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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
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[X]ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1999,
Or
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 000-26287
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KANA COMMUNICATIONS, INC.
(Exact name of Registrant as specified in its charter)
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Delaware 77-0435679
(State or other jurisdiction (I.R.S. Employer
of incorporation or Organization) Identification No.)
740 Bay Road, Redwood City, CA 94063
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (650) 298-9282
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Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.001 par value
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form.[_]
As of March 10, 2000, the aggregate market value of the voting stock held
by non-affiliates of the Registrant was approximately $5,234,550,000 based
upon the closing sales price of the Common Stock as reported on the Nasdaq
Stock Market(R) on such date. Shares of Common Stock held by officers,
directors and holders of more than ten percent of the outstanding Common Stock
have been excluded from this calculation because such persons may be deemed to
be affiliates. The determination of affiliate status is not necessarily a
conclusive determination for other purposes.
As of March 10, 2000, the Registrant had outstanding 60,809,098 shares of
Common Stock.
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This Report on Form 10-K includes 89 pages with the Index to Exhibits
located on page 64.
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KANA COMMUNICATIONS, INC.
TABLE OF CONTENTS
ANNUAL REPORT ON FORM 10-K
FOR YEAR ENDED DECEMBER 31, 1999
Page
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PART I
Item 1 Business ...................................................... 3
Item 2 Properties..................................................... 17
Item 3 Legal Proceedings.............................................. 17
Item 4 Submission of Matters to a Vote of Security Holders............ 17
PART II
Item 5 Market for the Registrant's Common Equity and Related
Stockholder Matters............................................ 18
Item 6 Selected Consolidated Financial Data........................... 20
Item 7 Management's Discussion and Analysis of Financial Condition and
Results of Operations.......................................... 21
Item 7A Quantitative and Qualitative Disclosures About Market Risk..... 47
Item 8 Financial Statements and Supplementary Data.................... 47
Item 9 Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure........................................... 47
PART III
Item 10 Directors and Executive Officers of the Registrant............. 48
Item 11 Executive Compensation......................................... 54
Item 12 Security Ownership of Certain Beneficial Owners and
Management..................................................... 59
Item 13 Certain Relationships and Related Transactions................. 61
PART IV
Item 14 Exhibits, Financial Statement Schedules, and Reports on Form 8-
K.............................................................. 63
Signatures.............................................................. 88
PART I
The following contains forward-looking statements within the meaning of
Section 21e of the Securities Exchange Act of 1934. Kana's actual results and
timing of certain events could differ materially from those anticipated in
these forward-looking statements as a result of certain factors, including, but
not limited to, those set forth under "Risk Factors" and elsewhere in this
Annual Report on Form 10-K.
ITEM 1. BUSINESS
Overview
Kana develops, markets and supports customer communication software
products and services for e-Businesses. Kana defines e-Businesses as companies
that leverage the reach and efficiency of the Internet to enhance their
competitive market position, from Internet start-ups to the largest 2,000
companies in the world, commonly known as the "Global 2000". Kana's products
and services allow these companies to manage high volumes of inbound and
outbound e-mail and website-based communications, while facilitating the
delivery of specific and personalized information to each customer. By using
Kana's software products and services, e-Businesses can, among other things:
. compile customer and communication history;
. profile and send targeted communications to potential and existing
customers;
. generate automated confirmations, notifications and receipts related to
e-commerce transactions;
. respond to online service and support inquiries; and
. trigger follow-on actions within the e-Business.
As a result, Kana enables e-Businesses to enhance customer relationships,
generate additional revenue opportunities and reduce the cost of online
communications.
Kana's software, which consists of applications built upon Kana's
technology platform, is designed with a web-based architecture. By web-based,
Kana means that its software design is based on the unique characteristics of
the Internet and uses industry standards, such as the Java programming
language, Hypertext Mark-up Language (HTML), and Extensible Mark-up Language
(XML). This web-based architecture allows Kana's products to facilitate
scaleability and the integration of Kana's platform with other e-Business and
legacy systems. By integrating with databases and other enterprise systems,
Kana's technology platform functions as the online customer communications
infrastructure for e-Businesses.
Kana offers its products on both a license and a hosted basis. Kana also
offers implementation, customization and maintenance services to support its
customers. Kana On-Line, Kana's hosted application service, allows e-Businesses
to rapidly and efficiently deploy an online customer communication system while
minimizing their up-front investment in hardware, software and services.
On December 3, 1999, Kana closed a merger with Business Evolution pursuant
to which Business Evolution became Kana's wholly-owned subsidiary. Business
Evolution develops, markets and supports real-time and e-mail based customer
communications software for e-Businesses. Business Evolution's software enables
e-Businesses to communicate with potential and existing customers through e-
mail and real-time world wide web based applications. By using Business
Evolution's software, e-businesses can enhance customer relationships and
minimize lost sales. Business Evolution was based in Princeton, New Jersey, and
had 66 employees at the time of the merger.
On December 3, 1999, Kana closed a merger with netDialog pursuant to which
netDialog became Kana's wholly-owned subsidiary. netDialog develops, markets
and supports internet based
3
self-service customer communications software for e-Businesses. netDialog's
software enables e-Businesses to assemble customer experience to better
communicate with potential and existing customers through world wide web based
applications. By using netDialog's software, e-businesses can enhance customer
relationships and minimize lost sales. netDialog was based in San Mateo,
California, and had 45 employees at the time of the merger.
Kana's objective is to become the leading provider of online customer
communication software products and services for e-Businesses. To achieve its
objective, Kana intends to expand its products to enter new markets, increase
its global distribution capabilities and alliances, leverage its hosted
application service and continue to emphasize customer advocacy and
satisfaction.
Kana's customers range from Global 2000 companies pursuing an e-Business
strategy to rapidly growing Internet companies. As of December 31, 1999, each
of more than 35 customers had ordered at least $110,000 of Kana's products and
services, including:
.eBay Inc .Ameritrade .Telstra
.eToys Inc .Kodak .Paine Webber
.Chase American .Gap
Airlines .barnesandnoble.com
.Manhattan Bank
No customer accounted for 10% or more of Kana's total revenues in 1998 or
1999.
Recent Developments
On February 6, 2000, Kana entered into a definitive agreement to acquire
Silknet Software, Inc. In the merger, Silknet will become a wholly-owned
subsidiary of Kana, and each share of Silknet common stock will be exchanged
for 1.66 shares of the common stock, par value $0.001 per share, of Kana
Communications, Inc. We expect to issue approximately 28.5 million shares of
our common stock and to assume 4.58 million common stock options and warrants
in the merger.
Silknet provides electronic customer relationship management software, or
eCRM software, that allows companies to offer marketing, sales, e-commerce and
support services through a single Web site interface personalized for
individual customers. Silknet's products enable a company to deliver these
services to its customers over the Web through customer self-service, assisted
service or immediate, direct collaboration among that company and its
customers, partners, employees and suppliers. These users can choose from a
variety of communications media, such as the Web, e-mail and the telephone, to
do business with that company. Silknet's software can capture and consolidate
data derived from all of these sources and distribute it throughout a company
and to its partners to provide a single view of the customer's interaction with
that company.
The proposed merger has not closed and is subject to approval by Kana and
Silknet stockholders. The details of the merger are described in a Registration
Statement on SEC Form S-4 that was declared effective by the SEC on March 22,
2000. Kana and Silknet have mailed a Joint Proxy Statement/Prospectus to Kana
and Silknet stockholders in connection with the Special Meeting of Stockholders
to be held on April 18, 2000. INVESTORS ARE URGED TO READ THE JOINT PROXY
STATEMENT/PROSPECTUS AND ANY OTHER MERGER-RELATED DOCUMENTS FILED WITH THE SEC,
AS THEY CONTAIN IMPORTANT INFORMATION. Investors may obtain free copies of
these documents through the SEC's website at http://www.sec.gov, Kana
Communications, Inc., 740 Bay Road, Redwood City, CA 94063, attn: Investor
Relations, telephone: (650) 298-9282, or Silknet Software, Inc., 50 Phillippe
Cote Street, Manchester, NH 03101, (603) 625-0070 attn: Investor Relations.
Kana, Silknet and their respective directors, officers and certain other
employees may be soliciting proxies from Kana and Silknet stockholders in favor
of the merger. Information concerning these solicitation participants is set
forth in the Registration Statement on Form S-4.
4
Industry Background
With the widespread adoption of the Internet, new businesses can enter and
disrupt established markets virtually overnight. In this environment, most
companies' customers have a variety of purchasing options and are only a click
away from the competition. As a result, businesses need to be closer and more
responsive to their customers than ever before. Whether a company is a Global
2000 enterprise, or a newly established Internet-based business, the ability to
provide a high quality customer experience, and thus to establish long-term
customer relationships and loyalty, is more important than ever. In fact, for
many e-Businesses, superior customer service and the brand reputation that
results are becoming key competitive advantages.
Until recently, most customer communications took place in person, by
telephone or by letter. In order to respond to these types of customer
inquiries more effectively, many companies invested substantial resources in
expensive call centers and traditional direct marketing initiatives. Call
centers typically served a customer service function, employed costly
technology and did not scale effectively. Traditional direct marketing is
typically expensive and not effective in terms of conversion and response
rates. With the advent of the Internet and the proliferation of e-mail, the
manner in which businesses communicate with their customers has undergone a
fundamental change: customers are now demanding that businesses be accessible
and communicate online.
Given the emerging shift to online customer interaction, traditional
solutions are not addressing the fundamental changes required by e-Businesses.
The Gartner Group estimates that companies will receive 25% of all customer
inquiries via e-mail and web-based forms by 2001, so the incorporation of these
new online communications channels is critical to continued success. However,
most companies remain unprepared to address the dramatic growth of e-mail and
web-based customer communications. A survey of 125 companies with content,
consumer brands, travel, retail and financial services web sites conducted by
Jupiter Communications in late 1998 found that 42% of the surveyed companies'
web sites took longer than five days to reply to e-mail inquiries, never
replied or were not accessible by e-mail.
There can be negative consequences for an e-Business if it fails to manage
online customer communications effectively. These consequences can include loss
of customers, increased difficulty in acquiring new customers and a
deterioration of competitive position. In addition, e-Businesses face higher
operating and information technology costs without efficient and reliable
management of online customer communications. Perhaps most significantly, e-
Businesses may lose the opportunity to take advantage of new revenue-generating
opportunities by failing to capitalize upon the wealth of information conveyed
through online customer communications. While addressing these challenges, e-
Businesses must also be able to deploy a customer communications solution
across multiple departments, to integrate the solution with existing e-Business
and legacy systems and databases and to scale the solution as volumes grow.
Kana believes that in order for companies to compete effectively in today's
rapidly changing e-Business environment, it must differentiate itself by
providing the highest quality customer experience. To accomplish this, e-
Businesses require a software solution that:
. enables personalized online customer interaction that is timely,
relevant and specific to the needs of the customer;
. reduces operating and information technology costs while integrating
with existing e-Business and legacy systems and databases across
multiple departments; and
. broadens the opportunities for revenue generation through the
extraction, analysis and management of the valuable information
contained within online customer interactions.
5
The Kana Solution
Kana's products and services enable e-Businesses to manage their online
customer communications in order to generate additional revenue opportunities,
enhance customer relationships, and reduce operating and information technology
costs. Kana On-Line, Kana's web-based service, offers the Kana solution on a
hosted basis.
Kana believes its products and services provide the following business
benefits:
Increased Revenue Opportunities. Kana's software enables e-Businesses to
track and manage online customer communications and integrate online customer
information with relevant data contained within existing corporate databases
and systems. By integrating and using information in this way, e-Businesses can
identify and create additional revenue-generating opportunities. For example,
e-Businesses can:
. proactively market and sell existing products and services in a
targeted, individualized fashion using outbound messaging campaigns;
. sell additional products and services, such as product upgrades, during
the response process; and
. identify and develop new product and service offerings.
Enhanced Customer Relationships. Kana's products and services enable e-
Businesses to interact with their customers in a personalized and timely
manner. The ability to collaborate seamlessly across the enterprise facilitates
the generation of comprehensive, accurate responses. Kana's software provides
e-Businesses with the ability to track and manage online customer
communications and integrate the online customer information with relevant data
contained within existing corporate databases and systems. e-Businesses can
then analyze and report on this information and launch customized initiatives
in response to the gathered information. Kana believes that the resulting
improvements in the overall customer experience will enable e-Businesses to
significantly enhance customer retention and loyalty.
Reduced Operating and Information Technology Costs. Kana's products and
services reduce the operating and information technology costs of e-Businesses
by increasing the efficiency and effectiveness of online customer
communications. For instance, an e- Business using Kana's software will be able
to handle significantly greater volumes of customer e-mails, thereby increasing
efficiency and productivity, and reducing costs. Costs are further reduced as a
result of migrating customer communications from expensive telephony-based
environments to the more cost- effective channels of e-mail and the web.
Kana's products use a combination of automation, business process and
artificial intelligence workflow and advanced messaging analysis technologies
to allow e-Businesses to deliver information and respond to customer messages
rapidly and accurately, which can increase the effectiveness of messages
delivered, decrease the number of repeat inquiries received and increase the
efficiency of users. Kana's open, scaleable web-based architecture is designed
to be integrated readily with e-Businesses' legacy systems, extending these
systems' useful lives and allowing e-Businesses to avoid expensive upgrades. In
addition, Kana's hosted web-based service, Kana On-Line, allows e-Businesses to
utilize a customized Kana product while minimizing information technology
infrastructure costs.
In addition to these business benefits, Kana's products and services differ
from those of Kana's competitors, and as a result of the following Kana
believes they enable it to deliver superior value to e-Businesses:
6
Advanced Architecture. Kana's software features a scaleable, web-based
architecture that incorporates industry standards.
. Web-Based. Kana's software is based upon a web-based architecture that
supports multiple hardware and software platforms and browser-based
interfaces. Kana's software runs on multiple hardware platforms
simultaneously in order to enhance scaleability. In addition, Kana's
software is readily deployable and performs in demanding operating
environments.
. Scaleable. Kana's architecture scales to accommodate large numbers of
transactions and concurrent users. For example, by deploying Kana's
advanced message classification technologies, e-Businesses can more
effectively categorize customer messages, automate responses and
increase message volume. Kana's architecture also scales to accommodate
new functionalities and applications that may be required by e-
Businesses.
. Open and Standards-Based. Kana's software supports open industry
standards such as the Java programming language, Hypertext Mark-up
Language (HTML) and Extensible Mark-up Language (XML), and integrates
easily with:
. existing enterprise software environments;
. e-mail, telephony, billing and customer relationship management
systems;
. product and other databases; and
. a broad range of other information systems.
The ability to share data across these multiple applications provides e-
Businesses with a powerful tool for capitalizing on their customer
communications.
. Optimize Key Business Processes. Kana's software is designed to optimize
workflow, information and communications associated with online customer
communications. Kana's software can be configured to trigger not only a
message delivery and response but also other actions within an
organization. For example, Kana's software can alert an e-Business'
engineering department if the e-Business receives repeat inquiries about
a software defect or the human resources department if a resume is
attached to a communication.
. Enhanced Productivity. Kana's software is designed to automate key
functions of the online communications process while simultaneously
providing high-quality customer communications. Users can customize the
applications and access an integrated knowledge base of corporate
information to handle increased message volume. Kana's software also
provides one-click access to customer histories and all previous
communications so that users can accurately target customers and provide
fully informed, accurate and personalized answers that are consistent
across the organization. System administrators can set preferences,
routing rules and user permissions and establish address books and
message queues, all on a real-time basis.
. Comprehensive Data Analysis and Reporting. Kana's software includes an
application that analyzes metrics ranging from system utilization to
user performance and provides a broad range of packaged reports that
enable management to maximize message volume and user productivity. It
also enables e-Businesses to maximize the value of their customer
communications by collecting, extracting and analyzing the large amounts
of information contained within online customer communications. e-
Businesses can use this information to enhance their customer
relationships and capitalize on new opportunities by identifying trends,
understanding customer interests and responses, addressing problems and
improving corporate decision-making. In addition, e-Businesses can use
any data created or captured by Kana software to design custom reports
and decision management tools.
7
. Advanced Message Classification. Kana's software enables e-Businesses to
classify and respond to customer messages rapidly and accurately with
the desired level of human intervention. Kana is developing advanced
message classification technologies that significantly increase the
efficiency of the message management process. e-Businesses experiencing
a high volume of inbound messages can choose the level of automation
appropriate for their needs, including routing a message to a particular
queue or user for response, categorizing a message for a fully automated
response or allowing the creation of a fully personalized response to
the inquiry.
The Kana Strategy
Kana's objective is to become the leading provider of mission-critical
online customer communication software products and services for e-Businesses.
The key elements of Kana's strategy include:
Extend Market Leadership Position. Kana's objective is to extend its
position as a leader in the e-Business software market for managing online
customer communications by leveraging its suite of software applications and
establishing itself as the solution of choice. Kana intends to take advantage
of its technological leadership, strategic customer base and distribution
capabilities to extend its current position as a market leader. Moreover, Kana
believes that, by broadening its platform and suite of applications, it can
expand its market opportunities and solidify its position as a leading provider
of comprehensive e-Business products and services.
Expand Kana's Suite of Products to Enter New Markets. Kana intends to
expand its suite of products to include additional e-commerce and content
management applications in order to enter new markets. In developing these
applications, Kana is working with its customers to identify the strategic and
functional needs of e-Businesses that operate in the rapidly changing Internet
environment. Kana's focus is to develop applications that address those needs
and integrate them seamlessly with its existing platform to help e-Businesses
establish broader and deeper customer relationships. Kana believes these
applications will be integrated to merge e-commerce transactions with customer
communications to create further revenue opportunities.
Increase Distribution Capabilities. Kana intends to broaden and increase
its distribution capabilities worldwide by combining the efforts of its direct
sales force and its alliances with leading e-Business service and
infrastructure providers. Kana's sales alliances are reseller arrangements or
cooperative sales agreements with larger companies, such as MCI Worldcom, Inc.,
Davox, Inc. and Convergys Corporation. By expanding existing alliances and
aggressively developing new ones, Kana can leverage others' sales, marketing
and deployment capabilities to help establish Kana as a worldwide provider of
e-Business products and services to manage online customer communications.
Establish Technology Leadership with Open, Scaleable Web-based
Architecture. Kana's objective is to establish the Kana architecture as the
leading technology platform and market standard for e-Business products and
services to manage online customer communications. To deliver the high
performance required in the complex and rapidly changing e-Business
environment, Kana has designed its products to be highly scaleable, easily
customizable and readily able to integrate with existing enterprise
applications and systems. Because Kana's web-based architecture is based on
industry standards such as Java, HTML and XML, e-Businesses and third parties
are able to develop and deploy new applications on top of the Kana platform.
Kana intends to continue to develop and enhance its advanced architecture to
efficiently handle the growing volume of online customer communications while
providing increased functionality across e-Businesses.
Leverage Hosted Web-Based Application Service. Kana offers Kana On-Line,
Kana's hosted web-based application service, for e-Businesses that want to
deploy an online customer
8
communication system rapidly and efficiently while minimizing their up-front
investment in hardware, software and services. Kana On-Line allows Kana to
manage important customer data and monitor real-time, hands-on customer
feedback on Kana's software. Kana intends to continue developing this service
because this service allows Kana to target additional markets that are
complementary to Kana's software-based solution, provides it with recurring
revenue streams and may, in the future, allow it to enter into new business
opportunities. To date, revenues received from Kana On-Line have not been
material. Although Kana intends to develop and support this service, as a
result of many factors, including the relative success of sales of Kana's
products and Kana's services, Kana cannot accurately predict when revenues from
Kana On-Line will become material.
Emphasize Customer Advocacy and Satisfaction. Kana believes that delivering
complete customer satisfaction is vital to growing Kana's business. Kana's
emphasis on customer advocacy and satisfaction has provided it with a strong
base of referenceable customers. This strategy provides many benefits,
including potentially shortened sales cycles, incremental sales opportunities
to Kana's installed-base of customers and new and improved products resulting
from customer feedback. Kana intends to remain focused on providing the highest
level of satisfaction to its customers and to continue to design its solutions
to address their online customer communications needs. In addition, Kana
intends to continue to build its professional services group, which maintains
customer relationships beyond the implementation phase and is responsible for
providing a superior customer experience.
Products and Services
Kana Platform and Suite of Applications
Kana's products are comprised of a software platform and a suite of
customer communication applications. Together the platform and the applications
create an advanced and scaleable online customer communication system for e-
Businesses. The Kana platform consists of the Kana Core Technology, which
includes Kana Conduits. The suite of software applications consists of Kana
Connect, Kana Notify, Kana Realtime, Kana Assist, Kana Classify and Kana
Response. License fees for Kana's software are typically based on the number of
customer profiles processed by the software or the number of users authorized
to access Kana's software at any given time, and is also dependent upon the
specific application licensed.
Kana Core Technology. The Kana Core Technology has a number of
capabilities, including message delivery, enterprise integration, queue
management, collaboration, personalization, automation, message transport and
performance management. The Kana Core Technology uses an open, scaleable, web-
based architecture and serves as the foundation for the suite of Kana
applications. Kana Conduits, also part of the Kana Core Technology, allows e-
Businesses to integrate the Kana platform with other enterprise applications
such as telephony customer relationship management systems and e-commerce
infrastructure. This integration is designed to allow applications to exchange
information so that e-Businesses can communicate with their customers more
efficiently and consistently.
Kana Connect. Kana Connect is Kana's electronic direct marketing
application that enables e-Businesses to proactively deliver individually
targeted messages to increase the lifetime value of customers. The application
enables marketers to profile, target and engage customers in one-to-one
conversations through permission-based, e-mail communication.
Kana Notify. Kana Notify is Kana's automated communications application
that extends the customer retail experience by automating, customizing and
managing transaction-related communications such as order status and receipts,
and helps to reduce customer service inquiries by sending proactive messages.
9
Kana Realtime. Kana Realtime is an e-commerce application that enables
companies to engage in one-to-one realtime communications with customers to
generate higher sales conversions. The solution's live two-way web-based
dialogue between the company and customer provides immediate online sales
assistance to help companies turn browsers into buyers, reduce shopping cart
abandonment, cross-sell and up-sell during the sales cycle, and reduce sales
service costs.
Kana Assist. Kana Assist is an online self-service application that
improves the customer experience by delivering context-sensitive answers to
customer questions directly on the web site--allowing customers to quickly and
conveniently obtain answers to their questions without the intervention of a
customer service representative.
Kana Classify. Kana Classify is Kana's advanced message classification
technology that drives automated actions. Kana Classify categorizes customer
messages and can automatically respond to customers, suggest responses for user
review or route messages to skill-based queues.
Kana Response. Kana Response is Kana's e-mail and web communications
management application that assists e-Businesses in responding to large numbers
of inbound customer communications. Kana Response provides rule-based
automation, intelligent workflow, message queuing, specialized user tools and a
centralized knowledge base of issues and responses.
Kana On-Line
Kana On-Line is a web-based application service that offers the Kana
software on a hosted basis. Kana On-Line provides e-Businesses with access to a
customized version of Kana's software without the need to purchase, install or
maintain their own server or database infrastructure. With Kana On-Line, Kana
hosts the back-end infrastructure and the customer accesses Kana's powerful
functionality by deploying the core applications of the Kana solution.
The hardware and core technology supporting Kana On-Line is pre-installed
and managed at Exodus Communications, Inc., a leading provider of Internet
server hosting and management solutions. Kana believes that Exodus is equipped
to provide the security, reliability and performance required for hosting
Kana's solution through its nationwide network operating centers and high-speed
wide area network backbone.
Kana On-Line offers several key benefits to e-Businesses:
. Low Initial Investment. e-Businesses gain the benefits of the core
components of the Kana software with limited hardware and software
infrastructure costs.
. Low Cost of Ownership. Because Kana hosts the back-end infrastructure
for Kana On-Line, e-Businesses keep IT administration and overhead costs
low while achieving the benefits of the Kana software.
. Scalability. Kana On-Line is scaleable and, because of the Kana On-Line
fee structure, an e-Business' costs will increase only as its usage
increases.
. Reliability and Security. A team of dedicated professionals monitors and
maintains the customer business applications in a secure environment.
Kana actively works to promote the security of e-Business data and the
reliability of the Kana On-Line service.
. Rapid Deployment. Since e-Businesses run the Kana software locally, they
are not responsible for purchasing and configuring the appropriate
hardware and the system can often be set up in a matter of days. A Kana
On-Line representative works with the e-Business to ensure that the
system is configured to meet its specific needs.
. Easy Migration. Because Kana offers both a hosted and licensed version
of the Kana software, e-Businesses can start by using Kana's hosted
applications and convert to a premise license without disruption of
their service or additional training for system users.
10
Professional Services
Kana's professional services group consists of consulting services,
customer advocacy, technical support and education services.
Consulting Services. Kana's consulting services group provides a wide range
of business and technical expertise to support Kana's customers and partners
during the implementation of solutions. This group brings deep functional and
industry knowledge to the market as well as the technical capabilities to
deliver premium consulting services for Kana's customers and partners.
Customer Advocacy. Kana's customer advocacy group ensures ongoing customer
satisfaction with the Kana solution. This includes providing experienced
account planning to develop a long-term relationship and ensure business needs
are being met as Kana's customers evolve and grow. The group develops a
satisfaction plan with Kana's customers to ensure the successful delivery of
services and resources.
Technical Support. Kana's technical support group provides global support
for Kana's customers through a number of channels, including phone and e-mail,
as well as access to the Kana Support website.
Education Services. Kana's education services group delivers a full set of
training programs for Kana's 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 Kana's customers and partners through monthly
newsletters, website FAQ's, and regional user groups.
Technology
Kana's software incorporates industry standards, such as Java, HTML and
XML, in order to facilitate customization and to enable efficient development
cycles. The Kana software offers both web- and Windows-based interfaces.
Open, Standards-Based Architecture
The architecture of the Kana software is "open" because it relies upon
industry standards that facilitate integration with customers' e-Business and
legacy databases and systems and the development of applications on the Kana
platform. These industry standards include:
. Java;
. JDBC (Java DataBase Connectivity);
. standard relational databases from Oracle and Microsoft;
. JSP (Java Server Pages); and
. Microsoft ASP (Active Server Pages).
The use of industry standards also permits the Kana platform to be readily
customized to users' preferences.
Scaleable Web-Based Architecture
Kana's software relies on a scaleable web-based architecture. This
architecture separates the different system components into logical layers,
supports multiple hardware and software platforms, supports browser-based
interfaces and enables the system to run on multiple hardware platforms
simultaneously in order to enhance scaleability. The tiers are the
presentation, user interface, workflow, business object, mail delivery,
tracking and data layers.
11
Advanced Message Classification Technologies
Kana has focused its research and development of advanced message
classification technologies on Bayesian Network technology. Bayesian Network
technology is a classification technology approach that combines machine
learning with human expertise to infer conclusions about new data. Using
machine learning, the system automatically builds a classification model from
existing customer messages, thereby reducing the cost and time of installation
and maintenance and allowing the system to improve as new issues arise. With
human expertise, the system enables managers to add their knowledge selectively
to the system in order to improve accuracy and adjust the model to anticipate
new issues or react to them in real time. Bayesian Network technology underlies
Kana Classify, which categorizes customer messages and drives system
automation.
Ease of Platform Upgrade
Kana's software may be readily upgraded to new versions of the Kana system.
New versions of the software, when installed, are designed to recognize the
historical data and configurations from the previous version of the system and
automatically convert them to the new data format. This enables an e-Business
to upgrade Kana's software without any programming or advanced technical
capability.
Sales and Marketing
Sales
Kana's sales strategy is to pursue targeted accounts through a combination
of its direct sales force and its strategic alliances. To date, Kana has
targeted its sales efforts at the e-Business divisions of Global 2000 companies
and at rapidly growing Internet companies. Kana maintains direct sales
personnel domestically in Arizona, California, Colorado, Connecticut, Florida,
Georgia, Illinois, Maryland, Massachusetts, Michigan, New Jersey, New York,
Texas, Virginia, Washington and Washington D.C., and internationally in the
United Kingdom, Germany and Australia. The direct sales force is organized into
regional teams, which include both sales representatives and systems engineers.
As of December 31, 1999, Kana employed in its sales force 23 persons in its
offices in the United Kingdom and Germany and three persons in its office in
Australia. Kana's office in the United Kingdom is primarily responsible for
sales in Europe generally, Kana's office in Germany is primarily responsible
for sales in Germany and Austria, and Kana's office in Australia is primarily
responsible for sales in Australia and Asia. Sales managers currently based in
the United States handle other international sales and report to Kana's Vice
President, International. Kana's direct sales force is complemented by
telemarketing representatives based at Kana's headquarters in Redwood City,
California.
Kana complements its direct sales force with a series of reseller and sales
alliances, such as those with MCI WorldCom, Inc., Davox, Inc. and Convergys
Corporation. Through these alliances Kana is able to leverage additional sales,
marketing and deployment capabilities. In the future, Kana intends to expand
its distribution capabilities by increasing the size of its direct sales force,
establishing additional sales offices both domestically and internationally and
broadening its alliance activities. As of December 31, 1999, 93 of Kana's
employees were engaged in sales activities. See "Item 1. Business--Strategic
Relationships".
Kana's total revenues derived from sources outside of the United States for
fiscal year 1999 were $1,384,901. Prior to 1999, Kana did not derive revenues
from sources outside of the United States.
Marketing
Kana's marketing programs are targeted at e-Businesses and are currently
focused on educating its target market, generating new sales opportunities and
creating awareness for Kana's
12
e-Business customer communications software. Kana conducts marketing programs
worldwide to educate its target market. In addition, Kana engages in a variety
of marketing activities, including:
. conducting seminars;
. hosting regular customer events;
. participating in industry and technology-related conferences and trade
shows;
. establishing and maintaining close relationships with recognized
industry analysts;
. conducting electronic and traditional direct mailings and ongoing public
relations campaigns;
. managing and maintaining Kana's web site;
. conducting market research; and
. creating and placing advertisements.
Kana's marketing organization also serves an integral role in acquiring,
organizing and prioritizing industry and customer feedback in order to help
provide product direction to its development organizations. Kana has a detailed
product management process that surveys customer and market needs to predict
and prioritize future customer requirements. Kana also focuses on developing a
range of joint marketing strategies and programs in order to leverage their
existing strategic relationships and resources. These alliances provide
collaborative resources to help extend the reach of Kana's presence in the
marketplace. Kana intends to continue to pursue these alliances in the future.
As of December 31, 1999, 32 of Kana's employees were engaged in marketing
activities.
Strategic Relationships
Kana has three types of strategic relationships: service relationships,
marketing relationships and reseller and strategic sales relationships, that
are designed to leverage Kana's services, software development and sales
capabilities. These relationships are formal or informal agreements with third
parties, and they are typically not exclusive and for a short term. However,
Kana views these relationships as critical to Kana's success in providing
enterprise-wide e-Business communication software products and services.
Service Relationships. Kana collaborates with systems integrators such as
Andersen Consulting and Scient Corporation. These collaborations occur on a
project by project basis, and no formal agreements or commitments exist
regarding Kana's relationships with these systems integrators. These systems
integrators are highly trained in Kana's software, and on a project by project
basis provide integration and implementation services.
Marketing Relationships. Kana has established a series of relationships
with marketing partners across a variety of industries, including providers of
customer relationship management software, sales force automation software,
telephony systems and IT hardware, that allow it to provide a comprehensive
solution to e-Businesses. Kana's marketing relationships are typically
contained in a written agreement, but these agreements generally may be
terminated at any time by either party and do not contain penalties for
nonperformance.
Reseller and Strategic Sales Relationships. Kana complements its direct
sales force with a series of reseller and strategic sales relationships in
targeted industries such as telecommunications. Kana's agreements with these
companies are typically in the form of value-added reseller agreements.
In the future, Kana intends to establish additional strategic relationships
to broaden its product offerings by addressing multiple channels of online
communications and enhancing its distribution channels.
Many of the companies with which Kana has struck relationships also work
with competing software companies, and Kana's success will depend on their
willingness and ability to devote
13
sufficient resources and efforts to its products and services. Kana's
arrangements with these parties typically are in the form of non-exclusive
agreements that may be terminated by either party without cause or penalty and
with limited notice. Therefore, Kana can provide no guarantee that any of these
parties will continue their relationship with it.
Customers
Kana's customers range from Global 2000 companies pursuing an e-Business
strategy to rapidly growing Internet companies. As of December 31, 1999, Kana
had licensed its solution to more than 300 customers in a variety of industries
worldwide. The following is a list of customers that Kana believes are
representative of its overall customer base:
Internet Services Financial e-Tailing
City Index Ameritrade barnesandnoble.com
eBay CBOE CDNOW
eFax.com Datek Cendant
Excite@Home Dime Savings Bank Drugstore.com
iVendor Dow Jones eToys
iVillage Financial Engines Furniture.com
JFAX.com Wit Capital Insweb
Lycos Reel.com
priceline.com Tickets.com
The Motley Fool
The Street.com
Travel Communications Other
American Airlines Ameritech Coleman
Canadian Airlines AT&T Estee Lauder
Mapquest.com Convergys Ford Motor Company
NorthKanast Davox General Motors
SKanadish Railroads NTL Hewlett-Packard
Travelocity (Sabre) Sprynet (Mindspring) Microsoft
Stream International Shell International
Telstra The Gap
US Kanast Williams-Sonoma
No customer accounted for 10% or more of Kana's total revenues for 1999.
Although a substantial portion of Kana's license and service revenues in any
given quarter has been, and is expected to continue to be, generated from a
limited number of customers with large financial commitment contracts, Kana
does not depend on any ongoing commitments from its large customers.
Research and Development
Kana believes that strong product development capabilities are essential to
its strategy of enhancing its core technology, developing additional
applications incorporating that technology and maintaining the competitiveness
of its product and service offerings. Kana has 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 Kana 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, Kana has recruited key engineers and software
developers with experience in the customer communications and internetworking
markets and has complemented these individuals by hiring senior management with
experience in enterprise application development, sales and deployment.
14
Kana's research and development expenses totaled approximately $5.7 million
for the year ended December 31, 1998 and $12.9 million for the year ended
December 31, 1999. As of December 31, 1999, 115 of Kana's employees were
engaged in research and development activities. Kana's success depends, in
part, on its ability to enhance its existing customer interactions solutions
and to develop new services, functionality and technology that address the
increasingly sophisticated and varied needs of its 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
Kana's competitors. If Kana were to lose market share as a result of lapses in
its product management, its business would suffer.
Competition
The market for Kana's products and services is intensely competitive,
evolving and subject to rapid technological change. Kana expects the intensity
of competition to increase in the future. Kana currently faces competition for
its products from systems designed by in-house and third-party development
efforts. Kana expects that these systems will continue to be a principal source
of competition for the foreseeable future. Kana's competitors include a number
of companies offering one or more products for the e-Business customer
communication market, some of which compete directly with Kana's products. For
example, Kana's competitors include companies providing stand-alone point
solutions, including Annuncio, Inc., AskJeeves, Inc., Brightware, Inc., Digital
Impact, Inc., eGain Communications Corp., Inference Corporation, Marketfirst,
Inc., LivePerson, Inc., Mustang Software, Inc., Responsys.com. and Servicesoft,
Inc. In addition, Kana may compete with companies providing customer management
and communications solutions, such as Broadbase, Inc., Cisco Systems, Inc.,
Clarify Inc., (which has been acquired by Northern Telecom) E.piphany, Inc.,
Genesys Telecommunications Laboratories, Inc., (which has been acquired by
Alcatel) Lucent Technologies, Inc., Message Media, Inc., Oracle Corporation,
Pivotal Corporation, Siebel Systems, Inc., Silknet Software, Inc. (if the
merger is not completed) and Vantive Corporation (which has agreed to be
acquired by PeopleSoft, Inc.). Furthermore, Kana may face increased competition
should it expand its product line, through acquisition of complementary
businesses or otherwise.
Kana believes that the principal competitive factors affecting its market
include a significant base of referenceable customers, the breadth and depth of
a given solution, product quality and performance, customer service, core
technology, product scaleability and reliability, product features, the ability
to implement solutions and the value of a given solution. Although Kana
believes that its solution currently competes favorably with respect to these
factors, Kana's market is relatively new and is evolving rapidly. Kana may not
be able to maintain its competitive position against current and potential
competitors, especially those with significantly greater financial, marketing,
service, support, technical and other resources.
Many of Kana's competitors have longer operating histories, significantly
greater financial, technical, marketing and other resources, significantly
greater name recognition and a larger installed base of customers than does
Kana. In addition, many of Kana's competitors have well-established
relationships with Kana's current and potential customers and have extensive
knowledge of Kana's industry. It is possible that new competitors or alliances
among competitors may emerge and rapidly acquire significant market share. Kana
also expects that competition will increase as a result of industry
consolidations. See "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operation--Risk Factors--Kana faces substantial
competition and may not be able to compete effectively".
Intellectual Property
Kana relies upon a combination of patent, copyright, trade secret and
trademark laws to protect its intellectual property. Kana currently has seven
U.S. patent applications pending covering:
15
. A customer communication software product for e-mail and website-based
communications, using rules and message categories to codify workflow,
including use of standard phrases, response templates, recipient lists
and routing;
. A customer communication software product for e-mail and website-based
communications in which advanced workflow features are used in
conjunction with rules, queues and timers;
. A customer communication software product for e-mail and website-based
communications that uses queues and timers to track, route and escalate
the priority of messages;
. A customer communication software product for e-mail and website-based
communications that combines a rule-based workflow engine with a text
classification system to automate e-mail response;
. A customer communications software product for network based customer
service that provides differing levels of customer response;
. A method of using XML to distribute data between applications; and
. A customer communications software product for providing live support
over the world-wide web.
These patents, if allowed, will cover a material portion of Kana's products
and services. Kana has also filed international patent applications
corresponding to three of Kana's U.S. applications.
In addition, Kana has one U.S. trademark registration and seven pending
U.S. trademark registrations as well as pending trademark registrations in
Australia, Canada, the European Union, India, Japan, South Korea and Taiwan.
Although Kana relies on patent, copyright, trade secret and trademark law to
protect its technology, Kana believes that factors such as the technological
and creative skills of its personnel, new product developments, frequent
product enhancements and reliable product maintenance are more essential to
establishing and maintaining a technology leadership position. Kana can give no
assurance that others will not develop technologies that are similar or
superior to its technology.
Kana generally enters into confidentiality or license agreements with its
employees, consultants and alliance partners, and generally controls access to
and distribution of its software, documentation and other proprietary
information. Despite Kana's efforts to protect its proprietary rights,
unauthorized parties may attempt to copy or otherwise obtain and use Kana's
products or technology or to develop products with the same functionality as
its products. Policing unauthorized use of Kana's products is difficult, and
Kana cannot be certain that the steps it has taken will prevent
misappropriation of its 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 Kana's license agreements require Kana to place
the source code for its products into escrow. These agreements generally
provide that some parties will have a limited, non-exclusive right to use this
code if:
. there is a bankruptcy proceeding instituted by or against Kana;
. Kana ceases to do business without a successor; or
. Kana discontinues providing maintenance and support.
Substantial litigation regarding intellectual property rights exists in the
software industry. Kana's software products may be increasingly subject to
third-party infringement claims as the number of competitors in its industry
segment grows and the functionality of products in different industry segments
overlaps. Some of Kana's 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 Kana's technology infringes.
Some of these competitors may make a claim of infringement against us with
respect to Kana's products and technology. See "Legal Proceedings".
16
Employees
As of December 31, 1999, Kana had 337 full-time employees, 73 of whom were
in Kana's professional services group, 110 in sales and marketing, 99 in
research and development, and 47 in finance, administration and operations.
Kana added 182 employees between July 1, 1999 and December 31, 1999, which
number does not include 118 new employees resulting from the Business Evolution
and netDialog mergers. Kana's future performance depends in significant part
upon the continued service of Kana's 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 Kana's key employees could harm its business.
Kana's future success also depends on its 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 Kana is headquartered. Due to the limited number of people
available with the necessary technical skills and understanding of the
Internet, Kana can give no assurance that it can retain or attract key
personnel in the future. None of Kana's employees is represented by a labor
union. Kana has not experienced any work stoppages and considers its relations
with its employees to be good. See "Item 7. Management's Discussion and
Analysis of Financial Conditions and Results of Operations Risk Factors--Kana
may be unable to hire and retain the skilled personnel necessary to develop its
engineering, professional services and support capabilities in order to
continue to grow" and "--Kana may face difficulties in hiring and retaining
qualified sales personnel to sell its products and services, which could harm
Kana's ability to increase its revenues in the future".
ITEM 2. PROPERTIES
Kana's corporate offices are located in Redwood City, California, where
Kana leases approximately 60,861 square feet under a lease that expires in
October 2006. As of December 31, 1999, the annual base rent for this facility
was approximately $1.9 million. In addition, Kana leases facilities and offices
domestically in Westport, Connecticut, Chicago, Illinois and Richardson, Texas;
and internationally in the United Kingdom, Germany and Australia. The terms of
these leases expire beginning in August 2000, and automatically renew unless
earlier terminated. On February 11, 2000, Kana entered into an agreement to
lease approximately 62,500 additional square feet in Redwood City, California
under a lease that expires in December, 2010. The annual base rent for this
facility for the first year is approximately $2.4 million. We believe that our
corporate office space in Redwood City and the other facilities we currently
lease will be sufficient to meet our needs through at least the next 12 months.
ITEM 3. LEGAL PROCEEDINGS
On October 8, 1999, Genesys Telecommunications Laboratories, Inc. filed a
complaint against Kana in the United States District Court for the District of
Delaware. Genesys has amended its complaint to allege that Kana's Customer
Messaging System 3.0 infringes one or more claims of two Genesys patents.
Genesys is seeking relief in the forms of an injunction, damages, punitive
damages, attorneys' fees, costs and pre- and post-judgment interest. The
litigation is currently in its early stages and Kana has not received material
information or documentation. Kana intends to fight this claim vigorously and
does not expect it to impact results. Kana is not currently a party to any
other material legal proceedings. See "Item 7. Management Discussion and
Analysis of Financial Conditions and Results of Operations--Risk Factors." Kana
may become involved in litigation over proprietary rights, which could be
costly and time consuming, and Genesys Telecommunications Laboratories, Inc.
has filed an infringement suit against Kana".
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
17
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
(a) Market Information and Recent sales of Unregistered Securities
Kana's common stock is listed on the Nasdaq Stock Market under the Symbol
"KANA".
The following table sets forth the range of high and low closing sales
prices for each period indicated, adjusted for the two-for-three reverse stock
split effective September 1999 and the two for one forward stock split
effective February 2000:
High Low
------- -------
Year Ended December 31, 1999:
Fourth quarter............................................ $122.50 $ 24.03
Third quarter (from September 22, 1999)................... $ 26.13 $ 22.78
The reported last sale price of Kana's common stock on the Nasdaq Stock
Market on March 21, 2000 was $99.94. The approximate number of holders of
record of the shares of the Company's common stock was 396 as of March 21,
2000. 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. The Company estimates that the number of
beneficial stockholders of the shares of the Company's common stock as of March
21, 2000 was approximately 36,667.
Kana has authorized common stock, $.001 par value and Preferred Stock,
$.001 par value. Kana has not issued any Preferred Stock.
Kana has not paid any cash dividends on its capital stock. Kana currently
intends to retain its earnings to fund the development and growth of its
business and, therefore, does not anticipate paying any cash dividends in the
foreseeable future. In addition, Kana's existing credit facilities prohibit the
payment of cash or stock dividends on Kana's 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."
Kana made the following unregistered sales of its common stock during the
quarter ended December 31, 1999:
Name of Persons of class
Underwriter or of persons to
Transaction Amount of placement Consideration whom securities Exemption from
Date Securities Sold agent Received were sold Registration claimed
- ----------- --------------- -------------- ------------- ---------------- --------------------
12/3/99 1,120,286 None (1) Stockholders Section 4(2) of the
Securities Act of 1933, as
amended
12/3/99 1,890,200 None (2) Stockholders Section 4(2) of the
Securities Act of 1933, as
amended
- --------
(1)Pursuant to an Agreement and Plan of Reorganization dated as of December 3,
1999, by and among Kana Communications, Inc., Kong Acquisition Corp., a
wholly-owned subsidiary of Kana Communications, Inc., and netDialog, Inc.,
on December 3, 1999 (the effective date of the acquisition), all
outstanding shares of netDialog capital stock were converted into 1,120,286
shares of Kana common stock.
(2)Pursuant to an Agreement and Plan of Reorganization dated as of December 3,
1999, by and among Kana Communications, Inc., King Acquisition Corp., a
wholly-owned subsidiary of Kana Communications, Inc., and Business
Evolution, Inc., on December 3, 1999 (the effective date of the
acquisition), all outstanding shares of Business Evolution capital stock
were converted into 1,890,200 shares of Kana common stock.
18
(b) Report of offering securities and use of proceeds therefrom:
On September 21, 1999, we consummated our initial public offering of common
stock, $0.001 par value. The managing underwriters in the offering were Goldman
Sach & Co, Hambrecht & Quist LLC and Wit Capital Corporation. The shares of
common stock sold in the offering were registered under the Securities Act of
1933, as amended, on a registration statement on Form S-1 (Reg. No. 333-82587)
that was declared effective by the SEC on September 21, 1999. All 7,590,000
shares of common stock registered under the registration statement, including
shares covered by an over-allotment option that was exercised, were sold at a
price to the public of $7.50 per share. The aggregate offering amount
registered was $56,925,000. In connection with the offering, Kana paid an
aggregate of $3,985,000 in underwriting discounts to the underwriters. In
addition, the following table sets forth an approximation of all expenses
incurred in connection with the offering, other than underwriting discounts.
All amounts shown are approximations except for the registration fees of the
SEC and the National Association of Securities Dealers, Inc.
SEC Registration Fee............................................. $ 28,130
NASD Filing Fee.................................................. 5,500
Nasdaq National Market Listing Fee............................... 91,000
Printing and Engraving Expenses.................................. 440,000
Legal Fees and Expenses.......................................... 700,000
Accounting Fees and Expenses..................................... 360,000
Blue Sky Fees and Expenses....................................... 15,000
Transfer Agent Fees.............................................. 30,000
Miscellaneous.................................................... 276,370
----------
Total Expenses:.................................................. $1,946,000
==========
All of such expenses were direct or indirect payments to others.
The net offering proceeds to us after deducting the total expenses above
were approximately $51,066,000. From September 21, 1999 to December 31, 1999,
we used such net offering proceeds from our initial public offering of common
stock to invest in short-term, interest bearing, investment grade securities
and used proceeds for working capital and other corporate purposes. This use of
proceeds does not represent a material change in the use of proceeds described
in the prospectus of the registration statement. We used its existing cash
balances to fund Kana's general operations.
We currently estimate that we will use the remaining net proceeds as
follows: 45% for marketing and distribution activities; 20% for various product
development initiatives; 10% for capital expenditures; and 25% for working
capital and other general corporate purposes.
19
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the consolidated financial statements of Kana
Communications, Inc. and the notes to consolidated financial statements
included elsewhere in this annual report.
The consolidated statement of operations data for each of the years in the
three-year period ended December 31, 1999, and the consolidated balance sheet
data at December 31, 1998 and 1999 are derived from our consolidated financial
statements. These consolidated financial statements have been audited by KPMG
LLP, independent auditors, and are included elsewhere in this annual report.
The diluted net loss per share computation excludes potential shares of common
stock (preferred stock, options to purchase common stock and common stock
subject to repurchase rights held by Kana), since their effect would be
antidilutive. See Note 1 of Notes to Consolidated Financial Statements for a
detailed explanation of the determination of the shares used to compute actual
basic and diluted net loss per share. The historical results are not
necessarily indicative of results to be expected for any future period. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Years Ended December 31,
--------------------------------------------
1999 1998 1997
-------------- ------------- -------------
(in thousands, except per share amounts)
Consolidated Statement of
Operations Data:
Revenues:
License........................ $ 10,536 $ 2,014 $ --
Service........................ 3,528 333 617
-------------- ------------- ------------
Total revenues............... 14,064 2,347 617
-------------- ------------- ------------
Cost of revenues:
License........................ 271 54
Service........................ 6,610 666 253
-------------- ------------- ------------
Total cost of revenues........... 6,881 720 253
-------------- ------------- ------------
Gross profit..................... 7,183 1,627 364
Operating expenses:
Sales and marketing............ 21,199 5,504 512
Research and development....... 12,854 5,669 971
General and administrative..... 5,018 1,826 378
Amortization of stock-based
compensation.................. 80,476 1,456 113
Acquisition related costs...... 5,635 -- --
-------------- ------------- ------------
Total operating expenses..... 125,182 14,455 1,974
-------------- ------------- ------------
Operating loss................... (117,999) (12,828) (1,610)
Other income (expense), net...... (744) 227 57
-------------- ------------- ------------
Net loss..................... $ (118,743) $ (12,601) $ (1,553)
============== ============= ============
Basic and diluted net loss per
share........................... $ (4.61) $ (2.01) $ (0.37)
============== ============= ============
Shares used in computing basic
and diluted net loss per share
amounts......................... 25,772 6,258 4,152
============== ============= ============
December 31,
----------------------
1999 1998 1997
------- ------- ------
(in thousands)
Consolidated Balance Sheet Data:
Cash, cash equivalents and short-term investments....... $54,862 $14,035 $5,594
Working capital......................................... 40,236 11,833 5,364
Total assets............................................ 70,229 16,876 6,158
Notes payable, less current portion..................... 412 726 51
Total stockholders' equity.............................. $48,500 $12,951 $5,684
20
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of the Financial Condition and Results of
Operations of Kana contains forward-looking statements within the meaning of
Section 21e of the Securities Exchange Act of 1934. Kana's actual results and
timing of certain events could differ materially from those anticipated in
these forward-looking statements as a result of certain factors, including, but
not limited to, those set forth under "Risk Factors" and elsewhere in this
Annual Report on Form 10-K.
Overview
Kana was incorporated in July 1996 in California and was reincorporated in
Delaware in September 1999. Kana had no significant operations until 1997.
Through January 1998, Kana was a development stage enterprise and had no
revenues. Kana's operating activities during this period related primarily to
conducting research, developing its initial products, raising capital and
building its sales and marketing organization. In February 1998, Kana released
the first commercially available version of the Kana platform. To date, Kana
has derived substantially all of its revenues from licensing its software and
related services, and Kana has sold its products worldwide primarily through
its direct sales force.
On August 13, 1999, Kana closed a merger with Connectify, Inc. pursuant to
which Connectify became a wholly-owned subsidiary of Kana. Connectify develops,
markets and supports electronic direct marketing software for e-Businesses.
Connectify's software enables e-Businesses to profile and target potential and
existing customers and then deliver and track personalized e-mails to their
customers. By using electronic direct marketing software in this way, e-
Businesses can build customer loyalty, increase the probability of repeat
transactions and reduce customer attrition. Connectify was based in San Mateo,
California, and had 31 employees as of the merger.
In connection with the merger, Kana issued approximately 6,982,000 shares
of our common stock in exchange for all outstanding shares of Connectify
capital stock and reserved 416,690 shares of common stock for issuance upon the
exercise of Connectify options and warrants Kana assumed in connection with the
merger. The merger was accounted for as a pooling of interests.
On December 3, 1999, Kana closed a merger with Business Evolution, Inc.
pursuant to which Business Evolution became Kana's wholly-owned subsidiary.
Business Evolution is a leading provider of customer assistance support
software that helps companies prioritize customer queries by urgency, and send
responses through delayed or real-time channels. Business Evolution's offering,
now called Kana Realtime, lets e-businesses engage their customers in a live
two-way dialog while they are browsing a web site, helping them close more
business and increase customer loyalty. Business Evolution is based in
Princeton, New Jersey, and had 66 employees as of the merger.
In connection with the acquisition of Business Evolution, 1,935,206 shares
of Kana common stock, were issued or reserved for issuance for all outstanding
shares, warrants and options of Business Evolution. This transaction was
accounted for as a pooling of interests.
On December 3, 1999, Kana closed a merger with netDialog, pursuant to which
netDialog became Kana's wholly-owned subsidiary. netDialog provides context-
sensitive, self-service customer service software. The company's online self-
service solution, now called Kana Assist, turns e-business web sites into
knowledge bases by delivering predictive and proactive answers to customer
questions directly on the web site. In addition to building customer loyalty by
enabling e-business customers to conveniently and quickly obtain answers to
their questions, it also allows e-businesses to reduce customer support costs
by helping customers directly on the web site without the
21
intervention of a customer service representative. netDialog was based in San
Mateo, California, and had 45 employees as of the merger.
In connection with the acquisition of netDialog, 1,244,062 shares of our
common stock, were issued or reserved for issuance for all outstanding shares,
warrants, convertible notes and options of netDialog. This transaction was
accounted for as a pooling of interests.
On February 6, 2000, Kana and Silknet entered into a merger agreement
whereby we will issue approximately 28.5 million shares of common stock in
exchange for all of the outstanding shares of Silknet common stock and assume
Silknet options and warrants to purchase approximately 4.58 million shares of
Kana common stock. The proposed merger will be accounted for as a purchase and
is subject to shareholder approval by both companies. As a result of the merger
with Silknet, we expect to incur acquisition-related costs of approximately
$20.7 million which will be included in the estimated purchase price of
Silknet. This is an estimate and is subject to change. There can be no
assurance that Kana will not incur additional charges to reflect costs
associated with the merger and integration of the operations of the two
companies. In addition, we estimate that we will record goodwill and intangible
assets of approximately $3.9 billion, which will be amortized over a period of
three years.
We derive our revenues from the sale of software product licenses and from
professional services including implementation, customization, hosting and
maintenance. License revenue is recognized when persuasive evidence of an
agreement exists, the product has been delivered, the arrangement does not
involve significant customization of the software, acceptance has occurred, the
license fee is fixed and determinable and collection of the fee is probable.
Service revenue includes revenues from maintenance contracts, implementation,
customization and hosting services. Revenue from maintenance contracts is
recognized ratably over the term of the contract. Revenue from implementation,
customization and hosting services is recognized as the services are provided.
Revenue under arrangements where multiple products or services are sold
together is allocated to each element based on its relative fair value.
Our cost of license revenue includes royalties due to a third party for
technology integrated into some of Kana's products, the cost of product
documentation, the cost of the media used to deliver Kana's products and
shipping costs. Cost of service revenue consists primarily of personnel-related
expenses, travel costs, equipment costs and overhead associated with delivering
professional services to Kana's customers.
Our operating expenses are classified into three general categories: sales
and marketing, research and development, and general and administrative. Kana
classifies all charges to these operating expense categories based on the
nature of the expenditures. Although each category includes expenses that are
unique to the category, some expenditures, such as compensation, employee
benefits, recruiting costs, equipment costs, travel and entertainment costs,
facilities costs and third-party professional services fees, occur in each of
these categories.
We allocate the total costs for information services and facilities to each
functional area that uses the information services and facilities based on its
relative headcount. These allocated costs include rent and other facility-
related costs for the corporate office, communication charges and depreciation
expense for furniture and equipment.
In connection with the granting of stock options to our employees, we
recorded deferred stock-based compensation totaling approximately $97.0 million
through December 31, 1999. This amount represents the total difference between
the exercise prices of stock options and the deemed fair value of the
underlying common stock for accounting purposes on the date these stock options
were granted. This amount is included as a component of stockholders' equity
and is being amortized on
22
an accelerated basis by charges to operations over the vesting period of the
options, consistent with the method described in Financial Accounting Standards
Board (FASB) Interpretation No. 28. Kana recorded approximately $93.2 million
of deferred stock-based compensation for the year ended December 31, 1999,
approximately $3.0 million of deferred stock- based compensation for the year
ended December 31, 1998, and approximately $890,000 of deferred stock-based
compensation for the year ended December 31, 1997. The amortization of deferred
stock-based compensation is classified as a separate component of operating
expenses in Kana's consolidated statements of operations.
Since the beginning of 1997, Kana has incurred substantial costs to develop
its products and to recruit, train and compensate personnel for its
engineering, sales, marketing, client services and administration departments.
As a result, Kana has incurred substantial losses since inception and, for the
year ended December 31, 1999, incurred a net loss of $118.7 million. As of
December 31, 1999, Kana had an accumulated deficit of $132.6 million. Kana
believes its future success is contingent upon providing superior customer
service, increasing its customer base and developing its products. Kana intends
to invest heavily in sales, marketing, research and development, client
services and infrastructure to support these activities. Kana therefore expects
to continue to incur substantial operating losses for the foreseeable future.
Kana had 337 full-time employees as of December 31, 1999 and intends to
hire a significant number of employees in the future. This expansion places
significant demands on Kana's management and operational resources. To manage
this rapid growth, Kana must invest in and implement scaleable operational
systems, procedures and controls. Kana expect future expansion to continue to
challenge its ability to hire, train, manage and retain employees.
Kana believes that its 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
Kana's. Although Kana has experienced significant revenue growth recently, this
trend may not continue. Furthermore, Kana may not achieve or maintain
profitability in the future.
23
Quarterly Results of Operations
The following tables set forth a summary of our unaudited quarterly
operating results for each of the eight quarters in the period ended December
31, 1999. The information has been derived from Kana's unaudited consolidated
financial statements that, in management's opinion, have been prepared on a
basis consistent with the audited consolidated financial statements contained
elsewhere in this annual report and include all adjustments, consisting of only
normal recurring adjustments, necessary for a fair presentation of such
information when read in conjunction with our audited consolidated financial
statements and notes thereto. The operating results for any quarter are not
necessarily indicative of results for any future period.
Quarter Ended
---------------------------------------------------------------------------------------
Mar. 31, June 30, Sept. 30, Dec. 31, March 31, June 30, Sept. 30, Dec. 31,
1999 1999 1999 1999 1998 1998 1998 1998
-------- -------- --------- --------- --------- -------- --------- --------
(In thousands)
Consolidated Statement
of Operations Data:
Revenues:
License................ $ 1,209 $ 1,821 $ 2,781 $ 4,725 $ 161 $ 464 $ 600 $ 788
Service................ 280 517 998 1,733 25 89 139 80
------- ------- -------- --------- ------- ------- ------- -------
Total revenues......... 1,489 2,338 3,779 6,458 186 553 739 868
------- ------- -------- --------- ------- ------- ------- -------
Cost of revenues:
License................ 34 38 52 147 4 12 17 21
Service................ 498 851 2,191 3,070 36 63 225 342
------- ------- -------- --------- ------- ------- ------- -------
Total cost of
revenues.............. 532 889 2,243 3,217 40 75 242 363
------- ------- -------- --------- ------- ------- ------- -------
Gross profit............ 957 1,449 1,536 3,241 146 478 497 505
------- ------- -------- --------- ------- ------- ------- -------
Operating expenses:
Sales and marketing.... 2,479 4,180 5,482 9,058 586 1,218 1,723 1,977
Research and
development........... 2,329 2,732 3,384 4,409 918 1,023 1,787 1,941
General and
administrative........ 725 1,086 1,402 1,805 255 443 529 599
Amortization of
deferred stock-based
compensation.......... 520 2,734 3,377 73,845 200 277 405 575
Acquisition related
costs................. -- -- 910 4,725 -- -- -- --
------- ------- -------- --------- ------- ------- ------- -------
Total operating
expenses.............. 6,053 10,732 14,555 93,842 1,959 2,961 4,444 5,092
------- ------- -------- --------- ------- ------- ------- -------
Operating loss.......... (5,096) (9,283) (13,019) (90,601) (1,813) (2,483) (3,947) (4,587)
Other income, net....... (125) (394) (231) 6 43 24 51 109
------- ------- -------- --------- ------- ------- ------- -------
Net loss................ $(5,221) $(9,677) $(13,250) $ (90,595) $(1,770) $(2,459) $(3,896) $(4,478)
======= ======= ======== ========= ======= ======= ======= =======
As a Percentage of Total
Revenues:
Revenues:
License................ 81.2 % 77.9 % 73.6 % 73.2 % 86.6 % 83.9 % 81.2 % 90.8 %
Service................ 18.8 22.1 26.4 26.8 13.4 16.1 18.8 9.2
------- ------- -------- --------- ------- ------- ------- -------
Total revenues......... 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
------- ------- -------- --------- ------- ------- ------- -------
Cost of revenues:
License................ 2.3 1.6 1.4 2.3 2.2 2.2 2.3 2.4
Service................ 33.4 36.4 58.0 47.5 19.4 11.4 30.4 39.4
------- ------- -------- --------- ------- ------- ------- -------
Total cost of
revenues.............. 35.7 38.0 59.4 49.8 21.5 13.6 32.7 41.8
------- ------- -------- --------- ------- ------- ------- -------
Gross profit............ 64.3 62.0 40.6 50.2 78.5 86.4 67.3 58.2
------- ------- -------- --------- ------- ------- ------- -------
Operating expenses:
Sales and marketing.... 166.5 178.8 145.1 140.3 315.1 220.3 233.2 227.8
Research and
development........... 156.4 116.9 89.5 68.3 493.5 185.0 241.8 223.6
General and
administrative........ 48.7 46.4 37.1 27.9 137.1 80.1 71.6 69.0
Amortization of
deferred stock-based
compensation.......... 34.9 116.9 89.4 1,143.45 107.5 50.1 54.8 66.2
Acquisition related
costs................. -- -- 24.1 73.2 -- -- -- --
------- ------- -------- --------- ------- ------- ------- -------
Total operating
expenses.............. 406.5 459.0 385.2 1,453.1 1,053.2 535.4 601.4 586.6
Operating loss.......... (342.2) (397.0) (344.5) (1,402.9) (974.7) (449.0) (564.1) (528.5)
Other income, net....... (8.4) (16.9) (6.1) 0.1 23.1 4.3 6.9 12.6
------- ------- -------- --------- ------- ------- ------- -------
Net loss............... (350.6)% (413.9)% (350.6)% (1,402.8)% (951.6)% (444.7)% (527.2)% (515.9)%
======= ======= ======== ========= ======= ======= ======= =======
24
The amount and timing of Kana's operating expenses generally will vary from
quarter to quarter depending on Kana's level of actual and anticipated business
activities. Kana's revenues and operating results are difficult to forecast and
will fluctuate, and Kana believes that period-to-period comparisons of Kana's
operating results will not necessarily be meaningful. As a result, you should
not rely upon them as an indication of future performance.
Results of Operations
The following table sets forth the results of operations for the periods
presented expressed as a percentage of total revenues.
Years Ended December
31,
------------------------
1999 1998 1997
------ ------ ------
Revenues:
License............................................ 74.9 % 85.8 % -- %
Service............................................ 25.1 14.2 100.0
------ ------ ------
Total revenues................................... 100.0 100.0 100.0
------ ------ ------
Cost of revenues:
License............................................ 1.9 2.3 --
Service............................................ 47.0 28.4 41.0
------ ------ ------
Total cost of revenues........................... 48.9 30.7 41.0
------ ------ ------
Gross profit......................................... 51.1 69.3 59.2
Operating expenses:
Sales and marketing................................ 150.7 234.5 83.0
Research and development........................... 91.4 241.6 157.4
General and administrative......................... 35.7 77.8 61.3
Amortization of stock-based compensation........... 572.2 62.0 18.3
Acquisition related costs.......................... 40.1 -- --
------ ------ ------
Total operating expenses......................... 890.1 615.9 319.9
------ ------ ------
Operating loss..................................... (839.0) (546.6) 260.9
------ ------ ------
Other income, (expense) net.......................... (5.3) 9.7 9.2
------ ------ ------
Net loss......................................... (844.3)% (536.9)% (251.7)%
====== ====== ======
Operating Results for the Years Ended December 31, 1999, 1998 and 1997
Revenues
Total revenues increased by 500% to 14.1 million for the year ended
December 31, 1999 from $2.3 million for the year ended December 31, 1998,
primarily as a result of increased license revenue. License revenues increased
by 423% to $10.5 million for the year ended December 31, 1999 from $2.0 million
for 1998. This increase in license revenue was due primarily to increased
market acceptance of Kana's products, expansion of Kana's product line and
increased sales generated by Kana's expanded sales force. Total headcount in
Kana's sales department increased to 93 people at December 31, 1999 from 20
people at December 31, 1998. License revenue represented 75% of total revenues
for the year ended December 31, 1999 and 86% of total revenues for 1998.
Service revenues increased by 960% to $3.5 million for the year ended
December 31, 1999 from $333,000 for 1998. Service revenue increased primarily
due to increased licensing activity, resulting in increased revenue from
maintenance contracts, customer implementations and hosted
25
service. Service revenue represented 25% of total revenues for the year ended
December 31, 1999 and 14% of total revenues for 1998.
Total revenues increased by 280% to $2.3 million for the year ended
December 31, 1998 from $617,000 for 1997, primarily because Kana began
recognizing license revenues in February 1998. License revenue represented 86%
of total revenues for the year ended December 31, 1998. No license revenues
were recognized in 1997. License revenue resulted from introduction of our
product line and growing market acceptance of Kana's software products.
Service revenues decreased by 46% to $333,000 for the year ended December
31, 1998 from $617,000 for 1997. This decrease in service revenues was due
primarily to the completion of a special consulting project. Service revenue
represented 14% of total revenues for the year ended December 31, 1998 and 100%
of total revenues for the year ended December 31, 1997.
Revenues from international sales for the years ended December 31, 1999,
1998 and 1997 were less than 10% of total revenues.
Cost of Revenues
Total cost of revenues increased by 856% to $6.9 million in 1999 from
$720,000 in 1998, primarily due to increased cost of service revenues. Cost of
license revenues increased by 402% to $271,000 in 1999 from $54,000 in 1998,
associated with increased license revenues. As a percentage of license
revenues, cost of license revenues was 3% in 1999 and 1998. Cost of license
revenues includes third party software royalties, product packaging,
documentation, production and delivery costs for shipments to customers.
Cost of service revenues consists primarily of personnel, facilities and
system costs incurred in providing customer support and with building Kana's
customer service organization. Cost of service revenues increased by 893% to
$6.6 million in 1999 from $666,000 in 1998. The growth in cost of service
revenues was attributable primarily to an increase in personnel dedicated to
support Kana's growing number of customers and related recruiting and travel
expenses as well as facility expenses and system costs. As a percentage of
service revenues, cost of service revenues was 187% in 1999 and 200% in 1998.
Total cost of revenues increased by 185% to $720,000 in 1998 from $253,000
in 1997, primarily due to increased cost of service revenues. Cost of license
revenues increased to $54,000 in 1998 from none in 1997. The increase in the
cost of license revenue was due primarily to royalties, product documentation
costs and delivery costs for shipments to customers. As a percentage of license
revenues, cost of license revenues was 3% in 1998 and none in 1997.
Cost of service revenues increased by 163% to $666,000 for the year ended
December 31, 1998 from $253,000 in 1997. The growth in cost of service revenues
was attributable primarily to an increase in personnel dedicated to support our
growing number of customers and related facility expenses and system costs.
Kana further expects its cost of service expenses to increase due to its recent
mergers and anticipated growth. As a percent of service revenues, cost of
service revenues was 31% in 1998 and 41% in 1997.
Kana anticipates that the cost of license revenue will increase in absolute
dollars as Kana licenses additional technologies, although cost of license
revenue will vary as a percentage of license revenue from period to period.
Kana anticipates that cost of service revenue will increase in absolute
dollars.
Operating Expenses
Sales and Marketing. Sales and marketing expenses consist primarily of
compensation and related costs for sales and marketing personnel and
promotional expenditures, including public
26
relations, advertising, trade shows, and marketing collateral materials. Sales
and marketing expenses increased by 285% to $21.2 million for the year ended
December 31, 1999 from $5.5 million for the year ended December 31, 1998. This
increase was attributable primarily to the addition of sales and marketing
personnel, an increase in sales commissions associated with increased revenues
and higher marketing costs due to expanded promotional activities including
advertising and trade show participation. As a percentage of total revenues,
sales and marketing expenses were 151% for the year ended December 31, 1999 and
235% for the year ended December 31, 1998. This decrease in sales and marketing
expense as a percent of total revenues was due primarily to the increase in
total revenues over the period. Kana expects to continue to increase its
marketing and promotional efforts and hire additional sales personnel. Kana
further expects its sales and marketing expenses to increase due to its recent
mergers. Accordingly, Kana anticipates that sales and marketing expenses will
increase in absolute dollars, but will vary as a percentage of total revenues
from period to period.
Sales and marketing expenses were $5.5 million for the year ended December
31,1998 and $512,000 for 1997. The increase was due primarily to the addition
of sales and marketing personnel, increased sales commissions related to
increased total revenues and, to a lesser extent, increased marketing costs. As
a percentage of total revenues, sales and marketing expenses were 235% in 1998
and 83% in 1997.
Research and Development. Research and development expenses consist
primarily of compensation and related costs for research and development
employees and contractors and enhancement of existing products and quality
assurance activities. Research and development expenses increased by 127% to
$12.9 million for the year ended December 31, 1999 from $5.7 million for the
year ended December 31, 1998. This increase was attributable primarily to the
addition of personnel associated with product development and related benefits
and recruiting costs and related consulting expenses. As a percentage of total
revenues, research and development expenses were 91% for the year ended
December 31, 1999 and 242% for the year ended December 31, 1998. This decrease
in research and development expense as a percent of total revenues was due
primarily to the increase in total revenues over the period. Kana expects to
continue to make substantial investments in research and development and
anticipates that research and development expenses will continue to increase in
absolute dollars, but will vary as a percentage of total revenues from period
to period. Kana further expects its research and development expenses to
increase due to its recent mergers.
Research and development expenses increased by 484% to $5.7 million for the
year ended December 31,1998 from $971,000 for 1997. The increase was
attributable primarily to the addition of personnel associated with product
development. As a percentage of total revenues, research and development
expenses were 242% in 1998 and 157% in 1997.
General and Administrative. General and administrative expenses consist
primarily of compensation and related costs for administrative personnel,
legal, accounting and other general corporate expenses. General and
administrative expenses increased by 175% to $5.0 million for the year ended
December 31, 1999 from $1.8 million for the year ended December 31, 1998, due
primarily to increased personnel, consultants, facilities expenses and outside
services necessary to support Kana's growth. As a percentage of total revenues,
general and administrative expenses were 36% for the year ended December 31,
1999 and 78% for 1998. This decrease in general and administrative expenses as
a percent of total revenues from 1999 to 1998 was due primarily to the
proportionately greater increase in total revenues than general and
administrative expenses over the period. Kana expects that general and
administrative expenses will increase in absolute dollars as Kana adds
personnel and incurs additional costs related to the anticipated growth of its
business and operation as a public company. Kana further expects its general
and administrative expenses to increase due to its recent mergers and
anticipated growth. However, Kana expects that these expenses will vary as a
percentage of total revenues from period to period.
27
General and administrative expenses increased by 383% to $1.8 million for
the year ended December 31, 1998 from $378,000 for the year ended December 31,
1997. The increase was due primarily to the addition of management and
financial personnel necessary to support Kana's growth. As a percentage of
total revenues, general and administrative expenses were 78% in 1998 and 61% in
1997.
Amortization of stock-based compensation
In connection with the granting of stock options to its employees, Kana
recorded stock-based compensation totaling approximately $97.0 million through
December 31, 1999. This amount represents the total difference between the
exercise prices of stock options and the deemed fair value of the underlying
common stock for accounting purposes on the date these stock options were
granted. This amount is included as a component of stockholders' equity and is
being amortized on an accelerated basis by charges to operations over the
vesting period of the options, consistent with the method described in FASB
Interpretation No. 28.
The amortization of stock-based compensation by operating expense is
detailed as follows (in thousands):
Years ended, December 31,
---------------------------
1999 1998 1997
--------- -------- --------
Cost of service................................... $ 19,752 $ 143 $ 13
Sales and marketing............................... 34,000 564 52
Research and development.......................... 19,864 438 31
General and administrative........................ 6,860 311 17
--------- -------- ------
Total........................................... $ 80,476 $ 1,456 $ 113
========= ======== ======
Subsequent to the mergers with Business Evolution and netDialog, Kana
granted options to certain employees hired from the acquired companies for an
exercise price below the fair market value of the common stock. These options
immediately vested on the date of grant. The difference between the market
value of the underlying common stock and the exercise price of the options was
recorded as compensation expense in the fourth quarter of 1999 in the amount of
approximately $60.4 million.
Acquisition related costs
In connection with the merger with Connectify, Kana recorded a charge for
merger integration costs of $1.2 million consisting primarily of transaction
fees for attorneys and accountants of approximately $390,000 and employee
severance benefits and facility related costs of $780,000 in 1999. As of
December 31, 1999, Kana had $30,000 remaining in accrued merger expenses, which
Kana expects to pay by the first quarter of 2000.
In connection with the mergers with Business Evolution and netDialog, Kana
recorded a nonrecurring charge for merger integration costs of $4.5 million,
consisting primarily of transaction fees for attorneys and accountants of
approximately $1.5 million, advertising and announcements of $1.7 million
incurred as of December 31, 1999, charges for the elimination of duplicate
facilities of approximately $840,000 and severance costs and certain other
related costs of approximately $433,000. As of December 31, 1999, Kana had
$3,118,000 remaining in accrued acquisition related costs, which Kana expects
to pay during 2000.
Other Income (Expense)
Other income (expense) consists primarily of interest earned on cash and
short-term investments, offset by interest expense related to warrants issued
to convertible debt holders. Other
28
income (expense) decreased by 272% to an expense of $744,000 for the year ended
December 31, 1999 from income of $227,000 for 1998. The decrease in other
income (expense) was due primarily to interest expense associated with warrants
issued to convertible debt holders offset by increased interest income earned
on higher average cash balances.
Other income, net increased by 298% to $227,000 for the year ended December
31, 1998 from $57,000 for 1997. The increase was due primarily to an increase
in interest income earned on higher balances of cash and short-term investments
primarily from Kana's Series C preferred stock financing in September 1998.
Provision for Income Taxes
Kana has incurred operating losses for all periods from inception through
December 31, 1999, and therefore has not recorded a provision for income taxes.
Kana has recorded a valuation allowance for the full amount of its gross
deferred tax assets, as the future realization of the tax benefit is not
currently likely.
As of December 31, 1999, Kana had net operating loss carryforwards for
federal and state tax purposes of approximately $44.0 million and $34.6
million, respectively. These federal and state loss carryforwards are available
to reduce future taxable income. The federal loss carryforwards expire at
various dates into the year 2019. Under the provisions of the Internal Revenue
Code, substantial changes in ownership may limit the amount of net operating
loss carryforwards that could be utilized annually in the future to offset
taxable income.
Net Loss
Kana's net loss was $118.7 million, $12.6 million and $1.6 million for the
years ended December 31, 1999, 1998 and 1997, respectively. Kana has
experienced substantial increases in its expenditures since its inception
consistent with growth in its operations and personnel. In addition, stock
based compensation charges have contributed to the significant increase in net
loss during 1999. Kana anticipates that its expenditures will continue to
increase in the future. Although its revenue has grown in recent quarters, Kana
cannot be certain that it can sustain this growth or that it will generate
sufficient revenue to attain profitability.
Liquidity and Capital Resources
In September 1999, Kana completed the initial public offering of its common
stock and realized net proceeds from the offering of approximately $51.1
million. Prior to the offering, Kana had financed its operations primarily from
private sales of convertible preferred and common stock totaling $40.8 million
and, to a lesser extent, from bank borrowings and lease financing.
Our operating activities used $25.7 million of cash for the year ended
December 31, 1999, which is primarily attributable to net losses experienced
during this period excluding amortization of stock-based compensation as Kana
invested in the development of its products, expanded its sales force and
expanded its infrastructure to support its growth. Kana's operating activities
used $10.1 million of cash for the year ended December 31, 1998, which is
primarily attributable to net losses experienced during this period, excluding
amortization of stock-based compensation.
Our investing activities, consisting of purchases of computer equipment,
furniture, fixtures and leasehold improvements to support its growing number of
employees and net purchases of short-term investments, used $44.4 million of
cash for the year ended December 31, 1999. Kana's investing activities used
$1.4 million of cash for the year ended December 31, 1998, which is primarily
due to purchases of computer equipment, furniture, fixtures and leasehold
improvements.
29
Our financing activities generated $75.0 million in cash for the year ended
December 31, 1999, primarily from the net proceeds of its initial public
offering, net proceeds from private sales of preferred and common stock, and
net proceeds from debt arrangements. Kana's financing activities generated
$20.0 million in cash for the year ended December 31, 1998, primarily from the
net proceeds from private sales of preferred stock.
At December 31, 1999, we had cash and cash equivalents aggregating $18.7
million and short-term investments totaling $36.2 million. A portion of our
short-term investments secure three letters of credit totalling $1,806,000,
issued in connection with the lease of its corporate office and two other
offices. Kana has a line of credit totaling $3.0 million, which is secured by
all of Kana's assets, bears interest at the bank's prime rate (8.5% as of
December 31, 1999), and expires in May 2000. Kana's total bank debt was $1.2
million at December 31, 1999. In October 1999, Kana issued $2.8 million of
subordinated promissory notes which bear an annual interest rate of 10%. These
were paid in the first quarter of 2000.
Our capital requirements depend on numerous factors. Kana expects to devote
substantial resources to continue its research and development efforts, expand
its sales, support, marketing and product development organizations, establish
additional facilities worldwide and build the infrastructure necessary to
support its growth. Kana has experienced substantial increases in its
expenditures since its inception consistent with growth in operations and
personnel, and Kana anticipates that its expenditures will continue to increase
in the future. Kana believes that its current cash and projected revenues will
be sufficient to meet its working capital and operating resource expenditure
requirements for at least the next 12 months. However, Kana may need to raise
additional funds in order to fund more rapid expansion, including significant
increases in personnel and office facilities; to develop new or enhance
existing services or products; to respond to competitive pressures; or to
acquire or invest in complementary businesses, technologies, services or
products. Additional funding may not be available on favorable terms or at all.
In addition, although there are no present understandings, commitments or
agreements with respect to any acquisition of other businesses, products or
technologies, other than the potential merger with Silknet, Kana may, from time
to time, evaluate potential acquisitions of other businesses, products and
technologies. In order to consummate potential acquisitions, Kana may issue
additional securities or need additional equity or debt financing and any
financing may be dilutive to existing investors.
Year 2000 Readiness Disclosure
Year 2000 Compliance
Many currently installed computer systems and software products are coded
to accept or recognize only two digit entries in the date code field. These
systems and software products will need to accept four digit entries to
distinguish 21st century dates from 20th century dates. As a result, computer
systems and/or software used by many companies and governmental agencies may
need to be upgraded to comply with these Year 2000 requirements or risk system
failure or miscalculations causing disruptions of normal business activities.
In the fourth quarter of 1998 Kana initiated a Year 2000 compliance
program. The program was directed by Kana's quality assurance group. Kana's
quality assurance group was charged with identifying issues of potential risk
within each department and making the appropriate evaluation, modification,
upgrade or replacement. Members of the quality assurance group have worked with
members of each of Kana's principal internal divisions in the course of
assessing Year 2000 compliance.
Kana has not observed any Year 2000 related problems with Kana's business
or products as of this date. However, computer experts have warned that there
may still be residual consequences of
30
the change in centuries and any Year 2000 difficulties could result in a
decrease in sales of Kana's products, an increase in allocation of resources to
address Year 2000 problems of Kana's customers without additional revenue
commensurate with the dedication of resources, or an increase in litigation
costs relating to losses suffered by Kana's customers due to Year 2000
problems.
Scope of Year 2000 Assessment
The scope of Kana's Year 2000 compliance program included testing the Kana
platform and the IT and non-IT systems used at Kana's corporate office in
Redwood City, California. Kana's other sales offices use the same third-party
hardware and software systems as those in the Redwood City office. Accordingly,
the quality assurance group determined that it would not conduct an independent
review of those systems. The operational areas under investigation included:
. products;
. software applications;
. facilities;
. suppliers and vendors; and
. computer systems.
Kana has not observed any significant Year 2000 related problems as of this
date.
Budget and Schedule
Kana funded its Year 2000 plan from available cash and has not separately
accounted for these expenses. To date, external expenditures for Year 2000
compliance have totaled less than $20,000. Because Kana's products were
designed to be Year 2000 compliant, most of Kana's expenses have related to,
and are expected to continue to relate to, the operating costs associated with
time spent by employees in the internal evaluation process and Year 2000
compliance matters generally. Kana may experience unanticipated, material
problems and expenses associated with Year 2000 compliance that could harm its
business. Finally, Kana is also subject to external forces that might generally
affect industry and commerce, such as Year 2000 compliance failures by utility
or transportation companies and related service interruptions.
Kana has completed the evaluation of its products and its third-party
software systems.
Products
Kana has tested the products shipped to date. Kana's testing determined
that these products are capable of properly distinguishing between 20th and
21st century dates, when configured and used in accordance with the related
documentation, and provided that the underlying operating system of the host
machine and any other software used with these products are also capable of
properly distinguishing between 20th and 21st century dates.
Third-party Hardware and Software Systems and Services
Kana evaluated all of the critical third-party systems and software it uses
in its business. Kana received written statements of Year 2000 compliance from
substantially all of the providers of hardware used in its business. Kana has
identified approximately 20 different software vendors that provide software
products in its business. If any of the compliance statements received from its
third-party software or hardware providers are false, Kana's internal systems
and ability to ship its product would be materially harmed.
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Kana obtained written compliance statements as to Year 2000 compliance from
its hosting service provider and its other third-party service providers,
including Kana's Internet service providers, cellular telephone providers and
all of Kana's utilities. Kana received compliance statements from such entities
without additional expenditures by December 31, 1999.
Contingency Plan
Kana may discover residual Year 2000 compliance problems in its systems
that will require substantial revision. In addition, third-party software,
hardware or services incorporated into Kana's products and services may need to
be revised or replaced, all of which could be time-consuming and expensive and
result in the following, any of which could adversely affect Kana's business:
. delay or loss of revenue;
. cancellation of customer contracts;
. diversion of development resources;
. damage to our reputation;
. increased service and warranty costs; and
. litigation costs.
Kana did not experience any significant disruptions to its business,
results of operations, or products as a result of the transition from 1999 to
2000. Kana plans to retain its Year 2000 contingency plans in case of any
potential Year 2000 related events that may arise in the first half of 2000,
including any Year 2000 problems encountered by Kana's customers and third-
party providers. Kana believes it has taken the steps necessary to understand
and resolve Year 2000 issues; however, failure to adequately address all known
and unknown Y2K readiness issues could result in, among other things, unforseen
operating expenses and lower net income.
Our failure to fix or replace our third-party software, hardware or
services on a timely basis could result in lost revenues, increased operating
costs, the loss of customers and other business interruptions.
Kana has not observed any significant problems with Year 2000 as of this
date.
Recent Accounting Pronouncements
In June 1998, the FASB issued Statement of Financial Accounting Standard
(SFAS) No. 133, Accounting for Derivative and Hedging Activities. This standard
requires that an entity recognize all derivatives as either assets or
liabilities in the balance sheet and measures those instruments at fair value.
The type and use of the derivative, and whether it qualifies for hedge
accounting, will determine the treatment of gains or losses resulting from
changes in the derivative. Kana believes the adoption of SFAS No. 133 will not
have a material effect on its results of operations, financial position, or
cash flows. The statement will be effective for Kana beginning January 1, 2001.
In December 1998, the American Institute of Certified Public Accountants
issued SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition with
Respect to Certain Transactions. SOP 98-9 amends SOP 97-2 to require the entity
to recognize revenue for multiple element arrangements by means of the
"residual method" when: (1) there is vendor-specific evidence of the fair
values of all of the undelivered elements; (2) vendor-specific evidence of fair
value does not exist for one or more of the delivered elements; and (3) the
revenue recognition criteria of SOP 97-2 are satisfied. SOP 98-9 became
effective January 1, 2000. Kana believes the adoption of SOP 98-9 will not have
a material effect on its results of operations, financial position or cash
flows.
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RISK FACTORS ASSOCIATED WITH KANA'S BUSINESS AND FUTURE OPERATING RESULTS
Our future operating results may vary substantially from period to period.
The price of our common stock will fluctuate in the future, and an investment
in our common stock is subject to a variety of risks, including but not
limited to the specific risks identified below. Inevitably, some investors in
our securities will experience gains while others will experience losses
depending on the prices at which they purchase and sell securities.
Prospective and existing investors are strongly urged to carefully consider
the various cautionary statements and risks set forth in this report.
This report contains forward-looking statements that are not historical
facts but rather are based on current expectations, estimates and projections
about our business and industry, our beliefs and assumptions. Words such as
"anticipates", "expects", "intends", "plans", "believes", "seeks", estimates"
and variations of these words and similar expressions are intended to identify
forward-looking statements. These statements are not guarantees of future
performance and are subject to risks, uncertainties and other factors, some of
which are beyond our control, are difficult to predict and could cause actual
results to differ materially from those expressed or forecasted in the
forward-looking statements. These risks and uncertainties include those
described in this "Risks Associated With Kana's Business and Future Operating
Results" and elsewhere in this annual report. Forward-looking statements that
were true at the time made may ultimately prove to be incorrect or false.
Readers are cautioned not to place undue reliance on forward-looking
statement, which reflect our management's view only as of the date of this
annual report. Except as required by law, we undertake no obligation to update
any forward-looking statement, whether as a result of new information, future
events or otherwise.
Because Kana has a limited operating history, there is limited information
upon which you can evaluate Kana's business
Kana is still in the early stages of its development, and Kana's limited
operating history makes it difficult to evaluate Kana's business and
prospects. Kana was incorporated in July 1996 and first recorded revenue in
February 1998. Thus, Kana has a limited operating history upon which you can
evaluate its business and prospects. In addition, Kana's operating results
include the results of operations of Connectify, Inc., netDialog, Inc. and
Business Evolution, Inc., three companies acquired by Kana and accounted for
as poolings of interests. Due to Kana's limited operating history, it is
difficult or impossible to predict future results of operations. For example,
Kana cannot forecast operating expenses based on its historical results
because they are limited, and Kana is required to forecast expenses in part on
future revenue projections. Moreover, due to Kana's limited operating history,
any evaluation of its business and prospects must be made in light of the
risks and uncertainties often encountered by early-stage companies in
Internet-related markets. Many of these risks are discussed in the subheadings
below, and include Kana's ability to:
. attract more customers;
. implement its sales, marketing and after-sales service initiatives, both
domestically and internationally;
. execute its product development activities;
. anticipate and adapt to the changing Internet market;
. attract, retain and motivate qualified personnel;
. respond to actions taken by its competitors;
33
. continue to build an infrastructure to effectively manage growth and
handle any future increased usage; and
. integrate acquired businesses, technologies, products and services.
If Kana is unsuccessful in addressing these risks or in executing its
business strategy, its business, results of operations and financial condition
would be materially and adversely affected.
Kana's quarterly revenues and operating results may fluctuate in future periods
and Kana may fail to meet expectations, which may cause the price of Kana's
common stock to decline
Kana's quarterly revenues and operating results are difficult to predict
and may fluctuate significantly from quarter to quarter particularly because
Kana's products and services are relatively new and Kana's prospects uncertain.
If quarterly revenues or operating results fall below the expectations of
investors or public market analysts, the price of Kana's common stock could
decline substantially. Factors that might cause quarterly fluctuations in
Kana's operating results include the factors described in the subheadings below
as well as:
. the evolving and varying demand for customer communication software
products and services for e-Businesses, particularly Kana's products and
services;
. costs associated with integrating Kana's recent acquisitions, and costs
associated with any future acquisitions;
. the timing of new releases of Kana's products;
. the discretionary nature of Kana's customers' purchasing and budgetary
cycles;
. changes in Kana's pricing policies or those of Kana's competitors;
. the timing of execution of large contracts that materially affect Kana's
operating results;
. the mix of sales channels through which Kana's products and services are
sold;
. the mix of Kana's domestic and international sales;
. costs related to the customization of Kana's products;
. Kana's ability to expand its operations, and the amount and timing of
expenditures related to this expansion; and
. global economic conditions, as well as those specific to large
enterprises with high e-mail volume.
Kana also often offers volume-based pricing, which may affect operating
margins. Most of Kana's expenses, such as employee compensation and rent, are
relatively fixed in the short term. Moreover, Kana's expense levels are based,
in part, on its expectations regarding future revenue levels. As a result, if
total revenues for a particular quarter are below expectations, Kana could not
proportionately reduce operating expenses for that quarter. Therefore, this
revenue shortfall would have a disproportionate effect on Kana's expected
operating results for that quarter. In addition, because Kana's service revenue
is largely correlated with its license revenue, a decline in license revenue
could also cause a decline in service revenue in the same quarter or in
subsequent quarters.
Due to the foregoing factors, Kana believes that quarter-to-quarter
comparisons of its operating results are not a good indication of its future
performance.
34
Kana has a history of losses and may not be profitable in the future, which may
reduce the trading price of Kana common stock
Since Kana began operations in 1997, it has incurred substantial operating
losses in every quarter. As a result of accumulated operating losses, at
December 31, 1999, Kana had an accumulated deficit of approximately $133
million. For the twelve months ended December 31, 1999, Kana had a net loss of
approximately $119 million, or 844% of revenues for that period. Since
inception, Kana has funded its business primarily through selling its stock,
not from cash generated by its business. Kana's growth in recent periods has
been from a limited base of customers, and Kana may not be able to sustain
these growth rates. Kana expects to continue to increase its operating
expenses. As a result, Kana expects to continue to experience losses and
negative cash flows, even if sales of its products and services continue to
grow, and Kana may not generate sufficient revenues to achieve profitability in
the future.
In addition, as a result of its mergers with Connectify, netDialog and
Business Evolution, Kana expects that its losses will increase even more
significantly because of additional costs and expenses related to:
. an increase in the number of employees;
. an increase in research and development activities;
. an increase in sales and marketing activities; and
. assimilation of operations and personnel.
If Kana does achieve profitability, it may not be able to sustain or
increase any profitability on a quarterly or annual basis in the future. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations ".
Kana faces substantial competition and may not be able to compete effectively
The market for Kana's products and services is intensely competitive,
evolving and subject to rapid technological change. Kana expects the intensity
of competition to increase in the future. Increased competition may result in
price reductions, reduced gross margins and loss of market share.
Kana currently faces competition for its products from systems designed by
in-house and third-party development efforts. Kana expects that these systems
will continue to be a principal source of competition for the foreseeable
future. Kana's competitors include a number of companies offering one or more
products for the e-Business communications market, some of which compete
directly with Kana's products. For example, Kana's competitors include
companies providing stand-alone point solutions, including Annuncio, Inc.,
AskJeeves, Inc., Brightware, Inc., Digital Impact, Inc., eGain Communications
Corp., Inference Corp., Marketfirst, Inc., Live Person, Inc., Mustang Software,
Inc., Responsys.com and Servicesoft, Inc. In addition, Kana may compete with
companies providing customer management and communications solutions, such as
Broadbase, Inc., Clarify Inc. (which was recently acquired by Northern
Telecom), E.piphany, Inc., Genesys Telecommunications Laboratories, Inc. (which
was recently acquired by Alcatel), Cisco Systems, Inc., Lucent Technologies,
Inc., Message Media, Inc., Oracle Corporation, Pivotal Corporation, Siebel
Systems, Inc., Silknet Software, Inc. (if the merger is not completed) and
Vantive Corporation (which was recently acquired by PeopleSoft, Inc.).
Furthermore, Kana may face increased competition should it expand its product
line, through acquisition of complementary businesses or otherwise.
Many of Kana's competitors have longer operating histories, significantly
greater financial, technical, marketing and other resources, significantly
greater name recognition and a larger installed base of customers than Kana
has. In addition, many of Kana's competitors have well-established
35
relationships with Kana's current and potential customers and have extensive
knowledge of Kana's industry. Kana may lose potential customers to competitors
for various reasons, including the ability or willingness of competitors to
offer lower prices and other incentives that Kana cannot match. Accordingly, it
is possible that new competitors or alliances among competitors may emerge and
rapidly acquire significant market share. Kana also expects that competition
will increase as a result of recently-announced industry consolidations, as
well as future consolidations.
Kana may not be able to compete successfully against current and future
competitors, and competitive pressures may seriously harm its business. See
"Item 1. Business--Competition".
Kana's failure to consummate its expected sales in any given quarter could
dramatically harm its operating results because of the large size of typical
orders
Kana's sales cycle is subject to a number of significant risks, including
customers' budgetary constraints and internal acceptance reviews, over which
Kana has little or no control. Consequently, if sales expected from a specific
customer in a particular quarter are not realized in that quarter, Kana is
unlikely to be able to generate revenue from alternate sources in time to
compensate for the shortfall. As a result, and due to the relatively large size
of a typical order, a lost or delayed sale could result in revenues that are
lower than expected. Moreover, to the extent that significant sales occur
earlier than anticipated, revenues for subsequent quarters may be lower than
expected.
Kana may not be able to forecast its revenues accurately because its products
have a long and variable sales cycle
The long sales cycle for Kana's products may cause license revenue and
operating results to vary significantly from period to period. To date, the
sales cycle for Kana's products has taken three to 12 months in the United
States and longer in foreign countries. Kana's sales cycle has required pre-
purchase evaluation by a significant number of individuals in its customers'
organizations. Along with third parties that often jointly market Kana's
software with Kana, Kana invests significant amounts of time and resources
educating and providing information to prospective customers regarding the use
and benefits of Kana's products. Many of Kana's customers evaluate Kana's
software slowly and deliberately, depending on the specific technical
capabilities of the customer, the size of the deployment, the complexity of the
customer's network environment, and the quantity of hardware and the degree of
hardware configuration necessary to deploy Kana's products.
Kana's stock price may be highly volatile and could drop, particularly because
its business depends on the Internet
The trading price of Kana's common stock has in the past and is expected to
continue in the future to fluctuate widely as a result of a number of factors,
many of which are outside Kana's control. In addition, the stock market has
experienced extreme price and volume fluctuations that have affected the market
prices of many technology and computer software companies, particularly
Internet-related companies, and which have often been unrelated or
disproportionate to the operating performance of these companies. These broad
market fluctuations could adversely affect the market price of Kana common
stock.
Difficulties in implementing Kana's products could harm Kana's revenues and
margins
Forecasting Kana's revenues depends upon the timing of implementation of
its products. This implementation typically involves working with sophisticated
software, computing and communications systems. If Kana experiences
difficulties with implementation or does not meet project milestones in a
timely manner, Kana could be obligated to devote more customer support,
engineering and other resources to a particular project. Some customers may
also require Kana to develop customized
36
features or capabilities. If new or existing customers have difficulty
deploying Kana's products or require significant amounts of Kana's professional
services support or customized features, Kana's revenue recognition could be
further delayed and Kana's costs could increase, causing increased variability
in Kana's operating results.
Kana's business depends on the acceptance of its products and services, and it
is uncertain whether the market will accept Kana's products and services
Of Kana's total revenue of $14 million for the twelve months ended December
31, 1999, $10.5 million was derived from licenses of products and $3.5 million
from related services. Kana is not certain that its target customers will
widely adopt and deploy its products and services. Kana's future financial
performance will depend on the successful development, introduction and
customer acceptance of new and enhanced versions of Kana's products and
services. In the future, Kana may not be successful in marketing its products
and services or any new or enhanced products.
Kana may be unable to hire and retain the skilled personnel necessary to
develop its engineering, professional services and support capabilities in
order to continue to grow
Kana intends to increase its sales, marketing, engineering, professional
services and product management personnel over the next 12 months. Competition
for these individuals is intense, and Kana may not be able to attract,
assimilate or retain highly qualified personnel in the future. Kana's business
cannot continue to grow if it cannot attract qualified personnel. Kana's
failure to attract and retain the highly trained personnel that are integral to
its product development and professional services group, which is the group
responsible for implementation and customization of, and technical support for,
Kana's products and services, may limit the rate at which Kana can develop and
install new products or product enhancements, which would harm its business.
Kana will need to increase its staff to support new customers and the expanding
needs of its existing customers, without compromising the quality of Kana's
customer service. Since Kana's inception, a number of employees have left or
have been terminated, and Kana expects to lose more employees in the future.
Hiring qualified professional services personnel, as well as sales, marketing,
administrative and research and development personnel, is very competitive in
Kana's industry, particularly in the San Francisco Bay Area, where Kana is
headquartered, due to the limited number of people available with the necessary
technical skills. Kana faces greater difficulty attracting these personnel with
equity incentives as a public company than it did as a privately held company.
See "Item 1. Business--Employees".
Kana may face difficulties in hiring and retaining qualified sales personnel to
sell its products and services, which could harm Kana's ability to increase its
revenues in the future
Kana's financial success depends to a large degree on the ability of its
direct sales force to increase sales to a level required to adequately fund
marketing and product development activities. Therefore, Kana's ability to
increase revenues in the future depends considerably upon its success in
recruiting, training and retaining additional direct sales personnel and the
success of the direct sales force. Also, it may take a new salesperson a number
of months before he or she becomes a productive member of Kana's sales force.
Kana's business will be harmed if it fails to hire or retain qualified sales
personnel, or if newly hired salespeople fail to develop the necessary sales
skills or develop these skills more slowly than Kana anticipates. See "Item 1.
Business--Employees".
Loss of Kana's Chief Executive Officer or any of Kana's executive officers
could harm Kana's business
Kana's future success depends to a significant degree on the skills,
experience and efforts of Kana's senior management. In particular, Kana depends
upon the continued services of Michael J. McCloskey, its
37
Chief Executive Officer. The loss of the services of Mr. McCloskey or any of
Kana's executive officers could harm Kana's business and operations. In
addition, Kana has not obtained life insurance benefiting Kana on any of its
key employees or entered into employment agreements with its key employees. If
any of Kana's key employees left or was seriously injured and unable to work
and Kana was unable to find a qualified replacement, Kana's business could be
harmed.
A failure to manage Kana's internal operating and financial functions could
lead to inefficiencies in conducting its business and subject Kana to increased
expenses
Kana's ability to offer its products and services successfully in a rapidly
evolving market requires an effective planning and management process. Kana has
limited experience in managing rapid growth. Kana is experiencing a period of
growth that is placing a significant strain on its managerial, financial and
personnel resources. Kana's business will suffer if this growth continues and
Kana fails to manage it successfully. On December 31, 1999, Kana had a total of
363 full-time employees compared to 109 on December 31, 1998. Kana expects to
continue to hire new employees at a rapid pace. For example, Kana added 182
employees between July 1, 1999 and December 31, 1999, which number excludes 118
new employees who joined Kana as a result of the Connectify, netDialog and
Business Evolution mergers. Completion of the potential merger with Silknet is
expected to result in approximately 300 new employees joining Kana. Moreover,
Kana will need to assimilate substantially all of these companies' operations
into its operations. The rate of Kana's recent growth has made management of
that growth more difficult. Any additional growth will further strain Kana's
management, financial, personnel, internal training and other resources. To
manage any future growth effectively, Kana must improve its financial and
accounting systems, controls, reporting systems and procedures, integrate new
personnel and manage expanded operations. Any failure to do so could negatively
affect the quality of Kana's products, Kana's ability to respond to its
customers and retain key personnel, and Kana's business in general.
The integration of Kana's new Vice President of Human Resources, Vice President
for Kana On-Line, Vice President of eBusiness Services and Vice President of
Realtime into its management team may interfere with its operations
Kana has recently hired a number of new officers, including a Vice
President of Human Resources, Vice President for Kana On-Line, Vice President
of eBusiness Services and Vice President of Realtime, each of whom has been
with Kana for less than six months. Completion of the potential merger with
Silknet is expected to result in additional officers joining Kana's management
team. To integrate into Kana, these individuals must spend a significant amount
of time learning Kana's business model and management system, in addition to
performing their regular duties. Accordingly, the integration of new personnel
has resulted and will continue to result in some disruption to Kana's ongoing
operations.
Kana has completed three mergers in the past eight months and has executed a
definitive agreement for a fourth merger, and those mergers may result in
disruptions to its business and management due to difficulties in assimilating
personnel and operations
Kana may not realize the benefits from the significant mergers it has
completed. In August 1999, Kana acquired Connectify, and in December 1999, Kana
acquired netDialog and Business Evolution. On February 6, 2000, Kana entered
into a definitive agreement to merge with Silknet, Inc. Kana may not be able to
successfully assimilate the additional personnel, operations, acquired
technology and products into its business. In particular, Kana will need to
assimilate and retain key professional services, engineering and marketing
personnel. This is particularly difficult with Business Evolution and Silknet,
since their operations are located on the east coast and Kana is headquartered
on the west coast. Key personnel from the acquired companies have in certain
instances decided, and they may in the future decide, that they do not want to
work for Kana. In
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addition, products of these companies will have to be integrated into Kana's
products, and it is uncertain whether Kana may accomplish this easily or at
all. These difficulties could disrupt Kana's ongoing business, distract
management and employees or increase expenses. Acquisitions are inherently
risky and Kana may also face unexpected costs, which may adversely affect
operating results in any quarter.
The merger of Silknet Software, Inc. into Kana could adversely affect combined
financial results
If the benefits of the merger of Silknet Software, Inc. into Kana do not
exceed the costs associated with the merger, including any dilution to Kana's
stockholders resulting from the issuance of shares in connection with the
merger, Kana's financial results, including earnings per share, could be
adversely affected. In addition, Kana expects to record goodwill and intangible
assets of approximately $3.9 billion, which will be amortized over a period of
three years.
The market price of Kana common stock may decline as a result of the merger of
Silknet Software, Inc. into Kana
The market price of Kana common stock may decline as a result of the merger
if:
. the integration of Kana and Silknet is unsuccessful;
. Kana does not achieve the perceived benefits of the merger as rapidly or
to the extent anticipated by financial or industry analysts or
investors; or
. the effect of the merger on Kana's financial results is not consistent
with the expectations of financial or industry analysts or investors.
The market price of the Kana common stock could also decline as a result of
factors related to the merger which may currently be unforeseen. A decline in
the market price of the Kana common stock could materially and adversely affect
Kana's operating results.
If Kana acquires additional companies, products or technologies, it may face
risks similar to those faced in its other mergers
If Kana is presented with appropriate opportunities, Kana intends to make
other investments in complementary companies, products or technologies. Kana
may not realize the anticipated benefits of any other acquisition or
investment. If Kana acquires another company, it will likely face the same
risks, uncertainties and disruptions as discussed above with respect to its
other mergers. Furthermore, Kana may have to incur debt or issue equity
securities to pay for any additional future acquisitions or investments, the
issuance of which could be dilutive to Kana or Kana's existing stockholders. In
addition, Kana's profitability may suffer because of acquisition-related costs
or amortization costs for acquired goodwill and other intangible assets.
Delays in the development of new products or enhancements to existing products
would hurt Kana's sales and damage its reputation
To be competitive, Kana must develop and introduce on a timely basis new
products and product enhancements for companies with significant e-Business
customer interactions needs. Any failure to do so could harm Kana's business.
If Kana experiences product delays in the future, it may face:
. customer dissatisfaction;
. cancellation of orders and license agreements;
. negative publicity;
. loss of revenues;
39
. slower market acceptance; and
. legal action by customers.
In the future, Kana's efforts to remedy this situation may not be
successful and Kana may lose customers as a result. Delays in bringing to
market new products or their enhancements, or the existence of defects in new
products or their enhancements, could be exploited by Kana's competitors. If
Kana were to lose market share as a result of lapses in its product management,
Kana's business would suffer.
Technical problems with either Kana's internal or outsourced computer and
communications systems could interrupt Kana's Kana On-Line service
The success of the Kana On-Line service depends on the efficient and
uninterrupted operation of its own and outsourced computer and communications
hardware and software systems. These systems and operations are vulnerable to
damage or interruption from human error, natural disasters, telecommunications
failures, break-ins, sabotage, computer viruses, intentional acts of vandalism
and similar adverse events. Kana has entered into an Internet-hosting agreement
with Exodus Communications, Inc. to maintain all of the Kana On-Line servers at
Exodus' data center in Santa Clara, California. Kana's operations depend on
Exodus' ability to protect its and Kana's systems in Exodus' data center
against damage or interruption. Exodus does not guarantee that Kana's Internet
access will be uninterrupted, error-free or secure. Kana has no formal disaster
recovery plan in the event of damage or interruption, and its insurance
policies may not adequately compensate Kana for any losses that it may incur.
Any system failure that causes an interruption in Kana's service or a decrease
in responsiveness could harm Kana's relationships with customers and result in
reduced revenues. See "Item 1. Business--Products and Services--Kana On-Line".
If Kana fails to build skills necessary to sell its Kana On-Line service, Kana
will lose revenue opportunities and its sales will suffer
The skills necessary to market and sell Kana On-Line are different from
those relating to Kana's software products. Kana licenses its software products
for a fixed fee based on the number of concurrent users and the optional
applications purchased. Kana licenses Kana On-Line based on a fixed fee for
installation, configuration and training, and a variable monthly component
depending on actual customer usage. Kana's sales force sells both Kana's
software products and Kana On-Line. Because different skills are necessary to
sell Kana On-Line as compared to selling software products, Kana's sales and
marketing groups may not be able to maintain or increase the level of sales of
either Kana On-Line or Kana's software products.
Kana's pending patents may never be issued and, even if issued, may provide
little protection
Kana's success and ability to compete depend to a significant degree upon
the protection of its software and other proprietary technology rights. Kana
regards the protection of patentable inventions as important to its future
opportunities. Kana currently has seven U.S. patent applications pending
relating to its software. However, none of Kana's technology is patented
outside of the United States, although Kana has filed three international
patent applications corresponding to three of Kana's U.S. patent applications.
It is possible that:
. Kana's pending patent applications may not result in the issuance of
patents;
. any patents issued may not be broad enough to protect Kana's proprietary
rights;
. any issued patent could be successfully challenged by one or more third
parties, which could result in Kana's loss of the right to prevent
others from exploiting the inventions claimed in those patents;
40
. current and future competitors may independently develop similar
technology, duplicate Kana's products or design around any of Kana's
patents; and
. effective patent protection may not be available in every country in
which Kana does business.
See "Item 1. Business--Intellectual Property".
Kana relies upon trademarks, copyrights and trade secrets to protect its
proprietary rights, which may not be sufficient to protect its intellectual
property
Kana also relies on a combination of laws, such as copyright, trademark and
trade secret laws, and contractual restrictions, such as confidentiality
agreements and licenses, to establish and protect its proprietary rights. In
the United States, Kana currently has a registered trademark, "Kana", and seven
pending trademark applications, including trademark applications for its logo
and "KANA COMMUNICATIONS and Design". Although none of its trademarks is
registered outside of the United States, Kana has trademark applications
pending in Australia, Canada, the European Union, India, Japan, South Korea and
Taiwan. Moreover, despite the precautions that Kana has taken:
. laws and contractual restrictions may not be sufficient to prevent
misappropriation of its technology or deter others from developing
similar technologies;
. current federal laws that prohibit software copying provide only limited
protection from software "pirates", and effective trademark, copyright
and trade secret protection may be unavailable or limited in foreign
countries;
. other companies may claim common law trademark rights based upon state
or foreign laws that precede the federal registration of Kana's marks;
and
. policing unauthorized use of Kana's products and trademarks is
difficult, expensive and time-consuming, and Kana may be unable to
determine the extent of this unauthorized use.
Also, the laws of other countries in which Kana markets its products may
offer little or no effective protection of Kana's proprietary technology.
Reverse engineering, unauthorized copying or other misappropriation of Kana's
proprietary technology could enable third parties to benefit from Kana's
technology without paying Kana for it, which would significantly harm Kana's
business. See "Item 1. Business--Intellectual Property".
Kana may become involved in litigation over proprietary rights, which could be
costly and time consuming, and Genesys Telecommunications Laboratories, Inc.
has filed an infringement suit against Kana
Substantial litigation regarding intellectual property rights exists in
Kana's industry. Kana expects that software in its industry may be increasingly
subject to third-party infringement claims as the number of competitors grows
and the functionality of products in different industry segments overlaps.
Third parties may currently have, or may eventually be issued, patents upon
which Kana's products or technology infringe. Any of these third parties might
make a claim of infringement against Kana. Many of Kana's software license
agreements require Kana to indemnify its customers from any claim or finding of
intellectual property infringement. Any litigation, brought by Kana or others,
could result in the expenditure of significant financial resources and the
diversion of management's time and efforts. In addition, litigation in which
Kana is accused of infringement might cause product shipment delays, require
Kana to develop non-infringing technology or require Kana to enter into royalty
or license agreements, which might not be available on acceptable terms, or at
all. If a successful claim of infringement were made against Kana and it could
not develop non-infringing technology or license the infringed or similar
technology on a timely and cost-effective basis, Kana's business could be
significantly harmed. See "Item 1. Business--Intellectual Property".
41
On October 8, 1999, Genesys Telecommunications Laboratories, Inc. filed a
complaint against Kana in the United States District Court for the District of
Delaware. Genesys has amended its complaint to allege that Kana's Customer
Messaging System 3.0 infringes one or more claims of two Genesys patents.
Genesys is seeking relief in the forms of an injunction, damages, punitive
damages, attorneys' fees, costs and pre- and post-judgment interest. The
litigation is currently in its early stages and Kana has not received material
information or documentation. Kana intends to fight this claim vigorously and
does not expect it to materially impact its results from operations. Kana is
not currently a party to any other material legal proceedings.
Kana may face higher costs and lost sales if its software contains errors
Kana faces the possibility of higher costs as a result of the complexity of
its products and the potential for undetected errors. Due to the mission-
critical nature of Kana's products and services, undetected errors are of
particular concern. Kana has only a few "beta" customers that test new features
and functionality of its software before Kana makes these features and
functionalities generally available to its customers. If Kana's software
contains undetected errors or Kana fails to meet customers' expectations in a
timely manner, Kana could experience:
. loss of or delay in revenues expected from the new product and an
immediate and significant loss of market share;
. loss of existing customers that upgrade to the new product and of new
customers;
. failure to achieve market acceptance;
. diversion of development resources;
. injury to its reputation;
. increased service and warranty costs;
. legal actions by customers; and
. increased insurance costs.
Kana may face liability claims that could result in unexpected costs and damage
to its reputation
Kana's licenses with customers generally contain provisions designed to
limit Kana's exposure to potential product liability claims, such as
disclaimers of warranties and limitations on liability for special,
consequential and incidental damages. In addition, Kana's license agreements
generally cap the amounts recoverable for damages to the amounts paid by the
licensee to Kana for the product or service giving rise to the damages.
However, these contractual limitations on liability may not be enforceable and
Kana may be subject to claims based on errors in its software or mistakes in
performing its services including claims relating to damages to its customers'
internal systems. A product liability claim, whether or not successful, could
harm Kana's business by increasing its costs, damaging its reputation and
distracting its management.
Kana intends to expand its international operations, which could divert
management attention and present financial issues
Kana's international operations are located in the United Kingdom,
Australia, Holland and Germany and, to date, have been limited. Kana plans to
expand its existing international operations and establish additional
facilities in other parts of the world. Kana may face difficulties in
accomplishing this expansion, including finding adequate staffing and
management resources for its international operations. The expansion of Kana's
existing international operations and entry into additional international
markets will require significant management attention and financial resources.
In addition, in order to expand its international sales operations, Kana will
need to, among other things:
42
. expand its international sales channel management and support
organizations;
. customize its products for local markets; and
. develop relationships with international service providers and
additional distributors and system integrators.
Kana's investments in establishing facilities in other countries may not
produce desired levels of revenues. Even if Kana is able to expand its
international operations successfully, Kana may not be able to maintain or
increase international market demand for its products. In addition, Kana has
only licensed its products internationally since January 1999 and has limited
experience in developing localized versions of its software and marketing and
distributing them internationally. Localizing Kana's products may take longer
than Kana anticipates due to difficulties in translation and delays Kana may
experience in recruiting and training international staff.
Kana's growth could be limited if it fails to execute its plan to expand
internationally
For the twelve month periods ended December 31, 1999 and December 31, 1998,
Kana derived approximately 10% and 0%, respectively, of its total revenues from
sales outside North America. Kana has established offices in the United
Kingdom, Australia and Germany. As of December 31, 1999 Kana had 7 sales
persons in its international offices. As a result, Kana faces risks from doing
business on an international basis, any of which could impair its internal
revenues. Kana could, in the future, encounter greater difficulty in accounts
receivable collection, longer sales cycles and collection periods or seasonal
reductions in business activity. In addition, Kana's international operations
could cause its average tax rate to increase. Any of these events could harm
Kana's international sales and results of operations.
International laws and regulations may expose Kana to potential costs and
litigation
Kana's international operations will increase its exposure to international
laws and regulations. If Kana cannot comply with foreign laws and regulations,
which are often complex and subject to variation and unexpected changes, it
could incur unexpected costs and potential litigation. For example, the
governments of foreign countries might attempt to regulate Kana's products and
services or levy sales or other taxes relating to Kana's activities. In
addition, foreign countries may impose tariffs, duties, price controls or other
restrictions on foreign currencies or trade barriers, any of which could make
it more difficult for Kana to conduct its business. The European Union has
enacted its own privacy regulations that may result in limits on the collection
and use of certain user information, which, if applied to the sale of Kana's
products and services, could negatively impact Kana's results of operations.
Kana may suffer foreign exchange rate losses
Kana's international revenues are denominated in local currency. Therefore,
a weakening of other currencies versus the U.S. dollar could make Kana's
products less competitive in foreign markets. Kana does not currently engage in
currency hedging activities. Kana has not yet but may in the future experience
foreign currency translation losses, especially to the extent that it does not
engage in hedging.
Kana's prospects for obtaining additional financing, if required, are uncertain
and failure to obtain needed financing could affect its ability to pursue
future growth
Kana may need to raise additional funds to develop or enhance its products
or services, to fund expansion, to respond to competitive pressures or to
acquire complementary products, businesses or
43
technologies. Kana does not have a long enough operating history to know with
certainty whether its existing cash and expected revenues will be sufficient to
finance its anticipated growth. Additional financing may not be available on
terms that are acceptable to Kana. If Kana raises additional funds through the
issuance of equity or convertible debt securities, the percentage ownership of
its stockholders would be reduced and these securities might have rights,
preferences and privileges senior to those of Kana's current stockholders. If
adequate funds are not available on acceptable terms, Kana's ability to fund
its expansion, take advantage of unanticipated opportunities, develop or
enhance products or services, or otherwise respond to competitive pressures
would be significantly limited.
Kana's executive officers and directors can exercise significant influence over
stockholder voting matters
After the closing of the potential merger, Kana's executive officers and
directors, and their affiliates will together control approximately 37% of
Kana's outstanding common stock. As a result, these stockholders, if they act
together, will have a significant impact on all matters requiring approval of
Kana's stockholders, including the election of directors and significant
corporate transactions. This concentration of ownership may delay, prevent or
deter a change in control of Kana, could deprive Kana's stockholders of an
opportunity to receive a premium for their common stock as part of a sale of
Kana or its assets and might affect the market price of Kana common stock.
Kana has adopted anti-takeover defenses that could delay or prevent an
acquisition of Kana
Kana's board of directors has the authority to issue up to 5,000,000 shares
of preferred stock. Moreover, without any further vote or action on the part of
the stockholders, the board of directors has the authority to determine the
price, rights, preferences, privileges and restrictions of the preferred stock.
This preferred stock, if issued, might have preference over and harm the rights
of the holders of common stock. Although the issuance of this preferred stock
will provide Kana with flexibility in connection with possible acquisitions and
other corporate purposes, this issuance may make it more difficult for a third
party to acquire a majority of Kana's outstanding voting stock. Kana currently
has no plans to issue preferred stock.
Kana's certificate of incorporation, bylaws and equity compensation plans
include provisions that may deter an unsolicited offer to purchase Kana. These
provisions, coupled with the provisions of the Delaware General Corporation
Law, may delay or impede a merger, tender offer or proxy contest involving
Kana. Furthermore, Kana's board of directors is divided into three classes,
only one of which is elected each year. Directors are removable by the
affirmative vote of at least 66 2/3% of all classes of voting stock. These
factors may further delay or prevent a change of control of Kana.
Kana's failure to manage multiple technologies and technological change could
harm its future product demand
Future versions of hardware and software platforms embodying new
technologies and the emergence of new industry standards could render Kana's
products obsolete. The market for e-Business customer communication software is
characterized by:
. rapid technological change;
. frequent new product introductions;
. changes in customer requirements; and
. evolving industry standards.
44
Kana's products are designed to work on a variety of hardware and software
platforms used by Kana's customers. However, Kana's software may not operate
correctly on evolving versions of hardware and software platforms, programming
languages, database environments and other systems that its customers use. For
example, the server component of the current version of Kana's products runs on
the Windows NT operating system from Microsoft, and Kana must develop products
and services that are compatible with UNIX and other operating systems to meet
the demands of its customers. If Kana cannot successfully develop these
products in response to customer demands, Kana's business could suffer. Also,
Kana must constantly modify and improve its products to keep pace with changes
made to these platforms and to database systems and other back-office
applications and Internet-related applications. This may result in uncertainty
relating to the timing and nature of new product announcements, introductions
or modifications, which may cause confusion in the market and harm Kana's
business. If Kana fails to modify or improve its products in response to
evolving industry standards, its products could rapidly become obsolete, which
would harm its business.
If Kana fails to respond to changing customer preferences in its market, demand
for its products and Kana's ability to enhance its revenues will suffer
Kana must continually improve the performance, features and reliability of
its products, particularly in response to competitive offerings. Kana's success
depends, in part, on Kana's ability to enhance its existing software and to
develop new services, functionality and technology that address the
increasingly sophisticated and varied needs of Kana's prospective customers. If
Kana does not properly identify the feature preferences of prospective
customers, or if Kana fails to deliver features that meet the requirements of
these customers, Kana's ability to market its products successfully and to
increase its revenues could be impaired. The development of proprietary
technology and necessary service enhancements entails significant technical and
business risks and requires substantial expenditures and lead time.
If the Internet and e-mail fail to grow and be accepted as media of
communication, demand for Kana's products and services will decline
Kana sells its products and services primarily to organizations that
receive large volumes of e-mail and Web-based communications. Many of Kana's
customers have business models that are based on the continued growth of the
Internet. Consequently, Kana's future revenues and profits, if any,
substantially depend upon the continued acceptance and use of the Internet and
e-mail, which are evolving as media of communication. Rapid growth in the use
of e-mail is a recent phenomenon and may not continue. As a result, a broad
base of enterprises that use e-mail as a primary means of communication may not
develop or be maintained. In addition, the market may not accept recently
introduced products and services that process e-mail, including Kana's products
and services. Moreover, companies that have already invested significant
resources in other methods of communications with customers, such as call
centers, may be reluctant to adopt a new strategy that may limit or compete
with their existing investments. If businesses do not continue to accept the
Internet and e-mail as media of communication, Kana's business will suffer.
Future regulation of the Internet may slow its growth, resulting in decreased
demand for Kana's products and services and increased costs of doing business
Due to the increasing popularity and use of the Internet, it is possible
that state, federal and foreign regulators could adopt laws and regulations
that impose additional burdens on those companies that conduct business online.
These laws and regulations could discourage communication by e-mail or other
Web-based communications, particularly targeted e-mail of the type facilitated
by the Connectify product, which could reduce demand for Kana's products and
services.
45
The growth and development of the market for online services may prompt
calls for more stringent consumer protection laws or laws that may inhibit the
use of Internet-based communications or the information contained in these
communications. The adoption of any additional laws or regulations may decrease
the expansion of the Internet. A decline in the growth of the Internet,
particularly as it relates to online communication, could decrease demand for
Kana's products and services and increase Kana's costs of doing business, or
otherwise harm its business. Kana's costs could increase and its growth could
be harmed by any new legislation or regulation, the application of laws and
regulations from jurisdictions whose laws do not currently apply to its
business, or the application of existing laws and regulations to the Internet
and other online services.
Year 2000 issues could continue to present technological risks, could cause
disruption to Kana's business and could harm sales of its products and services
Many currently installed computer systems and software products are coded
to accept or recognize only two digit entries in the date code field. These
systems and software products need to accept four digit entries to distinguish
21st century dates from 20th century dates. As a result, computer systems
and/or software used by many companies and governmental agencies may need to be
upgraded to comply with these Year 2000 requirements or risk system failure or
miscalculations causing disruptions of normal business activities.
Any failure of Kana's material systems, Kana's customers' material systems
or the Internet to be Year 2000 compliant would have material adverse
consequences for Kana. Kana is unable to predict to what extent its business
may be affected if its software, the systems that operate in conjunction with
its software or its internal systems experience a material failure due to
residual Year 2000 problems. Residual Year 2000 issues may disrupt Kana's
operations, subject Kana to liabilities and costs and lower net income. See
"Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations of Kana--Year 2000 Readiness Disclosure".
Kana's security could be breached, which could damage its reputation and deter
customers from using its services
Kana must protect its computer systems and network from physical break-ins,
security breaches and other disruptive problems caused by the Internet or other
users. Computer break-ins could jeopardize the security of information stored
in and transmitted through Kana's computer systems and network, which could
adversely affect Kana's ability to retain or attract customers, damage Kana's
reputation and subject Kana to litigation. Kana has in the past, and could in
the future, be subject to denial of service, vandalism and other attacks on its
systems by Internet hackers. Although Kana intends to continue to implement
security technology and establish operational procedures to prevent break-ins,
damage and failures, these security measures may fail. Kana's insurance
coverage in certain circumstances may be insufficient to cover issues that may
result from such events.
Future sales of stock could affect Kana's stock price
If Kana's stockholders sell substantial amounts of Kana common stock,
including shares issued upon the exercise of outstanding options and warrants,
in the public market, the market price of Kana common stock could fall. These
sales also might make it more difficult for Kana to sell equity or equity-
related securities in the future at a time and price that Kana deems
appropriate.
46
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Kana develops products in the United States and sells these products in
North America, Europe, Asia and Australia. Generally, Kana's sales are made in
local currency. As a result, Kana's financial results could be affected by
factors such as changes in foreign currency exchange rates or weak economic
conditions in foreign markets. Kana does not currently use derivative
instruments to hedge against foreign exchange risk.
Kana's exposure to market rate risk for changes in interest rates relates
primarily to Kana's investment portfolio. Kana's investments consist primarily
of short-term municipals and commercial paper, which have an average fixed
yield rate of 6%. These all mature within six months. Kana does not consider
its cash equivalents to be subject to interest rate risk due to their short
maturities.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Kana's consolidated financial statements, together with related notes and
the report of KPMG LLP, independent auditors, are set forth on the pages
indicated in Item 14, and incorporated herein by this reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
KPMG LLP was previously the principal accountants for Kana. On March 22,
2000, Kana and KPMG LLP mutually agreed to terminate KPMG LLP's appointment as
principal accountants due to an anticipated business relationship between the
two companies. The decision to change accountants was approved by the audit
committee of the board of directors of the Company.
In connection with the audits of the fiscal years ended December 31, 1998
and 1999, and the subsequent interim period through March 22, 2000, there were
no disagreements with KPMG LLP on any matter of accounting principles or
practices, financial statement disclosure, or auditing scope or procedures,
which disagreements, if not resolved to their satisfaction, would have caused
them to make reference in connection with their opinion to the subject matter
of the disagreement.
The audit reports of KPMG LLP on the consolidated financial statements of
Kana as of and for the years ended December 31, 1998 and 1999, did not contain
any adverse opinion or disclaimer of opinion, nor were they qualified or
modified as to uncertainty, audit scope, or accounting principles.
47
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth information regarding the executive officers
and directors of Kana as of March 10, 2000.
Name Age Position
---- --- --------
Michael J. McCloskey.... 44 Chief Executive Officer and Director
Mark S. Gainey.......... 31 President and Chairman of the Board of Directors
Joseph G. Ansanelli..... 30 Vice President, Marketing
Timothy E. Campbell..... 38 Vice President and General Manager, Kana On-Line
Ian P. Cavanagh......... 34 Vice President, Business Development
Alexander E. Evans...... 42 Vice President, International
Paul R. Holland......... 39 Vice President, Worldwide Sales
Pallipuram V. Kannan.... 32 Vice President, RealTime
Joseph D. McCarthy...... 35 Vice President, Finance and Operations
William R. Phelps....... 38 Vice President, Professional Services
Toya A. Rico............ 40 Vice President, Human Resource s
Donald R. Whitt......... 42 Vice President, eBusiness Services
Michael R. Wolfe........ 31 Vice President, Engineering
David M. Beirne......... 35 Director
Robert W. Frick......... 62 Director
Eric A. Hahn............ 39 Director
Charles A. Holloway, 63
Ph.D. ................. Director
Steven T. Jurvetson..... 32 Director
Ariel Poler............. 32 Director
Michael J. McCloskey. Mr. McCloskey joined Kana in June 1999 as Chief
Executive Officer and a director. Prior to joining Kana, from September 1996 to
February 1999, Mr. McCloskey served in various positions with Genesys
Telecommunications Laboratories, Inc., a provider of enterprise interaction
management software, including President from July 1998 to December 1998, Chief
Operating Officer from September 1997 to July 1998 and Vice President, Finance
and International, Chief Financial Officer and Secretary from September 1996 to
July 1998. From May 1995 to September 1996, he served as Vice President,
Finance, Chief Financial Officer and Vice President, Operations at Network
Appliance, Inc., a network data storage device company. From September 1993 to
May 1995, Mr. McCloskey served as Executive Vice President and Chief Financial
Officer at Digital Microwave Corporation, a telecommunications company. From
1991 to 1993, Mr. McCloskey was the Chief Operating Officer and a member of the
board of directors of Wavefront Technologies, a 3-D graphics visualization
software development company. Mr. McCloskey holds a B.S. in Business
Administration from Santa Clara University.
Mark S. Gainey. Mr. Gainey co-founded Kana in January 1996, served as
President, Chief Executive Officer and a director of Kana from January 1996 to
June 1999 and currently serves as its President and Chairman of the Board of
Directors. Prior to co-founding Kana, from April 1991 to September 1995, Mr.
Gainey served as an associate with TA Associates, Inc., a venture capital firm,
where he focused primarily on technology and business services investments. Mr.
Gainey holds a B.A. in General Studies from Harvard University.
Joseph G. Ansanelli. Mr. Ansanelli joined Kana in August 1999 as Vice
President, Marketing in connection with Kana's acquisition of Connectify, Inc.
Mr. Ansanelli co-founded Connectify in May 1998 and served as its President and
Chief Executive Officer. From February 1997 to May 1998, Mr. Ansanelli managed
a consulting company where he focused primarily on strategic marketing and
48
business development services for internet companies. From April 1996 to
January 1997, Mr. Ansanelli served as Director of Internet Product Marketing
for Macromedia, Inc., an Internet and multimedia tools software company. From
May 1992 to March 1996, Mr. Ansanelli held various product marketing positions
at Apple Computer, Inc. Mr. Ansanelli holds a B.S. in Applied Economics with a
concentration in Marketing from the Wharton School at the University of
Pennsylvania.
Timothy E. Campbell. Mr. Campbell joined Kana as Vice President and General
Manager of Kana On-Line in December 1999 in connection with our acquisition of
netDialog, Inc., where he had been employed as Vice President of Client
Services and Chief Services Officer since February 1999. From May 1997 to
February 1999, Mr. Campbell served as Senior Vice President of Consulting,
Americas for Baan Company, an enterprise software company. From September 1995
to February 1997, Mr. Campbell was Vice President of client services at Aurum
Software Inc. Prior to joining Aurum, Mr. Campbell had been with Electronic
Data Systems, Inc. since 1988 where he had been involved in systems
integration, MIS, and consulting.
Ian P. Cavanagh. Mr. Cavanagh joined Kana in July 1999 as Vice President,
Business Development. Prior to joining Kana, from February 1996 to July 1999,
Mr. Cavanagh served in various management roles at Genesys Telecommunications
Laboratories, Inc., a provider of enterprise interaction management software,
most recently as Vice President, Asia Pacific and Managing Director, Canada.
From 1994 to February 1996, Mr. Cavanagh served as Senior Manager-Call Centre
Service Development with the New Brunswick Telephone Company. Prior to 1994,
Mr. Cavanagh served as Senior Manager-Service Development with Stentor Canadian
Network Management, an alliance of Canadian telecommunication service
providers. Previously, Mr. Cavanagh held several engineering positions with
NBTel. Mr. Cavanagh holds a Bachelor of Electrical Engineering from the
Technical University of Nova Scotia and Acadia University.
Alexander E. Evans. Mr. Evans joined Kana in July 1999 as Vice President,
International. Prior to joining Kana, from May 1994 to July 1999, Mr. Evans
served as the Managing Director, Europe for Genesys Telecommunications
Laboratories, Inc., with responsibility for Europe, Middle East and Africa.
Prior to May 1994, Mr. Evans served in various managerial and sales capacities
at Digital Systems Ltd., a company that supplies outbound predictive dialers.
Previously, Mr. Evans served in various managerial, technical and marketing
positions at Digital Equipment Corp. Prior to his employment by Digital
Equipment, Mr. Evans worked in various technical and project roles involving
material requirement planning, process control and automated manufacturing
systems at Dupont, Inc., Mars Electronics Ltd. & Metal Box PLC. Mr. Evans holds
a degree in Electronics from John Moore University, England.
Paul R. Holland. Mr. Holland joined Kana in December 1997 as Vice
President, Worldwide Sales. Prior to joining Kana, from September 1994 to
September 1997, Mr. Holland worked at Pure Atria Corporation (now Rational
Software Corporation), a software tools company, most recently as its Vice
President, Europe. From June 1992 to September 1994, Mr. Holland held various
sales positions at Pure Atria Corporation (then Pure Software Corporation).
From 1988 to 1992, Mr. Holland was director of marketing and sales for
Rothchild Consultants, a high technology market research company. Mr. Holland
holds a B.S. in Public Administration from James Madison University, an M.A. in
Foreign Affairs from the University of Virginia and an M.B.A. from the
University of California at Berkeley.
Pallipuram V. Kannan. Mr. Kannan joined Kana as Vice President, RealTime in
December 1999 in connection with our acquisition of Business Evolution, Inc.
Mr. Kannan co-founded Business Evolution in July 1995 and served as its
President and Chief Executive Officer. From 1991 to June 1995, Mr. Kannan
worked as a consultant in various project management roles at Oracle and IBM.
Mr. Kannan is a Chartered Accountant in India and holds post- graduate degrees
in Accounting and Finance.
49
Joseph D. McCarthy. Mr. McCarthy joined Kana in March 1998 as Director of
Finance and Operations and served as Vice President, Finance and Operations
from April 1999 to December 1999, and has served as Vice President, Finance
since December 1999. Prior to joining Kana, from September 1997 to March 1998,
Mr. McCarthy served as Vice President, Finance at Reasoning, Inc., a
transformation software company. From March 1995 to September 1997, Mr.
McCarthy served as Corporate Controller of Pure Atria Corporation (now Rational
Software Corporation), a software tools company, and from September 1993 to
March 1995 he served as Controller of International Network Services, a network
services company. Mr. McCarthy holds a B.B.A. in Accounting from the University
of Notre Dame.
William R. Phelps. Mr. Phelps joined Kana in December 1998 as Vice
President, Professional Services. Prior to joining Kana, from March 1997 to
November 1998, Mr. Phelps served as Vice President, Professional Services for
CrossWorlds Software, Inc., an application integration software company. From
January 1994 to February 1997, Mr. Phelps served as a principal consultant at
Booz, Allen & Hamilton, a management consulting firm. Mr. Phelps holds a B.S.
in Industrial Engineering from Stanford University.
Toya A. Rico. Ms. Rico joined Kana in January 2000 as Vice President, Human
Resources. Prior to joining Kana, from October 1996 through May 1999, Ms. Rico
served as Director, Human Resources at Adaptec, Inc., a bandwidth management
company. From May 1988 through September 1996, Ms. Rico served in a variety of
human resources management positions at 3Com Corporation, a computer networking
company. Ms. Rico holds a B.A. in Communications from California State
University, San Francisco.
Donald R. Whitt. Mr. Whitt joined Kana as Vice President, eBusiness
Services in December 1999 in connection with our acquisition of netDialog, Inc.
From May 1999 to December 1999 Mr. Whitt served as Vice President, eBusiness
Services at netDialog. From May 1998 to April 1999, Mr. Whitt served as
Director of Product Development Services at netDialog. From July 1997 to May
1998, Mr. Whitt was an independent web development consultant. From November
1994 to June 1997, Mr. Whitt served as Director of Technical Operations for
America Online. Mr. Whitt holds a B.A. in philosophy from California State
University, Chico.
Michael R. Wolfe. Mr. Wolfe joined Kana in May 1997 as Director of
Engineering and has served as Vice President, Engineering since April 1998.
Prior to joining Kana, from March 1995 to February 1997, Mr. Wolfe served as
Director of Engineering at Internet Profiles Corporation, an internet marketing
company. From February 1994 to March 1995, Mr. Wolfe was an associate at Wells
Fargo Nikko, specializing in software development. From June 1991 to February
1994, Mr. Wolfe was a software programming analyst at Goldman, Sachs & Co. Mr.
Wolfe has taught computer science at Stanford University and the University of
California at Berkeley. Mr. Wolfe holds a B.S. and M.S. in Computer Science
from Stanford University.
David M. Beirne. Mr. Beirne has served as a director of Kana since
September 1997. Mr. Beirne has been a Managing Member of Benchmark Capital, a
venture capital firm, since June 1997. Prior to joining Benchmark Capital, Mr.
Beirne founded Ramsey/Beirne Associates, an executive search firm, and served
as its Chief Executive Officer from October 1987 to June 1997. Mr. Beirne
serves on the board of directors of Scient Corporation, PlanetRx.com, Inc.,
Webvan Group, Inc., 1-800-FLOWERS.COM, Inc., and several private companies. Mr.
Beirne holds a B.S. in Management from Bryant College.
Robert W. Frick. Mr. Frick has served as a director of Kana since August
1999. Mr. Frick previously served as the Vice Chairman of the Board, Chief
Financial Officer and head of the World Banking Group for Bank of America, as
Managing Director of BankAmerica International, and as President of Bank of
America's venture capital subsidiary. He is now retired. Mr. Frick previously
50
served as a director of Connectify, Inc. from its founding to its acquisition
by Kana, and he currently serves on the board of directors of six private
companies. Mr. Frick holds a B.S. in Civil Engineering and an M.B.A. from
Washington University in St. Louis, Missouri.
Eric A. Hahn. Mr. Hahn has served as a director of Kana since June 1998.
Mr. Hahn is a founding partner of Inventures Group, a leading "mentor
investment" stage venture capital firm. From November 1996 to June 1998, Mr.
Hahn served as the Executive Vice President and Chief Technical Officer of
Netscape Communications Corporation and served as a member of Netscape's
Executive Committee. Mr. Hahn also served as General Manager of Netscape's
Server Products Division, overseeing Netscape's product development and
marketing activities for enterprise Internet, intranet and extranet servers,
from November 1995 to November 1996. Prior to joining Netscape, from February
1993 to November 1995, Mr. Hahn was founder and Chief Executive Officer of
Collabra Software, Inc., a groupware provider that was acquired by Netscape.
Mr. Hahn holds a B.S. in Computer Science from the Worcester Polytechnic
Institute.
Dr. Charles A. Holloway. Dr. Holloway has served as a director of Kana
since December 1996. Dr. Holloway holds the Kleiner, Perkins, Caufield & Byers
Professorship in Management at the Stanford Graduate School of Business and has
been a faculty member of the Stanford Graduate School of Business since 1968.
Dr. Holloway is also currently co-director of the Stanford Center for
Entrepreneurial Studies at the Graduate School of Business. Dr. Holloway was
the founding co-chair of the Stanford Integrated Manufacturing Association, a
cooperative effort between the Graduate School of Business and the School of
Engineering, which focuses on research and curriculum development in
manufacturing and technology. Dr. Holloway serves on the board of directors of
several private companies. Dr. Holloway holds a B.S. in Electrical Engineering
from the University of California at Berkeley and an M.S. in Nuclear
Engineering and Ph.D. in Business Administration from the University of
California, Los Angeles.
Steven T. Jurvetson. Mr. Jurvetson has served as a director of Kana since
April 1997. Mr. Jurvetson has been a Managing Director of Draper Fisher
Jurvetson, a venture capital firm, since June 1995. Prior to joining Draper
Fisher Jurvetson, from July 1990 to September 1993, Mr. Jurvetson served as a
consultant with Bain & Company, a management consulting firm. Mr. Jurvetson
served as a research and development engineer at Hewlett-Packard during the
summer months from June 1987 to August 1989. Mr. Jurvetson serves on the boards
of directors of Cognigine Corporation, FastParts, Inc., iTv Corp., Tacit
Knowledge Corporation, Third Voice, Inc. and ReleaseNow.com Corporation. Mr.
Jurvetson holds a B.S. and an M.S. in Electrical Engineering from Stanford
University and an M.B.A. from the Stanford Graduate School of Business.
Ariel Poler. Mr. Poler has served as a director of Kana since December
1996. Mr. Poler has been the Chief Executive Officer of Topica Inc., a compiler
and provider of e-mail lists, since January 1998 and has served as a director
of Topica since February 1998. Mr. Poler founded and served as Chief Executive
Officer of Internet Profiles Inc. (IPRO), a Web measurement and auditing
service company, from May 1994 to January 1996. Mr. Poler served on the board
of directors of LinkExchange, Inc., a privately held Web advertising network,
from October 1996 to October 1998. Mr. Poler holds a B.S. in Mathematics with
Computer Science from the Massachusetts Institute of Technology and an M.B.A.
from the Stanford Graduate School of Business.
Board of Directors and Committees
Kana currently has authorized eight directors. The board consists of eight
directors divided into three classes, with each class serving for a term of
three years. At each annual meeting of stockholders, directors will be elected
by the holders of common stock to succeed the directors whose terms are
expiring. Messrs. Beirne, Frick and Jurvetson are Class I directors whose terms
will expire in 2000, Messrs. Hahn and Poler and Dr. Holloway are Class II
directors whose terms will
51
expire in 2001 and Messrs. Gainey and McCloskey are Class III directors whose
terms will expire in 2002. If the merger with Silknet is consummated, Kana will
increase the size of its board to nine directors. James C. Wood will be
appointed to fill the new seat on Kana's board of directors until his successor
is duly elected and qualified. Mr. Wood will be a Class III director and his
term will expire in 2002. Kana's officers serve at the discretion of the board.
Kana has established an audit committee composed of independent directors,
which reviews and supervises Kana's financial controls, including the selection
of its auditors, reviews the books and accounts, meets with its officers
regarding its financial controls, acts upon recommendations of the auditors and
takes any further actions the audit committee deems necessary to complete an
audit of Kana's books and accounts, as well as addressing other matters that
may come before it or as directed by the board. The audit committee currently
consists of two directors, Dr. Holloway and Mr. Jurvetson.
Kana has established a compensation committee, which reviews and approves
the compensation and benefits for Kana's executive officers, administers its
stock plans and performs other duties as may from time to time be determined by
the board. The compensation committee currently consists of two directors,
Messrs. Beirne and Hahn.
Compensation Committee Interlocks and Insider Participation
During 1999, Kana's compensation committee consisted of Messrs. Beirne and
Hahn. Neither Mr. Beirne nor Mr. Hahn was an employee of Kana or its
subsidiaries during 1999 or at any time prior to 1999. None of Kana's executive
officers serves on the board of directors or compensation committee of any
entity that has one or more executive officers serving as a member of Kana's
board of directors or compensation committee.
Director Compensation
Kana currently does not compensate any non-employee member of the board.
Directors who are also employees of Kana do not receive additional compensation
for serving as directors.
Non-employee directors are eligible to receive discretionary option grants
and stock issuances under the 1999 Stock Incentive Plan. In addition, under the
1999 Stock Incentive Plan, each new non-employee director will receive an
automatic option grant for 40,000 shares upon his or her initial appointment or
election to the board, and continuing non-employee directors will receive an
automatic option grant for 10,000 shares on the date of each annual meeting of
stockholders.
In August 1999, Kana granted an option to purchase 66,666 shares of common
stock to Mr. Frick at an exercise price of $4.50 per share under its 1997 Stock
Option/Stock Issuance Plan. The option was fully vested and immediately
exercisable on the grant date. Mr. Frick exercised this option in full in
September 1999. Mr. Frick delivered a full-recourse promissory note in the
amount of $300,000 to Kana in full payment of the purchase price. The note
bears interest at a rate of 6.0% per annum, compounded annually, and is payable
in a lump sum on September 18, 2004.
In September 1999, Kana granted an option to purchase 60,000 shares of
common stock to Dr. Holloway at an exercise price of $7.50 per share under the
Discretionary Grant program of its 1999 Stock Incentive Plan. The option may be
exercised for unvested shares, subject to Kana's right to repurchase those
shares at the exercise price paid per share if Dr. Holloway leaves the Board
before the shares vest. Twenty-five percent of the option shares will vest upon
Dr. Holloway's completion of one year of service measured from September 20,
1999, and the balance of the option shares will vest in a series of 36 equal
monthly installments upon his completion of each additional month of service
thereafter. All unvested shares will immediately vest upon a merger or asset
sale,
52
the successful completion of a hostile tender offer for more than 50% of Kana's
outstanding voting securities, or a change in the majority of the board through
one or more contested elections for board membership.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires
Kana's executive officers and directors and persons who own more than ten
percent of a registered class of Kana's equity securities to file reports of
ownership and changes in ownership with the Securities and Exchange Commission
and to furnish Kana with copies of these reports. Based on Kana's review of the
copies of these reports it has received, and written representations, if any,
received from reporting persons with respect to the filing of reports on Form
3, 4 and 5, Kana believes that all filings required to be made by the reporting
persons for 1999 were made on a timely basis for 1999 with the following
exception: a Form 5 for Don Whitt, an executive officer of Kana, reporting the
grant in December 1999 of options to purchase 46,746 shares of common stock was
filed in February 2000. The grant should have been reported on a Form 4 filed
in January 2000. In addition, a Form 5 for Timothy Campbell, an executive
officer of Kana, reporting the grant in December 1999 of options to purchase
51,944 shares of common stock was filed in February 2000. The grant should have
been reported on a Form 4 filed in January 2000.
53
ITEM 11. EXECUTIVE COMPENSATION
Summary Compensation Table
The following table sets forth information concerning compensation earned
for the year ended December 31, 1999, by the two individuals who served as
Kana's Chief Executive Officer during the 1999 fiscal year and each of the four
other most highly compensated executive officers whose salary and bonus for the
1999 fiscal year exceeded $100,000, for services rendered in all capacities to
Kana and its subsidiaries for the fiscal years ended December 31, 1998, and
1999. The listed individuals are referred to hereafter as the "Named Executive
Officers." No other executive officers who otherwise would have been includable
in this table on the basis of salary and bonus earned during 1999 have been
excluded because they terminated employment or changed their executive status
during the year.
The salary figures include amounts the employees put into Kana's tax-
qualified plan pursuant to Section 401(k) of the Internal Revenue Code.
However, compensation in the form of perquisites and other personal benefits
that constituted less than 10% of the total annual salary and bonus of each of
the Named Executive Officers in fiscal 1999 is excluded. The option grants
reflected in the table below were made under Kana's 1997 Stock Option/Stock
Issuance Plan.
Long-Term
Compensation
Awards
------------
Annual
Compensation Securities
Year ------------------ Underlying
Name and Principal Position Ended Salary($) Bonus($) Options (#)
--------------------------- ----- --------- -------- ------------
Michael J. McCloskey(1).................. 1999 81,250 -- 1,866,666
Chief Executive Officer and Director
Mark S. Gainey(2)........................ 1999 122,500 -- --
President and Chairman of the Board of
Directors 1998 72,500 -- --
Joseph D. McCarthy(3).................... 1999 143,308 -- 100,000
Vice President, Finance and Operations 1998 92,917 -- 213,332
Paul R. Holland(4)....................... 1999 75,000 721,600 --
Vice President, Worldwide Sales 1998 75,000 139,022 --
William R. Phelps(5)..................... 1999 130,000 56,000 413,332
Vice President, Professional Services 1998 8,917 -- --
Michael R. Wolfe(6)...................... 1999 135,000 -- 100,000
Vice President, Engineering 1998 103,333 -- --
- --------
(1) Mr. McCloskey joined Kana and became chief executive officer in June 1999.
His annualized salary for 1999 was $150,000. As of December 31, 1999, Mr.
McCloskey held 1,306,666 unvested shares acquired upon the exercise of the
1,866,666-share option granted him in June 1999. The shares will vest in a
series of 42 successive equal monthly upon his completion of each month of
service over the 42-month period measured from December 20, 1999. The year-
end market value of those shares, less the consideration he paid for them,
was $133,492,265.
(2) Mr. Gainey served as President, Chief Executive Officer, and Chairman of
the Board of Directors of Kana until June 17, 1999, when Mr. McCloskey
became CEO. Mr. Gainey remains as President and Chairman. As of December
31, 1999, Mr. Gainey held 625,000 unvested shares of common stock acquired
pursuant to a Restricted Stock Purchase Agreement dated April 7, 1997. The
shares will vest in a series of 6 successive equal monthly upon his
completion of each month of service over the 6-month period measured from
December 5, 1999. The year-end market value of those shares, less the
consideration he paid for them, was $64,012,500.
54
(3) Mr. McCarthy joined Kana in March 1998. As of December 31, 1999, he held
220,000 unvested shares of common stock acquired in connection with option
exercises. 120,000 of the shares will vest in a series of 27 successive
equal monthly installments upon his completion of each month of service
over the 27-month period measured from December 23, 1999. The remaining
100,000 shares will vest as follows: 25% upon his continuation in service
through June 16, 2000, and the balance in a series of 36 successive equal
monthly installments upon his completion of each additional month of
service thereafter. The aggregate year-end market value of those shares,
less the consideration he paid for them, was $22,511,750.
(4) As of December 31, 1999, Mr. Holland held 133,332 unvested shares of Kana
common stock acquired in connection with option exercises. As a result of
transfers made by Mr. Holland, the following entity also held unvested
shares originally issued to him in connection with his option exercises:
The Holland/Yates Family Trust dated July 23, 1999, 272,374 shares. The
unvested shares held by Mr. Holland and his transferees will vest in a
series of 23 successive equal monthly upon his completion of each month of
service over the 23-month period measured from January 1, 2000. The
aggregate year-end market value of these shares (less the consideration
paid by Mr. Holland for them) was $41,569,652.
(5) Mr. Phelps joined Kana in December 1998. As of December 31, 1999, Mr.
Phelps held 321,666 unvested shares of common stock acquired in connection
with option exercises. 275,000 of the shares will vest in a series of 36
successive equal monthly installments upon his completion of each month of
service over the 36-month period measured from December 7, 1999. The
remaining 46,666 shares will vest as follows: 25% upon his continuation in
service through June 16, 2000, and the balance in a series of 36 successive
equal monthly installments upon his completion of each additional month of
service thereafter. The aggregate year-end market value of those shares,
less the consideration he paid for those shares, was $32,907,578.
(6) As of December 31, 1999, Mr. Wolfe held 265,278 unvested shares of common
stock acquired in connection with option exercises. 165,278 of the shares
will vest in a series of 17 successive equal monthly installments upon his
completion of each month of service over the 17-month period measured from
December 19, 1999. The remaining 100,000 shares will vest as follows: 25%
upon his continuation in service through August 18, 2000, and the balance
in a series of 36 successive equal monthly installments upon his completion
of each additional month of service thereafter. The aggregate year-end
market value of those shares, less the consideration he paid for them, was
$16,938,516.
Option Grants in Last Fiscal Year
The following table sets forth information with respect to stock options
granted to each of the Named Executive Officers in 1999. Kana granted options
to purchase up to a total of 8,760,866 shares to employees during the year, and
the table's percentage column shows how much of that total was granted to the
Named Executive Officers. No stock appreciation rights were granted to the
Named Executive Officers during 1999.
The table includes the potential realizable value over the 10-year term of
the options, based on assumed rates of stock price appreciation of 5% and 10%,
compounded annually. The potential realizable value is calculated based on the
initial public offering price of the common stock, assuming that price
appreciates at the indicated rate for the entire term of the option and that
the option is exercised and sold on the last day of its term at the appreciated
price. All options listed have a term of 10 years. The stock price appreciation
rates of 5% and 10% are assumed pursuant to the rules of the Securities and
Exchange Commission. Kana can give no assurance that the actual stock price
will appreciate over the 10-year option term at the assumed 5% and 10% levels
or at any other defined level. Actual gains, if any, on stock option exercises
will be dependent on the future performance of Kana's common stock. Unless the
market price of the common stock appreciates over the option term, no value
will be realized from the option grants made to the Named Executive Officers.
55
The option grants to the Named Executive Officers were made under Kana's
1997 Stock Option/Stock Issuance Plan. The exercise price for each option grant
is equal to the fair market value of Kana's common stock on the grant, as
determined in good faith by the board of directors. All options were
immediately exercisable in full, but Kana can buy back any shares purchased
under those options, at the exercise price paid per share, to the extent the
shares are not vested when the officer leaves Kana. Kana's repurchase rights
will lapse on an accelerated basis under certain conditions in conjunction with
a change of control. See "Item 11. Executive Compensation--Employment
Arrangements, Termination of Employment Arrangements and Change in Control
Arrangements."
OPTION GRANTS IN 1999
Potential Realizable
Value at Assumed
Percent Annual Rates of Stock
of Price Appreciation
Number of Total for Option Term at
Securities Options Exercise Initial Public
Underlying Granted Price Offering Price(1)
Options in Per Expiration ---------------------
Name Granted (#) 1999 Share Date 5% 10%
- ---- ----------- ------- -------- ---------- ---------- ----------
Michael J. McCloskey.... 1,866,666 21.31% $0.3375 6/16/09 22,169,850 35,677,715
Mark S. Gainey.......... -- -- -- -- -- --
Joseph McCarthy......... 100,000 1.14% 0.3375 6/16/09 1,187,671 1,911,307
Paul R. Holland......... -- -- -- -- --
William R. Phelps....... 366,666 4.19% 0.175 12/06/08 4,415,286 7,068,612
46,666 0.53% 0.3375 6/16/09 554,239 891,930
Michael R. Wolfe........ 100,000 1.14% 4.50 8/17/09 771,671 1,495,307
- --------
(1) The 5% and 10% values are based upon the $7.50 price per share at which the
common stock was sold in the initial public offering on September 21, 2000.
OPTION EXERCISES IN LAST FISCAL YEAR
The following table sets forth the number of shares the Named Executive
Officers purchased in connection with option exercises during the 1999 fiscal
year and the value they realized on those exercises. None of these Named
Executive Officers held any unexercised options at the end of the 1999 fiscal
year. None of them exercised any stock appreciation rights during 1999, and
none held any stock appreciation rights at the end of the year.
The value realized is based on the fair market value of Kana's common stock
on the date of exercise, minus the exercise price payable for the shares. The
fair market value was determined in good faith by the board of directors for
exercises before September 21, 1999, and was based on Kana's closing price on
the exercise date for exercises on or after September 21, 1999. The exercise
price for each grant equaled the fair market value on the date of exercise, so
the Named Executive Officers who exercised did not realize any value on the
exercises.
# of Securities
Underlying Unexercised Value of Unexercised In-
Number of Options/ SARs at Fiscal the-Money Options/SARs
Shares Year End at Fiscal Year End
Acquired on Value ------------------------- -------------------------
Name Exercise Realized Exercisable Unexercisable Exercisable Unexercisable
- ---- ----------- -------- ----------- ------------- ----------- -------------
Michael McCloskey....... 1,866,666 0 -- -- -- --
Mark S. Gainey.......... -- -- -- -- -- --
Joseph D. McCarthy...... 100,000 0 -- -- -- --
Paul R. Holland......... -- -- -- -- -- --
William R. Phelps....... 366,666 0 -- -- -- --
46,666 0 -- -- -- --
Michael R. Wolfe........ 100,000 0 -- -- -- --
56
EMPLOYMENT ARRANGEMENTS, TERMINATION OF EMPLOYMENT ARRANGEMENTS
AND CHANGE IN CONTROL ARRANGEMENTS
In February 1997, Dr. Holloway, one of Kana's directors, exercised an
option to purchase 106,666 shares of common stock and entered into a stock
purchase agreement for the purchase of those shares. To the extent the shares
are unvested at the time of his termination of service, Kana will have the
right to repurchase those shares at the exercise price paid per share. Under
the stock purchase agreement, if Kana is acquired by merger or asset sale,
Kana's right to repurchase the unvested shares will automatically lapse in its
entirety, and the shares will vest in full, unless the repurchase right is
assigned to the successor entity.
Also in June 1998, Mr. Poler, one of Kana's directors, exercised options to
purchase a total of 333,332 shares of common stock and entered into a stock
purchase agreement for the purchase of those shares. To the extent the shares
are unvested at the time of his termination of service, Kana will have the
right to repurchase those shares at the exercise price paid per share. Under
the stock purchase agreement, if Kana is acquired by merger or asset sale,
Kana's right to repurchase the unvested shares will automatically lapse in its
entirety, and the shares will vest in full, unless the repurchase right is
assigned to the successor entity.
In April 1997, Kana sold to Mr. Gainey, Kana's co-founder, President and
Chairman of the Board, 5,000,000 shares of common stock at a purchase price of
$0.01 per share. To the extent the shares are unvested at the time of his
termination of service, Kana will have the right to repurchase those shares at
the original purchase price paid per share The repurchase right lapses in a
series of equal monthly installments over a four-year period measured from June
4, 1996. If Kana is acquired by merger or asset sale and Mr. Gainey is not
offered employment or is terminated without cause within three months after the
transaction, his shares will vest in full and no longer be subject to
repurchase. If Kana is acquired by merger or asset sale and Mr. Gainey is
terminated without cause more than three months after the transaction, or if he
is terminated without cause not in connection with any merger or asset sale,
then 50% of his unvested shares will vest and no longer be subject to
repurchase.
In April 1998, Mr. Holland, Kana's Vice President, Worldwide Sales,
exercised an option to purchase 811,410 shares of common stock and entered into
a stock purchase agreement for the purchase of those shares. To the extent the
shares are unvested at the time of his termination of service, Kana will have
the right to repurchase those shares at the exercise price paid per share.
Under the stock purchase agreement, upon an acquisition of Kana by merger or
asset sale, Kana's right to repurchase the unvested shares will automatically
lapse in its entirety, and the shares will vest in full, unless the repurchase
right is assigned to the successor entity. In addition, if Kana is acquired by
merger or asset sale and Mr. Holland is not offered comparable employment by
the successor entity, Kana's right to repurchase the unvested shares will
automatically lapse and the shares will vest in full.
In June 1998, Mr. McCarthy, Kana's Vice President, Finance and Operations,
exercised an option to purchase 213,332 shares of common stock and entered into
a stock purchase agreement for the purchase of those shares. To the extent the
shares are unvested at the time of his termination of service, Kana will have
the right to repurchase those shares at the exercise price paid per share.
Under the stock purchase agreement, upon an acquisition of Kana by merger or
asset sale, Kana's right to repurchase the unvested shares will automatically
lapse in its entirety, and the shares will vest in full, unless the repurchase
right is assigned to the successor entity. In addition, if Kana is acquired by
merger or asset sale and Mr. McCarthy is not offered employment by the
successor entity, 50% of the unvested shares will vest and no longer be subject
to repurchase.
In July 1998, Mr. Hahn, one of Kana's directors, exercised an option to
purchase 150,066 shares of common stock and entered into a stock purchase
agreement for the purchase of those
57
shares. To the extent the shares are unvested at the time of his termination of
service, Kana will have the right to repurchase those shares at the exercise
price paid per share. Under the stock purchase agreement, if Kana is acquired
by merger or asset sale, Kana's right to repurchase the unvested shares will
automatically lapse in its entirety and the shares will vest in full.
Also in July 1998, Dr. Holloway exercised an option to purchase 53,332
shares of common stock and entered into a stock purchase agreement for the
purchase of those shares. To the extent the shares are unvested at the time of
his termination of service, Kana will have the right to repurchase those shares
at the exercise price paid per share. Under the stock purchase agreement, upon
an acquisition of Kana by merger or asset sale, Kana's right to repurchase all
of the unvested shares will automatically lapse in its entirety, and the shares
will vest in full, unless the repurchase right is assigned to the successor
entity. In addition, if Kana is acquired by merger or asset sale and Dr.
Holloway does not provide services to the successor entity, 25% of the unvested
shares will vest and no longer be subject to repurchase.
In February and June 1999, Mr. Phelps, Kana's Vice President, Professional
Services, exercised an option to purchase a total of 413,332 shares of common
stock and entered into a stock purchase agreement for the purchase of those
shares. To the extent the shares are unvested at the time of his termination of
service, Kana will have the right to repurchase those shares at the exercise
price paid per share. Under the stock purchase agreement, upon an acquisition
of Kana by merger or asset sale, Kana's right to repurchase the unvested shares
will automatically lapse in its entirety, and the shares will vest in full,
unless the repurchase right is assigned to the successor entity. In addition,
if Kana is acquired by merger or asset sale and Mr. Phelps is not offered
employment by the successor entity, 25% of the unvested shares will vest and no
longer be subject to repurchase.
In June 1999, Kana entered into an employment arrangement with Mr.
McCloskey, Kana's Chief Executive Officer. In connection with this arrangement,
Kana granted Mr. McCloskey an option to purchase 1,866,666 shares of common
stock, which Mr. McCloskey exercised in June 1999. 1,493,334 of the shares are
subject to a right of repurchase granted to Kana which will allow Kana to
repurchase those shares at the option exercise price paid per share, to the
extent those shares are unvested at the time of his termination of service.
Under the stock purchase agreement and the terms of Mr. McCloskey's employment
arrangement, the unvested shares will vest in a series of 48 successive equal
monthly upon his completion of each month of service over the 48-month period
measured from June, 17, 1999. However, all or part of the shares will vest on
an accelerated basis, following a change of control of Kana, under the
following circumstances:
. if Mr. McCloskey is not offered full-time employment with the successor
corporation, all of his then unvested shares of common stock will
accelerate and vest in full;
. if Mr. McCloskey is offered full-time employment with the successor
corporation as that corporation's chief executive officer, all of his
then unvested shares of common stock will continue to vest in accordance
with their original terms;
. if Mr. McCloskey is offered full-time employment with the successor
corporation as other than that corporation's chief executive officer,
the rate at which his then unvested shares of common stock vest will
double, such that his shares of common stock will vest at a rate
equivalent to 62,224 shares of common stock per month;
. if Mr. McCloskey is offered full-time employment with the successor
corporation as set forth in the second and third points above and he
does not accept the position, his shares of common stock will be subject
to immediate repurchase; and
. if Mr. McCloskey is terminated without cause by the successor
corporation following the change in control, all of his then unvested
shares of common stock will accelerate and vest in full.
58
Also in June 1999, Mr. McCarthy exercised an option to purchase 100,000
shares of common stock and entered into a stock purchase agreement for the
purchase of those shares. To the extent the shares are unvested at the time of
his termination of service, Kana will have the right to repurchase those shares
at the exercise price paid per share. Under the stock purchase agreement, upon
an acquisition of Kana by merger or asset sale, Kana's right to repurchase the
unvested shares will automatically lapse in its entirety, and the shares will
vest in full, unless the repurchase right is assigned to the successor entity.
In addition, if Kana is acquired by merger or asset sale and Mr. McCarthy is
not offered employment by the successor entity, 25% of the unvested shares will
vest and no longer be subject to repurchase.
In August 1999, Kana granted an option to purchase 66,666 fully vested
shares of common stock to Mr. Frick at an exercise price of $4.50 per share,
which he exercised in full in September 1999.
In August 1999, Kana granted an option to purchase 100,000 shares of common
stock at $4.50 per share to Mr. Wolfe, which Mr. Wolfe exercised in September
1999. To the extent the purchased shares are unvested at the time of his
termination of service, Kana will have the right to repurchase those shares at
the exercise price paid per share. Under the stock purchase agreement, upon an
acquisition of Kana by merger or asset sale, Kana's right to repurchase the
unvested shares will automatically lapse in its entirety, and the shares will
vest in full, unless the repurchase right is assigned to the successor entity.
In addition, if Kana is acquired by merger or asset sale and Mr. Wolfe is not
offered employment by the successor entity, 25% of the unvested shares will
vest and no longer be subject to repurchase.
Generally, Kana's option grants to employees, other than those under the
1999 Special Stock Option Plan, provide that if Kana is acquired by merger or
asset sale and the employee is not offered employment by the successor entity,
then 25% of any unvested shares held by that individual will vest and no longer
be subject to repurchase.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The table below sets forth information regarding the beneficial ownership
of Kana's common stock as of March 10, 2000, by the following individuals or
groups:
. each person or entity who is known by Kana to own beneficially more than
five percent of Kana's outstanding stock;
. each of the Named Executive Officers;
. each director of Kana; and
. all directors and executive officers as a group.
Applicable percentage ownership in the following table is based on
60,809,098 shares of common stock outstanding as of March 10, 2000, as adjusted
to include all options exercisable within 60 days of March 10, 2000 held by the
particular stockholder and that are included in the first column.
59
Unless otherwise indicated, the principal address of each of the
stockholders below is c/o Kana Communications, Inc., 740 Bay Road, Redwood
City, CA 94063. Except as otherwise indicated, and subject to applicable
community property laws, the persons named in the table have sole voting and
investment power with respect to all shares of common stock held by them.
Percentage of Shares
Number of Beneficially Owned
Shares ------------------------------------
Name and Address of Beneficially
Beneficial Owner Owned Prior to the Merger After the Merger
------------------- ------------ ------------------- ----------------
Entities affiliated with
Draper Fisher
Jurvetson(1)............... 8,044,794 13.2% 9.0%
Entities affiliated with
Benchmark Capital
Partners L.P.(2)........... 8,624,254 14.2 9.7
Mark S. Gainey(3)........... 4,752,000 7.8 5.3
Michael J. McCloskey(4)..... 1,866,666 3.1 2.1
Paul R. Holland(5).......... 811,410 1.3 *
William R. Phelps(6)........ 413,334 * *
Joseph D. McCarthy(7)....... 313,334 * *
Michael R. Wolfe............ 628,732 1.0 *
Steven T. Jurvetson(1)...... 8,044,794 13.2 9.0
David M. Beirne(2).......... 8,624,254 14.2 9.7
Eric A. Hahn(8)............. 433,898 * *
Ariel Poler(9).............. 321,332 * *
Dr. Charles A.
Holloway(10)............... 219,998 * *
Robert W. Frick............. 146,312 * *
James C. Wood(11)........... -- -- 2.9
All directors and executive
officers as a group
(20 persons)............... 29,983,648 49.3 33.6
- --------
*Less than one percent.
(1) Principal address is 400 Seaport Court, Suite 250, Redwood City, CA 94063.
Includes 7,481,660 shares of common stock held by Draper Fisher Associates
Fund IV, L.P. and 563,134 shares of common stock held by Draper Fisher
Partners IV, LLC. Mr. Jurvetson disclaims beneficial ownership of these
shares, except to the extent of his pecuniary interest in the Draper
Fisher Jurvetson Funds.
(2) Principal address is 2480 Sand Hill Road, Suite 200, Menlo Park, CA 94025.
Represents 7,566,694 shares of common stock held by Benchmark Capital
Partners, L.P., and 1,057,558 shares of common stock held by Benchmark
Founders' Fund L.P. Mr. Beirne, one of Kana's directors, is a Managing
Member of Benchmark Capital Management Co., LLC. Mr. Beirne disclaims
beneficial ownership of these shares, except to the extent of his
pecuniary interest in the Benchmark funds.
(3) Represents shares of common stock held by the Mark and Elisabeth Gainey
Family Trust. Includes 937,500 shares of common stock subject to Kana's
right of repurchase. This repurchase right lapses with respect to 104,166
shares per month.
(4) Includes 1,462,224 shares of common stock subject to Kana's right of
repurchase. This repurchase right lapses with respect to 31,108 shares per
month.
(5) Includes 26,666 shares of common stock held by The Paul Holland Grantor
Retained Annuity Trust, 26,666 shares of common stock held by The Linda
Yates Holland Grantor Retained Annuity Trust, 53,332 shares of common
stock held by the Yates/Holland 1999 Irrevocable Trust, 571,410 shares of
common stock held by The Yates/Holland Family Trust and 133,332 shares of
common stock held by Paul Holland and Linda Yates as community property.
Includes 456,420 shares of common stock subject to Kana's right of
repurchase. This repurchase right lapses with respect to 16,902 shares per
month.
60
(6) Includes 26,666 shares of common stock held by The William Phelps Grantor
Retained Annuity Trust, 26,666 shares of common stock held by The Margaret
Phelps Grantor Retained Annuity Trust and 360,000 shares of common stock
held by The Phelps Family Trust. Includes 366,666 shares of common stock
subject to Kana's right of repurchase. This repurchase right lapses with
respect to 91,666 in December 1999 and 7,638 shares per month. Also
includes 26,666 shares of common stock subject to Kana's right of
repurchase, which lapses with respect to 11,666 shares in June 2000 and
972 shares per month thereafter.
(7) Includes 33,332 shares of common stock held by The Joseph McCarthy Grantor
Retained Annuity Trust, 33,332 shares of common stock held by Siobhan
Lawlor Grantor Retained Annuity Trust. Includes 133,334 shares of common
stock subject to Kana's right of repurchase. This repurchase right lapses
with respect to 4,444 shares per month. Also includes 100,000 shares of
common stock subject to Kana's right of repurchase, which lapses with
respect to 25,000 shares in June 2000 and 2,084 shares per month
thereafter.
(8) Includes 100,042 shares of common stock subject to Kana's right of
repurchase. This repurchase right lapses with respect to 3,128 shares per
month.
(9) Includes 6,666 shares of common stock held by Alejandro W. Poler and 3,332
shares of common stock held by Noel Poler.
(10) Includes 19,259 shares of common stock subject to Kana's right of
repurchase. This repurchase right lapses with respect to 1,481 shares per
month. Also includes 55,000 shares of common stock subject to Kana's right
of repurchase which lapses with respect to 1,250 shares per month.
(11) Nominated to be appointed to Kana's board of directors upon completion of
the merger. Principal address is c/o Silknet Software, Inc., 50 Philippe
Cote Street, Manchester, NH 03101. Upon completion of the merger and
exchange of his Silknet common stock for shares of Kana common stock, Mr.
Wood will own 2,567,430 shares of Kana Common Stock.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Sales of Securities. In July 1999, Kana sold to various investors,
including entities affiliated with Draper Fisher Jurvetson and entities
affiliated with Benchmark Capital, a total of 838,466 shares of Series D
preferred stock for total consideration of $10,200,004.
On August 13, 1999, Kana closed a merger with Connectify pursuant to which
Connectify became a wholly-owned subsidiary of Kana. In connection with the
merger, Kana issued approximately 6,982,000 shares of its common stock in
exchange for all outstanding shares of Connectify capital stock and reserved
416,690 shares of common stock for issuance upon the exercise of Connectify
options and warrants Kana assumed in connection with the merger.
On December 3, 1999, Kana closed a merger with Business Evolution pursuant
to which Business Evolution became Kana's wholly-owned subsidiary. In
connection with the acquisition of Business Evolution, approximately 1,935,206
shares of Kana common stock, valued at approximately $140 million, were issued
or reserved for issuance for all outstanding shares, warrants and options of
Business Evolution.
On December 3, 1999, Kana closed a merger with netDialog, pursuant to which
netDialog became Kana's wholly-owned subsidiary. In connection with the
acquisition of netDialog, approximately 1,244,062 shares of Kana common stock,
valued at approximately $90 million, were issued or reserved for issuance for
all outstanding shares, warrants, convertible notes and options of netDialog.
Loans to and Other Arrangements with Officers and Directors. In connection
with the option exercises described under "Item 11. Executive Compensation--
Employment Arrangements,
61
Termination of Employment Arrangements and Change of Control Arrangements," the
following officers and directors delivered five-year full recourse promissory
notes, bearing interest at an annual rate of 5.7%, except in the case of Robert
W. Frick and Michael R. Wolfe whose notes bear interest at an annual rate of
6.0%, in amounts and with the balances indicated:
Original Amount of Amount Outstanding at
Promissory Note December 31, 1999
------------------ ---------------------
Officer or Director
Michael J. McCloskey................... $630,000.00 $600,052.83
Robert W. Frick........................ 299,997.00 310,541.89
William R. Phelps...................... 79,000.00 83,674.13
Ian P. Cavanagh........................ 900,000.00 930,046.84
Michael R. Wolfe....................... 458,000.00 --
Joseph G. Ansanelli.................... 85,000.00 87,737.80
Kana has entered into an employment arrangement with Michael J. McCloskey,
its Chief Executive Officer. See "Item 11. Executive Compensation--Employment
Arrangements, Termination of Employment Arrangements and Change in Control
Arrangements."
Kana has granted options to its executive officers and directors. See "Item
11. Executive Compensation--Executive Compensation" and "--Director
Compensation."
Kana has entered into an indemnification agreement with each of its
executive officers and directors containing provisions that may require it,
among other things, to indemnify its executive officers and directors against
liabilities that may arise by reason of their status or service as executive
officers or directors (other than liabilities arising from willful misconduct
of a culpable nature) and to advance expenses incurred as a result of any
proceeding against them as to which they could be indemnified.
62
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Report:
1. Financial Statements.
Page
----
Independent Auditors' Report .................................... 65
Consolidated Balance Sheets as of December 31, 1999 and 1998..... 66
Consolidated Statements of Operations and Comprehensive Loss for
the Years ended December 31, 1999 1998 and 1997................. 67
Consolidated Statements of Stockholders' Equity for the Years
ended December 31, 1999, 1998 and 1997.......................... 68
Consolidated Statements of Cash Flows for the Years ended
December 31, 1999, 1998 and 1997................................ 70
Notes to Consolidated Financial Statements....................... 71
2.Financial Statement Schedules.
Schedule Title Page
-------- ----- ----
Independent Auditors Report on Schedule................... 86
II Valuation and Qualifying Accounts ........................ 87
Schedules not listed above have been omitted because they are not
applicable, not required, or the information required to be set
forth therein is included in the consolidated financial statements
or notes thereto.
3. Exhibits.
Exhibit
Number Description of Document
-------- -----------------------
2.1* Agreement and Plan of Reorganization, dated December 3, 1999, by and
among Kana, King Acquisition Corp. and Business Evolution, Inc.
2.2* Agreement and Plan of Reorganization, dated December 3, 1999, by and
among Kana, Kong Acquisition Corp. and netDialog.
2.3** Agreement and Plan of Reorganization, dated February 6, 2000, by and
among Kana Communications, Inc., Pistol Acquisition Corp. and Silknet
Software, Inc.
3.1*** Second Amended and Restated Certificate of Incorporation.
3.2*** Amended and Restated Bylaws.
4.1*** Fourth Amended and Restated Investors' Rights Agreement dated August
13, 1999 by and among Kana and parties listed on Schedule A therein.
4.2+ Form of amendment to Fourth Amended and Restated Investors' Rights
Agreement.
10.1*** Kana's 1997 Stock Option/Stock Issuance Plan.
10.2*** Kana's 1999 Stock Incentive Plan.
10.3*** Kana's 1999 Employee Stock Purchase Plan.
10.4*** Form of Kana's Directors' and Officers' Indemnification Agreement.
10.5*** Form of Kana's License Agreement.
10.6*** Letter of Credit, dated July 9, 1999, with Silicon Valley Bank and
Kana.
10.7*** Lease, dated May 1998, by and between Encina Properties and Kana.
10.8*** Office/R&D Lease, dated June 18, 1999, by and between Chestnut Bay
LLC and Kana.
63
Exhibit
Number Description of Document
-------- -----------------------
10.9*** Form of Kana's Kana On-Line Service Agreement.
10.10*** Form of Kana's Restricted Stock Purchase Agreement.
10.11*** QuickStart Loan and Security Agreement, dated November 6, 1998, with
Silicon Valley Bank and Connectify, Inc.
10.12+ Lease, dated February 11, 2000, by and between Veterans Self-Storage,
LLC and the Registrant.
10.13+ Amended and Restated 1999 Stock Incentive Plan of Kana
Communications, Inc.
16.1 Letter from KPMG LLP, dated March 30, 2000.
21.1+ Subsidiaries of Kana Communications, Inc.
23.1 Consent of KPMG LLP, Independent Auditors.
24.1 Power of Attorney (See Signature Page).
27.1 Financial Data Schedule.
99.1++ Connectify, Inc. 1998 Stock Plan.
Connectify, Inc. 1998 Stock Plan Form of Incentive Stock Option
99.2++ Agreement.
Connectify, Inc. 1998 Stock Plan Form of Nonstatutory Stock Option
99.3++ Agreement.
99.4++ Form of Option Assumption Agreement.
99.5+++ Business Evolution, Inc. 1999 Stock Plan.
99.6+++ Business Evolution, Inc. Form of Stock Option Agreement.
99.7+++ Form of Option Assumption Agreement--12 Months Acceleration (Business
Evolution Option Shares).
99.8+++ Form of Option Assumption Agreement --24 Months Acceleration
(Business Evolution Option Shares).
99.9+++ NetDialog, Inc. 1997 Stock Plan.
99.10+++ NetDialog, Inc. Form of Stock Option Agreement.
99.11+++ Form of Option Assumption Agreement (NetDialog Option Shares).
- --------
* Previously filed as an exhibit to the Form 8-K filed with the Commission of
Kana on December 14, 1999, and incorporated into this annual report by
reference.
** Previously filed as an exhibit to the form 13D filed with the Commission by
the registrant on February 16, 2000, and incorporated into this annual
report by reference.
*** Incorporated into this annual report by reference to Kana's registration
statement on Form S-1, File No. 333-82587, originally filed with the
Commission on July 9, 1999, as subsequently amended.
+ Incorporated into this annual report by reference to Kana's registration
statement on Form S-4, File No. 333-32428, originally filed with the
Commission on March 14, 2000, as subsequently amended.
++ Previously filed as an exhibit to the Form S-8 filed with the Commission by
Kana on December 6, 1999 and incorporated into this annual report by
reference.
+++ Previously filed as an exhibit to the Form S-8 filed with the Commission by
Kana on December 23, 1999 and incorporated into this annual report by
reference.
(b) Reports on Form 8-K.
1.On December 14, 1999, the Company filed a Current Report on Form 8-K
reporting under Item 5, relating to the acquisitions of Business Evolution,
Inc., a Delaware corporation and NetDialog, Inc., a California corporation.
64
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Kana Communications, Inc.
We have audited the accompanying consolidated balance sheets of Kana
Communications, Inc. and subsidiary (the Company) as of December 31, 1999 and
1998, and the related consolidated statements of operations and comprehensive
loss, stockholders' equity, and cash flows for each of the years in the three-
year period ended December 31, 1999. The consolidated financial statements are
the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Kana
Communications, Inc. and subsidiary as of December 31, 1999 and 1998, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1999 in conformity with generally accepted
accounting principles.
/s/ KPMG LLP
Mountain View, California
January 20, 2000, except
as to Note 8, which is
as of February 11, 2000
65
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
December 31,
-------------------
1999 1998
--------- --------
Assets
Current assets:
Cash and cash equivalents............................... $ 18,695 $ 13,875
Short-term investments.................................. 36,167 160
Accounts receivable, less allowance for doubtful
accounts of $366 in 1999 and $110 in 1998 ............. 4,655 847
Prepaid expenses and other current assets............... 2,036 150
--------- --------
Total current assets.................................. 61,553 15,032
Property and equipment, net............................... 8,360 1,473
Other assets.............................................. 316 371
--------- --------
Total assets.......................................... $ 70,229 $ 16,876
========= ========
Liabilities and Stockholders' Equity
Current liabilities:
Current portion of notes payable........................ $ 4,224 $ 1,071
Accounts payable........................................ 2,766 698
Accrued commissions..................................... 1,984 143
Accrued payroll......................................... 1,639 280
Other accrued liabilities............................... 1,303 445
Accrued acquisition related costs....................... 3,148 --
Deferred revenue........................................ 6,253 562
--------- --------
Total current liabilities............................. 21,317 3,199
Notes payable, less current portion....................... 412 726
--------- --------
Total liabilities..................................... 21,729 3,925
--------- --------
Commitments and contingencies
Stockholders' equity:
Convertible preferred stock, $0.001 par value;
50,000,000 and 5,000,000 shares authorized; no and
12,512,641 shares issued and outstanding............... -- 13
Common stock, $0.001 par value; 60,000,000 and
100,000,000 shares authorized; 60,766,650 and
19,274,516 shares issued and outstanding............... 61 19
Additional paid-in capital.............................. 202,473 29,246
Deferred stock-based compensation....................... (14,962) (2,284)
Notes receivable from stockholders...................... (6,380) (164)
Accumulated other comprehensive losses.................. (75) (5)
Accumulated deficit..................................... (132,617) (13,874)
--------- --------
Total stockholders' equity............................ 48,500 12,951
--------- --------
Total liabilities and stockholders' equity............ $ 70,229 $ 16,876
========= ========
The accompanying notes are an integral part of these consolidated financial
statements.
66
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(In thousands, except per share data)
Years Ended December 31,
----------------------------
1999 1998 1997
--------- -------- -------
Revenue:
License........................................ $ 10,536 $ 2,014 $ --
Service........................................ 3,528 333 617
--------- -------- -------
Total revenue................................ 14,064 2,347 617
--------- -------- -------
Cost of revenue:
License........................................ 271 54 --
Service, excluding amortization of stock-based
compensation of $19,752, $143 and $13......... 6,610 666 253
--------- -------- -------
Total cost of revenue........................ 6,881 720 253
--------- -------- -------
Gross profit................................. 7,183 1,627 364
--------- -------- -------
Operating expenses:
Sales and marketing, excluding amortization of
stock-based compensation of $34,000, $564 and
$52........................................... 21,199 5,504 512
Research and development, excluding
amortization of stock-based compensation of
$19,864, $438 and $31......................... 12,854 5,669 971
General and administrative, excluding
amortization of stock-based compensation of
$6,860, $311 and $17.......................... 5,018 1,826 378
Amortization of stock-based compensation....... 80,476 1,456 113
Acquisition related costs...................... 5,635 -- --
--------- -------- -------
Total operating expenses..................... 125,182 14,455 1,974
--------- -------- -------
Operating loss................................... (117,999) (12,828) (1,610)
Other income (expense), net...................... (744) 227 57
--------- -------- -------
Net loss..................................... (118,743) (12,601) (1,553)
--------- -------- -------
Other comprehensive loss:
Net unrealized gain on available for sale
securities.................................... 26 -- --
Foreign currency translation adjustments....... (96) (5) --
--------- -------- -------
Total other comprehensive loss............... (70) (5) --
--------- -------- -------
Comprehensive loss........................... $(118,813) $(12,606) $(1,553)
========= ======== =======
Basic and diluted net loss per share............. $ (4.61) $ (2.01) $ (0.37)
========= ======== =======
Shares used in computing basic and diluted net
loss per share amounts.......................... 25,772 6,258 4,152
========= ======== =======
The accompanying notes are an integral part of these consolidated financial
statements.
67
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except share data)
Convertible Notes Accumulated
Preferred Stock Common Stock Additional Deferred Receivable Other
----------------- ------------------ Paid-in Stock-based From Comprehensive Accumulated
Shares Amount Shares Amount Capital Compensation Stockholders Losses Deficit
---------- ------ ---------- ------ ---------- ------------ ------------ ------------- -----------
Balances,
January 1,
1997............ -- $ -- 106,742 $ -- $ -- $ -- $ -- $ -- $ 280
Issuance of
common stock to
Kana and
netDialog
founders........ -- -- 6,931,916 7 (6) -- -- -- --
Issuance of
common stock
upon exercise of
stock options... -- -- 106,666 -- -- -- -- -- --
Repurchase of
founders' common
stock, net...... -- -- (833,332) -- -- -- -- -- --
Issuance of
Series A and B
convertible
preferred stock,
net............. 8,917,855 9 -- -- 4,764 -- -- -- --
Issuance of
common stock of
pooled company.. -- -- 173,232 -- 2,070 -- -- -- --
Issuance of
shares of common
stock in
exchange for
services........ -- -- 1,334 -- 7 -- -- -- --
Deferred stock-
based
compensation.... -- -- -- -- 890 (890) -- -- --
Amortization of
deferred stock-
based
compensation.... -- -- -- -- -- 106 -- -- --
Net loss........ -- -- -- -- -- -- -- -- (1,553)
---------- ----- ---------- ----- ------ ------ ----- ----- -------
Balances,
December 31,
1997............ 8,917,855 9 6,486,558 7 7,725 (784) -- -- (1,273)
Issuance of
common stock to
Connectify and
BEI founders.... -- -- 3,954,940 4 61 -- -- -- --
Issuance of
stock upon
exercise of
stock options
and warrants,
net of
repurchases..... 68,139 -- 5,314,624 5 174 -- (164) -- --
Issuance of
common stock of
pooled
companies....... -- -- 3,442,704 3 6,573 -- -- -- --
Issuance of
Series B and C
convertible
preferred stock,
net............. 3,526,647 4 -- -- 11,624 -- -- -- --
Issuance of
common stock and
warrants in
exchange for
services and
intellectual
property........ -- -- 75,690 -- 133 -- -- -- --
Deferred stock-
based
compensation.... -- -- -- -- 2,956 (2,956) -- -- --
Amortization of
deferred stock-
based
compensation.... -- -- -- -- -- 1,456 -- -- --
Other
comprehensive
loss............ -- -- -- -- -- -- -- (5) --
Net loss........ -- -- -- -- -- -- -- -- (12,601)
---------- ----- ---------- ----- ------ ------ ----- ----- -------
Balances,
December 31,
1998............ 12,512,641 13 19,274,516 19 29,246 (2,284) (164) (5) (13,874)
Total
Stockholders'
Equity
-------------
Balances,
January 1,
1997............ $ 280
Issuance of
common stock to
Kana and
netDialog
founders........ 1
Issuance of
common stock
upon exercise of
stock options... --
Repurchase of
founders' common
stock, net...... --
Issuance of
Series A and B
convertible
preferred stock,
net............. 4,773
Issuance of
common stock of
pooled company.. 2,070
Issuance of
shares of common
stock in
exchange for
services........ 7
Deferred stock-
based
compensation.... --
Amortization of
deferred stock-
based
compensation.... 106
Net loss........ (1,553)
-------------
Balances,
December 31,
1997............ 5,684
Issuance of
common stock to
Connectify and
BEI founders.... 65
Issuance of
stock upon
exercise of
stock options
and warrants,
net of
repurchases..... 15
Issuance of
common stock of
pooled
companies....... 6,576
Issuance of
Series B and C
convertible
preferred stock,
net............. 11,628
Issuance of
common stock and
warrants in
exchange for
services and
intellectual
property........ 133
Deferred stock-
based
compensation.... --
Amortization of
deferred stock-
based
compensation.... 1,456
Other
comprehensive
loss............ (5)
Net loss........ (12,601)
-------------
Balances,
December 31,
1998............ 12,951
68
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY--(Continued)
(In thousands, except share data)
Convertible Notes Accumulated
Preferred Stock Common Stock Additional Deferred Receivable Other
------------------- ----------------- Paid-in Stock-based From Comprehensive Accumulated
Shares Amount Shares Amount Capital Compensation Stockholders Losses Deficit
----------- ------ ---------- ------ ---------- ------------ ------------ ------------- -----------
Balances,
December 31,
1998............ 12,512,641 13 19,274,516 19 29,246 (2,284) (164) (5) (13,874)
Issuance of
common stock
upon exercise of
stock options
and warrants,
net of
repurchases..... -- -- 5,749,356 6 6,393 -- (6,544) -- --
Issuance of
Series D
convertible
preferred
stock........... 838,466 -- -- -- 10,169 -- -- -- --
Conversion of
convertible
preferred stock
to common
stock........... (13,351,107) (13) 26,702,214 27 (14) -- -- -- --
Issuance of
common stock of
pooled
companies....... -- -- 964,964 1 5,790 -- -- -- --
Issuance of
common stock in
exchange for
services........ -- -- 5,306 -- 60 -- -- -- --
Issuance of
common stock in
conjunction with
initial public
offering, net... -- -- 7,590,000 8 51,058 -- -- -- --
Conversion of
debt, accrued
interest, and
warrants to
common stock.... -- -- 480,294 -- 5,058 -- -- -- --
Payments on
notes receivable
from
stockholders.... -- -- -- -- -- -- 501 -- --
Interest
receivable from
notes receivable
from
stockholders.... -- -- -- -- -- -- (173) -- --
Interest expense
from warrants
issued in
connection with
bridge loans.... -- -- -- -- 1,559 -- -- -- --
Deferred stock-
based
compensation.... -- -- -- -- 93,154 (93,154) -- -- --
Amortization of
deferred stock-
based
compensation.... -- -- -- -- -- 80,476 -- -- --
Other
comprehensive
loss............ -- -- -- -- -- -- -- (70) --
Net loss........ -- -- -- -- -- -- -- -- (118,743)
----------- ----- ---------- --- -------- -------- ------- ---- ---------
Balances,
December 31,
1999............ -- $ -- 60,766,650 $61 $202,473 $(14,962) $(6,380) $(75) $(132,617)
=========== ===== ========== === ======== ======== ======= ==== =========
Total
Stockholders'
Equity
-------------
Balances,
December 31,
1998............ 12,951
Issuance of
common stock
upon exercise of
stock options
and warrants,
net of
repurchases..... (145)
Issuance of
Series D
convertible
preferred
stock........... 10,169
Conversion of
convertible
preferred stock
to common
stock........... --
Issuance of
common stock of
pooled
companies....... 5,791
Issuance of
common stock in
exchange for
services........ 60
Issuance of
common stock in
conjunction with
initial public
offering, net... 51,066
Conversion of
debt, accrued
interest, and
warrants to
common stock.... 5,058
Payments on
notes receivable
from
stockholders.... 501
Interest
receivable from
notes receivable
from
stockholders.... (173)
Interest expense
from warrants
issued in
connection with
bridge loans.... 1,559
Deferred stock-
based
compensation.... --
Amortization of
deferred stock-
based
compensation.... 80,476
Other
comprehensive
loss............ (70)
Net loss........ (118,743)
-------------
Balances,
December 31,
1999............ $ 48,500
=============
The accompanying notes are an integral part of these consolidated financial
statements.
69
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Years Ended December 31,
----------------------------
1999 1998 1997
--------- -------- -------
Cash flows from operating activities:
Net loss........................................ $(118,743) $(12,601) $(1,553)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization.................. 1,531 328 45
Amortization of stock-based compensation and
other stock-based items....................... 80,536 1,589 113
Interest expense from warrants issued in
connection with bridge loans.................. 1,559 -- --
Conversion of accrued interest to common
stock......................................... 258 -- --
Interest on stockholders' notes receivable..... (173) -- --
Changes in operating assets and liabilities:
Accounts receivable........................... (3,807) (690) (15)
Prepaid expenses and other assets............. (1,831) (469) (50)
Accounts payable and accrued liabilities...... 9,274 1,177 379
Deferred revenue.............................. 5,691 562 --
--------- -------- -------
Net cash used in operating activities......... (25,705) (10,104) (1,081)
--------- -------- -------
Cash flows from investing activities:
(Purchases) sales of short-term investments,
net............................................ (35,981) 50 (210)
Purchases of property and equipment............. (8,418) (1,446) (371)
--------- -------- -------
Net cash used in investing activities......... (44,399) (1,396) (581)
--------- -------- -------
Cash flows from financing activities:
Proceeds from notes payable and convertible
notes payable.................................. 9,790 1,834 256
Payments on notes payable....................... (2,151) (122) --
Net proceeds from issuance of convertible
preferred stock................................ 10,169 11,628 4,603
Net proceeds from issuance of common stock and
warrants....................................... 5,645 6,656 2,070
Net proceeds from initial public offering....... 51,066 -- --
Payments on stockholders' notes receivable...... 501 -- --
--------- -------- -------
Net cash provided by financing activities..... 75,020 19,996 6,929
--------- -------- -------
Effect of exchange rate changes on cash and cash
equivalents..................................... (96) (5) --
--------- -------- -------
Net change in cash and cash equivalents.......... 4,820 8,491 5,267
Cash and cash equivalents at beginning of year... 13,875 5,384 117
--------- -------- -------
Cash and cash equivalents at end of year......... $ 18,695 $ 13,875 $ 5,384
========= ======== =======
Supplemental disclosure of cash flow information:
Cash paid during the year for interest.......... $ 131 $ 36 $ 3
========= ======== =======
Noncash investing and financial activities:
Issuance of Series A convertible preferred
stock upon conversion of stockholder loan..... $ -- $ -- $ 170
========= ======== =======
Issuance of common stock upon conversion of
convertible note payable...................... $ 4,800 $ 300 $ --
========= ======== =======
Issuance of common stock in exchange for notes
receivable from stockholders.................. $ 6,544 $ 155 $ --
========= ======== =======
Grant of options to purchase common stock with
an exercise price below fair value............ $ 93,154 $ 2,273 $ 890
========= ======== =======
The accompanying notes are an integral part of these consolidated financial
statements.
70
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 1999, 1998 and 1997
1. Description of Business and Summary of Significant Accounting Policies
(a) Description of Business
Kana Communications, Inc. and subsidiaries (the Company or Kana) develop,
market and support customer communications software products and services for
e-Businesses. The Company sells its products primarily in the United States
and, to a lesser extent, in Europe primarily through its direct sales force.
(b) Principles of Consolidation
The consolidated financial statements include the financial statements of
Kana Communications, Inc. and its wholly-owned subsidiaries. All significant
intercompany balances and transactions have been eliminated in consolidation.
(c) Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
(d) Foreign Currency Translation
The functional currency for the Company's international subsidiary is the
local currency of the country in which it operates. Assets and liabilities are
translated using the exchange rate at the balance sheet date. Revenues,
expenses, gains, and losses are translated at the average exchange rates
prevailing during the year. Any translation adjustments are included in other
comprehensive loss.
(e) Cash Equivalents and Short-Term Investments
The Company considers all highly liquid investments with an original
maturity or reset date of three months or less to be cash equivalents. The
Company has classified its cash equivalents and short-term investments as
"available for sale." These items are carried at fair value, based on the
quoted market prices, and unrealized gains and losses, are reported as a
separate component of accumulated other comprehensive losses in stockholders'
equity. All short term investments mature in less than one year. To date,
realized gains or losses have not been material.
(f) Property and Equipment
Property and equipment are stated at cost, less accumulated depreciation
and amortization. Depreciation is computed using the straight-line method over
the estimated useful lives of the respective assets, generally three to five
years. Leasehold improvements are amortized over the lesser of the related
lease term or the life of the improvement.
The Company evaluates long-lived assets for impairment whenever changes in
circumstances indicate that the carrying amount of the asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future net cash
71
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1999, 1998 and 1997
flows expected to be generated by the asset. If assets are considered to be
impaired, the impairment to be recognized is measured by the amount by which
the carrying amounts exceed the fair values of the assets. Assets to be
disposed of are reported at the lower of carrying values or fair values, less
costs of disposal.
(g) Concentration of Credit Risk
Financial instruments subjecting the Company to concentrations of credit
risk consist primarily of cash and cash equivalents, short-term investments and
trade accounts receivable. The Company maintains cash and cash equivalents with
two domestic financial institutions. From time to time, the Company's cash
balances with its financial institutions may exceed Federal Deposit Insurance
Corporation insurance limits.
The Company's customers are currently concentrated in the United States.
The Company performs ongoing credit evaluations, generally does not require
collateral and establishes an allowance for doubtful accounts based upon
factors surrounding the credit risk of customers, historical trends and other
information. To date, such losses have been immaterial.
(h) Revenue Recognition
The Company recognizes revenue in accordance with Statement of Position
(SOP) 97-2, Software Revenue Recognition. SOP 97-2 requires that revenue
recognized from software arrangements be allocated to each element of the
arrangement based on the relative fair values of the elements, such as software
products, upgrades, enhancements, post contract customer support, installation,
or training. Under SOP 97-2, the determination of fair value is based on
objective evidence that is specific to the vendor. If evidence of fair value
for each element of the arrangement does not exist, all revenue from the
arrangement is deferred until such time as evidence of fair value does exist or
until all elements of the arrangement are delivered.
License revenue is recognized when there is persuasive evidence of an
arrangement and delivery to the customer has occurred, provided the arrangement
does not require significant customization of the software, the fee is fixed
and determinable, and collectibility is considered probable. Maintenance
contracts generally call for the Company to provide technical support and
software updates and upgrades to customers. Revenue from maintenance contracts
is recognized ratably over the term of the maintenance contract, on a straight-
line basis. Other service revenue, consisting primarily of consulting and
implementation, is generally recognized at the time the service is performed.
(i) Software Development Costs
Software development costs are expensed as incurred until technological
feasibility of the underlying software product is achieved. After technological
feasibility is established, software development costs are capitalized.
Capitalized costs are then amortized on a straight-line basis over the
estimated product life, or based on the ratio of current revenue to total
projected product revenue, whichever is greater. To date, technological
feasibility and general availability of such software have occurred
simultaneously and software development costs qualifying for capitalization
have been insignificant. Accordingly, the Company has not capitalized any
software development costs.
72
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1999, 1998 and 1997
The Company accounts for the costs of computer software developed or
obtained for internal use in accordance with SOP 98-1, Accounting for the Costs
of Computer Software Developed or Obtained for Internal Use, which was
effective for fiscal years beginning after December 15, 1998. This statement
requires that certain costs incurred during a software development project be
capitalized. These costs generally include external direct costs of materials
and services consumed in the project, and internal costs such as payroll and
benefits of those employees directly associated with the development of the
software. During 1999, the Company did not capitalize any internal costs as
such costs qualifying for capitalization have been insignificant. External
direct costs of purchased internal use software have been capitalized and
included in fixed assets.
(j) Income Taxes
The Company uses the asset and liability method of accounting for income
taxes. Deferred tax assets and liabilities are recognized for the estimated
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in tax rates is recognized
in the statement of operations in the period that includes the enactment date.
A valuation allowance is recorded to reduce deferred tax assets to an amount
whose realization is more likely than not.
(k) Stock-Based Compensation
The Company accounts for its stock-based compensation arrangements with
employees using the intrinsic-value method. Deferred stock-based compensation
is recorded on the date of grant when the deemed fair value of the underlying
common stock exceeds the exercise price for stock options or the purchase price
for the shares of common stock. Nonemployee options are accounted for under
Statement of Financial Accounting Standards (SFAS) No. 123.
Deferred stock-based compensation resulting from employee and nonemployee
option grants is amortized on an accelerated basis over the vesting period of
the individual options, generally four years, in accordance with Financial
Accounting Standards Board Interpretation No. 28.
(l) Comprehensive Loss
Other comprehensive loss recorded by the Company for the years ended
December 31, 1999 and 1998 was attributable to foreign currency translation
adjustments for the Company's U.K. subsidiary and unrealized gain from
investments. Tax effects and reclassification adjustments of comprehensive loss
are not material.
(m) Net Loss Per Share
Basic net loss per share is computed using the weighted-average number of
outstanding shares of common stock, excluding common stock subject to
repurchase. Diluted net loss per share is computed using the weighted-average
number of outstanding shares of common stock and, when dilutive, potential
common shares from options and warrants to purchase common stock and common
stock subject to repurchase using the treasury stock method, and from
convertible securities
73
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1999, 1998 and 1997
using the as-if converted basis. All potential common shares have been excluded
from the computation of diluted net loss per share for all periods presented
because the effect would have been antidilutive.
Diluted net loss per share does not include the effect of the following
antidilutive common equivalent shares:
Years Ended December 31,
--------------------------------
1999 1998 1997
---------- ---------- ----------
Stock options and warrants................... 3,771,116 824,630 3,576,632
Common stock subject to repurchase........... 9,101,206 8,926,146 5,189,824
Convertible preferred stock (as if converted
basis)...................................... -- 25,025,282 17,835,710
---------- ---------- ----------
12,872,322 34,776,058 26,602,166
========== ========== ==========
(n) Segment Reporting
The Company is organized in a single operating segment for purposes of
making operating decisions and assessing performance. The chief executive
officer, the chief operating decision maker, evaluates performance, makes
operating decisions, and allocates resources based on financial data consistent
with the presentation in the accompanying consolidated financial statements.
The Company's revenues derived from sources outside of the United States,
primarily in the United Kingdom, for the year ended December 31, 1999 were
approximately $1,385,000. Prior to 1999, the Company's revenues have been
earned primarily from customers in the United States. In addition, all
significant operations and assets are based in the United States. No customer
accounted for more than 10% of revenues for the years ended December 31, 1999,
1998 and 1997.
(o) Recent Accounting Pronouncements
In December 1998, the American Institute of Certified Public Accountants
issued SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition with
Respect to Certain Transactions. SOP 98-9 amends SOP 97-2 to require the entity
to recognize revenue for multiple element arrangements by means of the
"residual method" when: 1) there is vendor-specific evidence of the fair values
of all of the undelivered elements; 2) vendor-specific evidence of fair value
does not exist for one or more of the delivered elements; and 3) the revenue
recognition criteria of SOP 97-2 are satisfied. SOP 98-9 will be effective
beginning January 1, 2000. The Company believes the adoption of SOP 98-9 will
not have a material effect on its results of operations, financial position or
cash flows.
In June 1998, the FASB issued Statement of Financial Accounting Standard
(SFAS) No. 133, Accounting for Derivative and Hedging Activities. This standard
requires that an entity recognize all derivatives as either assets or
liabilities in the balance sheet and measures those instruments at fair value.
The type and use of the derivative, and whether it qualifies for hedge
accounting, will determine the treatment of gains or losses resulting from
changes in the derivative. The Company believes the adoption of SFAS No. 133
will not have a material effect on its results of operations, financial
position, or cash flows. The statement will be effective for the Company
beginning January 1, 2001.
74
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1999, 1998 and 1997
2. Business Combinations
On August 13, 1999, the Company issued 6,982,542 shares of its common stock
to the shareholders of Connectify in exchange for all of the outstanding
capital stock of Connectify. Prior to the consummation of the merger, 5,095,819
shares of the outstanding Kana perferred stock were converted to 10,191,638
shares of Kana common stock. As a result of the conversion, the Company created
a controlling class of common stock.
On December 3, 1999, in connection with the acquisition of Business
Evolution, Inc. ("BEI"), 1,935,206 shares of Kana common stock were issued or
reserved for issuance for all outstanding shares, warrants and options of BEI.
Pursuant to the terms of the merger, BEI's convertible preferred stock with a
book value of $4,976,000 converted into 474,332 shares of Kana common stock. On
the same date, in connection with the acquisition of netDialog, Inc.
("netDialog"), 1,244,062 shares of Kana common stock were issued or reserved
for issuance for all outstanding shares, warrants, convertible notes and
options of netDialog. Pursuant to the terms of the merger, netDialog's
redeemable preferred stock with a book value of $4,995,000 and convertible debt
with a book value of $4,800,000 converted into 773,942 shares of Kana's common
stock at the closing of the merger.
The mergers have been accounted for as poolings of interests, and,
accordingly, the Company's consolidated financial statements have been restated
for all periods prior to the merger to include the results of operations,
financial position, and cash flows of the acquired companies. No significant
adjustments were required to conform the accounting policies of the Company and
the acquired companies.
In connection with the merger with Connectify, Kana recorded a charge for
merger integration costs of $1.2 million consisting primarily of transaction
fees for attorneys and accountants of approximately $390,000 and employee
severance benefits and facility related costs of $780,000. As of December 31,
1999, Kana had $30,000 remaining in accrued acquisition related costs, which
Kana expects to pay by the first quarter of fiscal 2000.
In connection with the mergers with BEI and netDialog, the Company recorded
a nonrecurring charge for merger integration costs of $4.5 million, consisting
primarily of transaction fees for attorneys and accountants of approximately
$1.5 million, merger-related advertising and announcements of $1.7 million
incurred by December 31, 1999, charges for the elimination of duplicate
facilities of approximately $840,000 and severance costs and certain other
related costs of approximately $433,000. As of December 31, 1999, Kana had
$3,118,000 remaining in accrued acquisition related costs, which Kana expects
to pay during fiscal 2000.
75
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1999, 1998 and 1997
Certain results of operations data for the separate companies and the
combined amounts presented in the consolidated financial statements were as
follows (in thousands):
Nine Months Years Ended
Ended December 31,
September 30, -----------------
1999 1998 1997
------------- -------- -------
(Unaudited)
-----------
Revenues:
Kana......................................... $ 7,174 $ 2,049 $ --
Connectify(1)................................ -- -- --
BEI.......................................... 361 298 617
netDialog.................................... 72 -- --
-------- -------- -------
$ 7,607 $ 2,347 $ 617
======== ======== =======
Nine Months Years Ended
Ended December 31,
September 30, -----------------
1999 1998 1997
------------- -------- -------
(Unaudited)
-------------
Net Loss:
Kana......................................... $(16,828) $ (6,337) $(1,383)
Connectify(1)................................ (2,627) (1,041) --
BEI.......................................... (2,404) (1,360) 93
netDialog.................................... (6,288) (3,863) (262)
-------- -------- -------
$(28,147) $(12,601) $(1,553)
======== ======== =======
- --------
(1) Connectify figures included in the nine months ended 1999 are stated for
the six months ended June 30, 1999.
3. Financial Statements Detail
Cash equivalents consist of the following as of December 31, 1999 (in
thousands):
Unrealized Unrealized Fair
Cost Loss Gain Value
------- ---------- ---------- -------
Money market funds.................... $ 3,553 $-- $-- $ 3,553
Municipal securities.................. 4,014 -- -- 4,014
Commercial paper...................... 7,949 -- -- 7,949
Certificates of deposit............... 283 -- -- 283
------- ---- ---- -------
$15,799 $-- $-- $15,799
======= ==== ==== =======
Short-term investments consist of the following as of December 31, 1999 (in
thousands):
Unrealized Unrealized Fair
Cost Loss Gain Value
------- ---------- ---------- -------
Municipal securities.................. $18,450 $-- $-- $18,450
Commercial paper...................... 9,330 -- 23 9,307
Corporate bonds....................... 5,121 -- 3 5,118
Certificates of deposit............... 3,292 -- -- 3,292
------- ---- ---- -------
$36,193 $-- $ 26 $36,167
======= ==== ==== =======
76
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1999, 1998 and 1997
As of December 31, 1998, short-term investments consisted of certificates
of deposit.
Property and equipment, net consisted of the following (in thousands):
December 31,
--------------
1999 1998
------- ------
Computer equipment........................................... $ 6,688 $1,352
Furniture and fixtures....................................... 1,972 259
Leasehold improvements....................................... 1,531 241
------- ------
10,191 1,852
Less accumulated depreciation and amortization............... 1,831 379
------- ------
$ 8,360 $1,473
======= ======
Other income (expense), net consisted of the following (in thousands):
Year Ended
December 31,
-------------------
1999 1998 1997
------- ---- ----
Interest income........................................ $ 1,419 $324 $59
Interest expense....................................... (520) (53) (2)
Interest expense from warrants issued in connection
with bridge loans..................................... (1,559) (35) --
Other ................................................. (84) (9) --
------- ---- ---
$ (744) $227 $57
======= ==== ===
4. Notes Payable
The Company maintained a line of credit providing for borrowings of up to
$3,000,000 and $2,000,000 as of December 31, 1999 and 1998, respectively, to be
used for qualified equipment purchases or working capital needs. Borrowings
under the line of credit are collateralized by all of the Company's assets and
bear interest at the bank's prime rate (8.50% and 7.75% as of December 31, 1999
and 1998, respectively). Total borrowings as of December 31, 1999 and 1998 were
$1,187,000 and $720,000, respectively. The line of credit expires on March 2,
2000.
As of December 31, 1998, the Company had two commercial loans totalling
$1,077,000. These were paid as of December 31, 1999.
On May 18, 1999, the Company entered into two term loan obligations
totaling $685,000. The loans bear interest at a fixed rate of approximately
14.5% and mature in June 2002. The aggregate principal payments due under these
obligations are as follows (in thousands):
Year Ending December 31,
------------------------
2000.................................................................. $237
2001.................................................................. 263
2002.................................................................. 149
----
$649
====
77
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1999, 1998 and 1997
On October 22, 1999, the Company issued subordinated promissory notes in
the aggregate principal amount of $2,800,000 to entities affiliated with Bay
Partners, BankAmerica Ventures and 5S Ventures LLC. Such notes bear interest at
an annual rate of 10%. This debt was paid in January 2000.
5. Stockholders' Equity
(a) Reincorporation
In September 1999, Kana reincorporated into the State of Delaware, effected
a two for three reverse stock split of Kana's common stock and preferred stock
and increased Kana's authorized common stock to 100,000,000 shares. Kana's
common stock has a par value equal to $0.001 per share. The accompanying
financial statements have been retroactively restated to reflect the effect of
this reincorporation and reverse stock split.
(b) Initial Public Offering
On September 21, 1999, Kana consummated its initial public offering in
which it sold 7,590,000 shares of common stock, including 990,000 shares in
connection with the exercise of the underwriters' over-allotment option, at
$7.50 per share. Kana received approximately $51.0 million in cash, net of
underwriting discounts, commissions and other offering costs. The net proceeds
were predominately held in short-term municipal securities and commercial paper
at December 31, 1999.
(c) Convertible Preferred Stock
Since inception Kana issued 13,351,107 shares of convertible preferred
stock. During 1999, at the time of the Connectify merger, 11,581,379 shares
were converted to common stock and, 1,769,728 shares were converted to common
stock at the initial public offering at a ratio of 1 share of preferred stock
for 2 shares of common stock.
(d) Common Stock
The Company has issued to founders 10,994,398 shares of common stock, which
are subject to repurchase on termination of employment. Such repurchase rights
lapse in a series of equal monthly installments over a four year period ending
in June 2000 and May 2002. As of December 31, 1999, 2,401,412 shares were
subject to repurchase. During 1997, the Company repurchased a net of 833,332
shares from one founder at the original exercise price of $0.00005 per share.
Certain option holders have exercised options to purchase shares of
restricted common stock in exchange for five-year full recourse promissory
notes. The notes bear interest at 5.7% and expire on various dates through
2004. The Company has the right to repurchase all unvested shares purchased by
the notes at the original exercise price in the event of employee termination.
The number of shares subject to this repurchase right decreases as the shares
vest under the original option terms, generally over four years. As of December
31, 1999, there were 6,699,794 shares subject to repurchase. These options were
exercised at prices ranging from $0.02 to $4.50 with a weighted-average
exercise price of $3.29 per share.
78
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1999, 1998 and 1997
(e) Stock Compensation Plans
The Company's 1997 Stock Option/Stock Issuance Plan (the 1997 Plan)
provides for stock options to be granted to employees, independent contractors,
officers, and directors. Options are generally granted at an exercise price
equivalent to the estimated fair market value per share at the date of grant,
as determined by the Company's Board of Directors. All options are granted at
the discretion of the Company's Board of Directors and have a term not greater
than 10 years from the date of grant. Options are immediately exercisable and
generally vest over four years, 25% one year after the grant date and the
remainder at a rate of 1/36 per month thereafter. Connectify's 1998 Stock Plan,
netDialog's 1997 Stock Plan and BEI's 1999 Stock Plan have similar terms as
those of the 1997 Plan. Outstanding options under all these plans were assumed
in the merger.
On July 7, 1999, the Company's Board of Directors approved the 1999 Stock
Incentive Plan (the 1999 Plan), which will serve as the successor plan to the
1997 Plan. The Board of Directors also approved a 1999 Employee Stock Purchase
Plan (the 1999 ESPP). These plans became effective immediately prior to the
IPO. The common stock reserved for future issuances under these plans was 18%
of the shares of common stock outstanding immediately after the IPO.
Additionally, the share reserve in each plan will automatically increase on the
first trading day in January each year, beginning with calendar year 2000, in
an amount equal to the lesser of (i) the number of shares initially reserved
for such increase in each respective plan, (ii) 4.25% and 0.75% of the then
outstanding shares for the 1999 Plan and the 1999 ESPP, respectively, or (iii)
an amount determined by the Board of Directors.
The 1999 ESPP allows eligible employees to purchase common stock through
payroll deductions of up to 15% of an employee's compensation. The 1999 ESPP
currently has a two-year offering period that ends in October 2001. The
purchase price of the common stock will be equal to 85% of the fair market
value per share on the participant's entry date into the offering period, or,
if lower, 85% of fair market value per share on each semi-annual purchase date.
The 1999 ESPP qualifies as an employee stock purchase plan under Section 423 of
the Internal Revenue Code of 1986, as amended. No shares have been issued from
the 1999 ESPP as of December 31, 1999.
In December 1999, the board of directors approved the 1999 Special Stock
Option Plan and 1,000,000 shares of common stock were reserved for issuance
under this plan. The Special Stock Option Plan has similar terms as those of
the 1997 plan, except that options may be granted with an exercise price less
than, equal to, or greater than the fair market value of the option shares on
the grant date.
79
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1999, 1998 and 1997
A summary of stock option activity follows:
Shares Weighted
Available for Number Average
Grant of Shares Exercise Price
------------- ---------- --------------
Balances, December 31, 1996............ -- -- $ --
Additional shares authorized......... 7,434,222 -- --
Options granted...................... (3,503,810) 3,503,810 0.03
Options exercised.................... -- (106,666) 0.01
Options canceled..................... -- -- --
---------- ----------
Balances, December 31, 1997............ 3,930,412 3,397,144 0.03
Additional shares authorized......... 3,825,842 -- --
Options granted...................... (3,004,420) 3,004,420 0.13
Options exercised.................... -- (5,394,478) 0.04
Options canceled..................... 230,770 (230,770) 0.12
---------- ----------
Balances, December 31, 1998............ 4,982,604 776,316 0.19
Additional shares authorized......... 11,976,310 -- --
Options granted...................... (9,394,740) 9,394,740 6.24
Options exercised.................... -- (6,096,242) 1.01
Options canceled..................... 303,698 (303,698) 14.88
---------- ----------
Balances, December 31, 1999............ 7,867,872 3,771,116 $12.71
========== ==========
The following table summarizes information about fixed stock options
outstanding at December 31, 1999:
Options
Options Outstanding Exercisable
------------------------------ ------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Number of Contractual Exercise Number of Exercise
shares Life Price Shares Price
--------- ----------- -------- --------- --------
$0.02......................... 33,332 7.3 $ 0.02 33,332 $0.02
$0.03--$0.18.................. 104,796 9.2 $ 0.17 104,796 $0.17
$0.26--$0.34.................. 10,666 9.3 $ 0.34 10,666 $0.34
$1.81--$2.25.................. 590,048 9.6 $ 2.16 486,058 $2.23
$3.38--$4.50.................. 491,598 9.6 $ 4.45 491,598 $4.45
$7.50......................... 1,346,730 9.7 $ 7.50 60,000 $7.50
$15.00........................ 738,264 10.0 $15.00 -- --
$31.63--$40.57................ 304,400 9.8 $39.62 -- --
$73.50--$85.24................ 151,282 9.9 $73.64 -- --
--------- ---------
$0.02--$85.24................. 3,771,116 9.1 $12.71 1,186,450 $3.15
========= =========
The Company uses the intrinsic-value method in accounting for its stock-
based compensation plans. Accordingly, compensation cost has been recognized in
the financial statements for those options issued with exercise prices at less
than fair value at date of grant. With respect to the stock options granted
from inception through December 31, 1999, the Company recorded deferred stock-
based compensation of $97.0 million for the difference at the grant date
between the exercise price and the fair value of the common stock underlying
the options. Subsequent to the consummation of the BEI and netDialog
acquisitions, the Company granted 698,264 under the 1999 Special Stock Option
Plan options to certain employees hired from the acquired companies for an
exercise price
80
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1999, 1998 and 1997
below the fair market value of the common stock. These options were immediately
vested on the date of grant and 50% of the options can be exercised 15 months
after the grant date and the remaining 50% of the options can be exercised 30
months after the grant date, provided the individual remains an employee of the
Company. If the employee is terminated prior to these dates, the options can be
exercised after 9.5 years. The difference between the fair market value of the
underlying common stock and the exercise price of the options was recorded as
compensation expense in the fourth quarter of 1999 in the amount of
approximately $60,372,000.
Pursuant to SFAS No. 123, the Company is required to disclose the pro forma
effects on net loss and net loss per share data as if the Company had elected
to use the fair value approach to account for its employee stock-based
compensation plans. Had compensation costs been determined in accordance with
SFAS No. 123 for all of the Company's stock-based compensation plans, net loss
and basic and diluted net loss per share would not have been materially
impacted for the years ended December 31, 1997 and 1998. Had compensation cost
for the Company's plans been determined consistent with the fair value approach
enumerated in SFAS No. 123, the Company's net loss and net loss per share for
the year ended December 31, 1999 would have been as indicated below (in
thousands):
Year Ended
December 31,
1999
------------
Net loss:
As reported................................................... $(118,743)
Pro forma..................................................... $(124,603)
Basic and diluted net loss per share:
As reported................................................... $ (4.61)
Pro forma..................................................... $ (4.83)
The fair value of the Company's stock-based awards was estimated assuming
no expected dividends and the following weighted average assumptions:
Options ESPP
------------------------- --------------------------
Interest Interest
Rate Term Volatility Rate Term Volatility
-------- ----- ---------- -------- ------ ----------
1999--Post IPO.......... 5.45% 3 yrs 100% 5.14% 6 mths 100%
1999--Pre IPO........... 5.30% 3 -- -- -- --
1998.................... 5.15% 3 -- -- -- --
1997.................... 6.22% 3 -- -- -- --
The weighted average fair value of the employee stock purchase rights
granted under the 1999 ESPP during 1999 was $6.55. The weighted average fair
value and exercise price of the options granted in 1997, 1998, and 1999 are as
follows:
Weighted Average Weighted Average
Exercise Price Fair Value
------------------ ------------------
1999 1998 1997 1999 1998 1997
------ ----- ----- ------ ----- -----
Exercise price equals fair value on
grant date............................. $24.67 $ -- $ -- $15.94 $ -- $ --
Exercise price exceeds fair value on
grant date............................. 2.71 $0.13 $0.03 12.83 0.13 0.03
------ ----- ----- ------ ----- -----
Total options........................... $ 6.24 $0.13 $0.03 $13.39 $0.13 $0.03
====== ===== ===== ====== ===== =====
81
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1999, 1998 and 1997
(f) Warrants
In connection with the Series A preferred stock issuance, the Company
issued a warrant to two investors to purchase 89,744 shares of Series A
preferred stock with an exercise price of $0.20 per share. The warrants were
exercisable any time prior to April 7, 1998. The fair value of the warrants
computed using the Black-Scholes option pricing model on the date of grant was
not material. In lieu of paying cash upon exercise of the warrants in 1998, the
warrant holders surrendered 43,209 shares of Series A preferred stock back to
the Company.
In connection with the issuance of convertible notes payable of $300,000,
Connectify issued warrants to purchase 48,314 shares of common stock for $1.25
per share in August 1998. Such warrants were exercised at the time of the
initial public offering. Using the Black-Scholes pricing model, the Company
determined that the fair value of the warrants was $35,000 at the date of
grant. Accordingly, following the conversion of the convertible notes payable
in 1998, the Company recorded $35,000 of interest expense associated with the
warrants.
In connection with its convertible debt offerings, netDialog issued
warrants to purchase preferred stock. The warrants were initially exercisable
into an amount of preferred stock equal to 10% of the value of the convertible
debt outstanding. As long as the convertible debt remained outstanding, the
amount of preferred stock into which the warrants could be exercised increased
in tranches of 3.33% of the value of the debt every two or three months
following the initial grant date up to a maximum of an additional 10% of the
debt value.
The fair value of each tranche of warrants was measured at each date the
exercise terms of the warrants changed. The fair value of the warrants was
treated as a discount on the convertible debt and recorded as interest expense.
In connection with the acquisition of netDialog, all warrants issued under the
arrangement were converted into approximately 74,000 shares of Kana common
stock at an exercise price of $12.13 per share, of which, approximately 10,000
shares of Kana common stock were surrendered back to the Company in lieu of
paying cash. The full value of the warrants of approximately $1.6 million was
expensed during the year ended December 31, 1999.
6. Commitments and Contingencies
(a) Lease Obligations
On June 18, 1999, the Company entered into a lease agreement for a new
facility. Payments under this lease began in November 1999. The Company leases
its facilities under noncancelable operating leases with various expiration
dates through October 2006. In connection with its existing leases, the Company
entered into three letters for credit totalling $1,645,000, expiring in 2000
and 2001. The letters of credit are secured by certificates of deposit.
82
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1999, 1998 and 1997
Future minimum lease payments under noncancelable operating leases as of
December 31, 1999, were as follows (in thousands):
Operating
Year ending December 31, Leases
------------------------ ---------
2000............................................................. $ 2,587
2001............................................................. 2,487
2002............................................................. 2,554
2003............................................................. 2,196
2004............................................................. 2,189
Thereafter....................................................... 4,599
-------
$16,612
=======
Rent expense, net of sublease payments, was approximately $1,620,000,
$604,000 and $85,000 for the years ended December 31, 1999, 1998 and 1997,
respectively. Sublease payments were approximately $212,000, $140,000 and -0-
in the years ended December 31, 1999, 1998 and 1997, respectively. The
Company's sublease and the underlying lease arrangements expired in December
1999.
(b) Litigation
On October 8, 1999, Genesys Telecommunications Laboratories, Inc. (Genesys)
filed a complaint against Kana in the United States District Court for the
District of Delaware. Genesys alleges that Kana's Customer Messaging System 3.0
infringes upon one or more claims of a Genesys patent. Genesys is seeking
relief in the forms of an injunction, damages, punitive damages, attorneys'
fees, costs and pre- and post-judgment interest. The litigation is currently in
its early stages and Kana has not received material information or
documentation. Kana intends to fight this claim vigorously and does not expect
it to materially impact its results from operations. Kana is not currently a
party to any other material legal proceedings.
7. Income Taxes
The 1999, 1998 and 1997 income tax benefit differed from the amounts
computed by applying the U.S. federal income tax rate of 34% to pretax loss as
a result of the following (in thousands):
Years Ended December 31,
-----------------------------
1999 1998 1997
--------- -------- --------
Federal tax benefit at statutory rate............ $ (40,372) $ (4,284) $ (528)
Stock compensation expense....................... 27,222 432 --
Merger costs..................................... 726 -- --
Current year foreign losses, no tax benefit
recognized...................................... 486 -- --
Current year net operating losses and temporary
differences, no tax benefit recognized.......... 11,896 3,172 478
S corporation income, no tax effect.............. -- 123 12
Other permanent differences...................... 42 557 38
--------- -------- ------
Total tax expense.............................. $ -- $ -- $ --
========= ======== ======
83
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1999, 1998 and 1997
The types of temporary differences that give rise to significant portions
of the Company's deferred tax assets and liabilities are set out below (in
thousands):
Years Ended
December 31,
---------------
1999 1998
------- ------
Deferred tax assets:
Accruals and reserves........................................ $ 2,489 $1,065
Plant and equipment.......................................... -- 2
Net operating loss and credit carryforwards.................. 18,020 4,409
------- ------
Gross deferred tax assets...................................... 20,509 5,476
Valuation allowance............................................ (20,469) (5,459)
------- ------
Total deferred tax assets.................................. 40 17
Deferred tax liabilities:
Plant and equipment.......................................... (40) (17)
------- ------
Total deferred tax liabilities............................. (40) (17)
------- ------
Net deferred tax assets (liabilities)...................... $ -- $ --
======= ======
The net change in the valuation allowance for the year ended December 31,
1999 was an increase of approximately $15,010,000. Management believes that
sufficient uncertainty exists as to whether the deferred tax assets will be
realized, and accordingly, a valuation allowance is required.
As of December 31, 1999, the Company had net operating loss carryforwards
for federal and state income tax purposes of approximately $43,969,000 and
$34,621,000, respectively. The federal net operating loss carryforwards, if not
offset against future taxable income, will expire from 2011 through 2019. The
state net operating loss carryforwards, if not offset against future taxable
income, expire from 2003 through 2004.
As of December 31, 1999, unused research and development tax credits of
approximately $623,000 and $425,000 were available to reduce future federal and
state income taxes, respectively. Federal credit carryforwards expire from 2011
through 2019. The Company also has an unused California manufacturers'
investment credit of approximately $15,000. The California manufacturers'
investment credit, if not utilized, will expire in 2008.
The Tax Reform Act of 1986 imposes substantial restrictions on the
utilization of net operating losses and tax credits in the event of an
"ownership change" as defined. Some of the U.S. federal and California net
operating loss carryforwards are subject to limitation as a result of these
restrictions. The ownership change restrictions are not expected to impair the
Company's ability to utilize the affected carryforward items. If there should
be a subsequent ownership change, as defined, of the Company, its ability to
utilize its carryforwards could be reduced.
8. Subsequent Events
On January 10, 2000, the Company announced that its Board of Directors has
approved a two-for-one stock split of its common stock. The split will be
effected in the form of a stock dividend. Stockholders will receive one
additional share for each share held of record at the end of business
84
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1999, 1998 and 1997
on January 28, 2000. Shares resulting from the split were distributed by the
transfer agent in February 2000. The accompanying financial statements have
been retroactively restated to reflect the effect of this stock split.
On February 6, 2000, the Company, Pistol Acquisition Corp., a wholly-owned,
subsidiary of Kana, and Silknet Software, Inc. ("Silknet") entered into an
Agreement and Plan of Reorganization. As a result of the merger, each
outstanding share of Silknet common stock will be converted into the right to
acquire 1.66 shares of Kana common stock. In addition, all outstanding options
and warrants to purchase Silknet common stock will be assumed by Kana, adjusted
for the exchange ratio. On a fully diluted basis, Kana will issue (or reserve)
approximately 32.8 million shares of its common stock having a value of
approximately $4.2 billion based on Kana's closing stock price on February 4,
2000. The transaction will be accounted for as a purchase.
On February 11, 2000, the Company entered into an agreement to lease
approximately 62,500 square feet under a lease that expires in December 2010.
The annual base rent for this facility for the first year is approximately $2.4
million. The total lease obligation pursuant to this lease is $28.3 million.
85
INDEPENDENT AUDITORS REPORT ON SCHEDULE
The Board of Directors and Stockholders
Kana Communications, Inc.:
The audits referred to in our report included herein dated January 20, 2000,
except as to Note 8, which is as of February 11, 2000, included the
accompanying financial statement schedule as of December 31, 1999, and for each
of the years in the three-year period ended December 31, 1999. The financial
statement schedule is the responsibility of the Company's management. Our
responsibility is to express an opinion on the financial statement schedule
based on our audits. In our opinion, the accompanying financial statement
schedule, when considered in relation to the basic financial statements taken
as a whole, presents fairly in all material respects the information set forth
therein.
/s/ KPMG LLP
Mountain View, California
January 20, 2000
86
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
KANA COMMUNICATIONS, INC.
Balance at Charged Balance at
Beginning To End
of Period Revenues Deductions of Year
---------- -------- ---------- ----------
Allowance for Doubtful Accounts:
Year ended December 31, 1999....... $110 $156 $-- $366
Year ended December 31, 1998....... -- 110 -- 110
Year ended December 31, 1997....... -- -- -- --
87
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized, in the City of
Redwood City, State of California, on this 30th day of March, 2000.
Kana Communications, Inc.
/s/ Michael J. Mccloskey
By: _________________________________
Michael J. McCloskey
Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Michael J. McCloskey, Mark S. Gainey and
Joseph D. McCarthy, and each of them, as such person's true and lawful
attorneys-in-fact and agents, with full power of substitution and
resubstitution, for such person and in such person's name, place and stead, in
any and all capacities, to sign any and all amendments (including post-
effective amendments) to this annual report, and to file same, with all
exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents, and each of them, full power and authority to do and perform each and
every act and thing requisite and necessary to be done in connection therewith,
as fully to all intents and purposes as such person might or could do in
person, hereby ratifying and confirming all that said attorneys-in-fact and
agents, or any of them, or their or his or her substitutes, may lawfully do or
cause to be done by virtue thereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
annual report has been signed below by the following persons in the capacities
and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Michael J. McCloskey Chief Executive Officer and March 30, 2000
____________________________________ Director (Principal
Michael J. McCloskey Executive Officer)
/s/ Joseph D. McCarthy Vice President, Finance and March 30, 2000
____________________________________ Operations (Principal
Joseph D. McCarthy Financial and Accounting
Officer)
/s/ Mark S. Gainey President and Chairman of March 30, 2000
____________________________________ the Board of Directors
Mark S. Gainey
/s/ David M. Beirne Director March 30, 2000
____________________________________
David M. Beirne
/s/ Robert W. Frick Director March 30, 2000
____________________________________
Robert W. Frick
/s/ Eric A. Hahn Director March 30, 2000
____________________________________
Eric A. Hahn
88
Signature Title Date
--------- ----- ----
/s/ Dr. Charles A. Holloway Director March 30, 2000
____________________________________
Dr. Charles A. Holloway
/s/ Steven T. Jurvetson Director March 30, 2000
____________________________________
Steven T. Jurvetson
/s/ Ariel Poler Director March 30, 2000
____________________________________
Ariel Poler
89