded $6.6 million of transaction costs and merger-related integration expenses in 2000. These amounts consisted primarily of merger-related advertising and announcements of $4.5 million and duplicate facility costs of $1.0 million.

Goodwill Impairment. 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 assumptions supporting our 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 until January 1, 2002 upon the adoption of SFAS No. 142 as discussed above.

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.

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 $175.8 million and $78.6 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.

In September 1999, we completed the initial public offering of our common stock and realized net proceeds from the offering of approximately $51.1 million. Prior to the initial public offering, we had financed our operations primarily from private sales of convertible preferred and common stock totaling $40.8 million and, to a lesser extent, from bank borrowings and lease financing.

In November 2001, we sold 1,000,000 shares of our common stock for net proceeds of $10.0 million in a private placement transaction, and an additional 10,000 shares for net proceeds of $100,000 to the same investor in December 2001.

In February 2002, we sold 2,910,000 shares of our common stock for gross proceeds of approximately $34.5 million, prior to associated transactions costs, in a private placement transaction.

Our operating activities used $112.4 million of cash for the year ended December 31, 2001. These expenditures were primarily attributable to the net loss experienced during 2001, including restructuring and merger costs, offset in part by non-cash charges. Our operating activities used $90.7 million of cash for the year ended December 31, 2000 and $25.7 million of cash for the year ended December 31, 1999. These expenditures were primarily attributable to net loss