SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter Ended September 30, 1999
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15
(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______________ to _______________
Commission File number 000-26287
Kana Communications, Inc.
(Exact Name of Registrant as Specified in Its Charter)
Delaware 77-0435679
- ------------------------------- ----------------------------
(State or Other Jurisdiction of (I.R.S.
Incorporation or Organization) Employer Identification No.)
87 Encina Avenue
Palo Alto, California 94301
---------------------------------------
(Address of Principal Executive Offices)
Registrant's Telephone Number, Including Area Code: (650) 325-9850
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 No X
------- -------
On September 30, 1999, approximately 28,866,000 shares of the Registrant's
Common Stock, $0.001 par value, were outstanding.
Kana Communications, Inc.
Form 10-Q
Quarter Ended September 30, 1999
Index
Part I: Financial Information
Item 1: Financial Statements
Unaudited Condensed Consolidated Balance Sheets at 3
September 30, 1999 and December 31, 1998
Unaudited Condensed Consolidated Statements of 4
Operations for the three and nine months
ended September 30, 1999 and 1998
Unaudited Condensed Consolidated Statements of 5
Cash Flows for the nine months ended
September 30, 1999 and 1998
Notes to the Unaudited Condensed Consolidated 6
Financial Statements
Item 2: Management's Discussion and Analysis of 10
Financial Condition and Results of Operations
Item 3: Quantitative and Qualitative Disclosures 31
About Market Risk
Part II: Other Information
Item 1. Legal Proceedings 32
Item 2. Changes in Securities and Use of Proceeds 32
Item 4. Submission of Matters to a Vote of Security Holders 33
Item 6. Exhibits and Reports on Form 8-K 33
Signatures
Exhibit Index
2
PART I: FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
KANA COMMUNICATIONS, INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
September 30, December 31,
1999 1998
---- ----
ASSETS
Current assets:
Cash and cash equivalents $ 57,200 $ 12,955
Short-term investments 7,427 160
Accounts receivable, net 2,268 817
Prepaid expenses and other current assets 1,606 141
--------- --------
Total current assets 68,501 14,073
Property and equipment, net 3,942 1,041
Other assets 150 161
--------- --------
Total assets $ 72,593 $ 15,275
========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of notes payable $ 1,236 $ 360
Accounts payable 1,389 330
Accrued payroll and related expenses 713 354
Other accrued liabilities 3,618 355
Deferred revenue 3,709 450
--------- ---------
Total current liabilities 10,665 1,849
Notes payable, less current portion 652 360
--------- ---------
Total liabilities 11,317 2,209
--------- ---------
Stockholders' equity:
Convertible preferred stock -- 13
Common stock 29 9
Additional paid-in capital 111,867 23,760
Deferred stock-based compensation (16,127) (1,795)
Notes receivable from stockholders (6,246) (155)
Accumulated other comprehensive loss (31) (5)
Accumulated deficit (28,216) (8,761)
--------- ---------
Total stockholders' equity 61,276 13,066
--------- ---------
Total liabilities and
stockholders' equity $ 72,593 $ 15,275
========= ========
See accompanying notes to unaudited condensed consolidated financial statements.
3
KANA COMMUNICATIONS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
Three Months Ended Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
---- ---- ---- ----
Revenues:
License $ 2,647 $ 478 $ 5,442 $ 1,093
Service 949 97 1,732 138
-------- ------- -------- -------
Total revenues 3,596 575 7,174 1,231
-------- ------- -------- -------
Cost of revenues:
License 52 17 124 33
Service 1,673 189 2,814 246
-------- ------- -------- -------
Total cost of revenues 1,725 206 2,938 279
-------- ------- -------- -------
Gross profit 1,871 369 4,236 952
-------- ------- -------- -------
Operating expenses:
Sales and marketing 4,245 1,159 9,202 2,580
Research and development 2,347 774 5,667 1,658
General and administrative 782 308 1,768 622
Amortization of deferred
stock-based compensation 3,267 352 6,330 782
Acquisition related costs 910 -- 910 --
-------- ------- -------- -------
Total operating expenses 11,551 2,593 23,877 5,642
-------- ------- -------- -------
Operating loss (9,680) (2,224) (19,641) (4,690)
Other income, net 79 38 186 79
-------- ------- -------- -------
Net loss $ (9,601) $(2,186) $(19,455) $(4,611)
======== ======= ======== =======
Basic and diluted net loss
per share $ (0.74) $ (0.92) $ (2.53) $ (2.34)
======== ======= ======== =======
Shares used in computing basic
and diluted net loss per share 12,940 2,385 7,689 1,973
======== ======= ======== =======
See accompanying notes to unaudited condensed consolidated financial statements.
4
KANA COMMUNICATIONS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Nine Months Ended
September 30,
1999 1998
---- ----
Cash flows from operating activities:
Net loss $(19,455) $ (4,611)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation 538 150
Loss on disposal of assets 105 --
Amortization of stock-based compensation 6,330 782
Changes in assets and liabilities:
Accounts receivable (1,450) (410)
Prepaid expenses and other assets (1,454) (256)
Accounts payable and accrued liabilities 4,635 287
Deferred revenue 3,258 271
-------- --------
Net cash used in operating activities (7,493) (3,787)
-------- --------
Cash flows from investing activities:
Purchases of short-term investments (6,479) --
Property and equipment purchases (4,329) (759)
-------- --------
Net cash used in investing activities (10,808) (759)
-------- --------
Cash flows from financing activities:
Payments on notes payable (521) 27
Proceeds from notes payable 1,685 467
Proceeds from convertible notes payable 50 265
Proceeds from issuance of common stock
and warrants 51,161 77
Proceeds from issuance of preferred stock 10,197 15,308
-------- --------
Net cash provided in financing activities 62,572 16,144
-------- --------
Effect of exchange rate changes on cash and
cash equivalents (26) --
-------- --------
Net increase in cash and cash equivalents 44,245 11,598
Cash and cash equivalents at beginning of period 12,955 3,303
-------- --------
Cash and cash equivalents at end of period $ 57,200 $ 14,901
======== ========
Supplemental disclosure of cash flow information:
Cash paid during period for interest $ 59 $ 11
======== ========
See accompanying notes to unaudited condensed consolidated financial statements.
5
KANA COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Basis of Presentation
The unaudited condensed consolidated financial statements have been prepared
by Kana Communications, Inc. ("Kana") and reflect all adjustments (all of which
are normal and recurring in nature) that, in the opinion of management, are
necessary for fair presentation of the interim periods presented. The results of
operations for the interim periods presented are not necessarily indicative of
the results to be expected for any subsequent quarter or for the entire year
ending December 31, 1999. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted under the Securities and
Exchange Commission's rules and regulations. These unaudited condensed
consolidated financial statements and notes included herein should be read in
conjunction with Kana's audited supplemental consolidated financial statements
and notes for the year ended December 31, 1998, included in Kana's Registration
Statement on Form S-1 declared effective by the Securities and Exchange
Commission on September 21, 1999.
Note 2. Business Combination
On August 13, 1999, Kana issued approximately 3,491,271 shares of its common
stock to the stockholders of Connectify, Inc. ("Connectify") in exchange for all
of the outstanding capital stock of Connectify and reserved 208,345 shares of
common stock for issuance upon the exercise of Connectify options and warrants
we assumed in connection with the merger. The merger has been accounted for as a
pooling of interests, and, accordingly, Kana'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 Connectify. No significant
adjustments were required to conform the accounting policies of Kana and
Connectify. In connection with the merger, Kana converted 11,581,379 shares of
its convertible preferred stock to Common Stock.
Connectify had not reported revenues in any of the periods presented. Net
losses for the individual entities as previously reported were as follows (in
thousands):
Three Months Ended Nine Months Ended Six Months Ended
September 30, 1998 September 30, 1998 June 30, 1999
------------------ ------------------ -------------
Kana $(1,942) $(4,293) $(7,227)
Connectify (244) (318) (2,627)
------- ------- -------
$(2,186) $(4,611) $(9,854)
In connection with the merger with Connectify, Kana recorded a charge for
merger integration costs of $910,000, consisting primarily of transaction fees
for attorneys and accountants of approximately $579,000 and employee severance
benefits and facility related costs of $331,000 during the third quarter of
1999. As of September 30, 1999, Kana had $416,000 remaining in accrued merger
expenses, which Kana expects to pay by the end of the year.
Note 3. Net Loss Per Share
Basic net loss per share is computed using the weighted-average number of
outstanding shares of common stock, excluding common stock subject to
repurchase. Diluted net loss per share is computed using the weighted-average
number of outstanding shares of common stock and, when dilutive, potential
common shares from options and warrants to purchase common stock and common
stock subject to repurchase using the treasury stock method, and from
convertible securities using the as-if converted basis.
6
All convertible preferred stock, warrants, outstanding stock options and
shares subject to repurchase by Kana have been excluded from the calculation of
diluted net loss per common share because all such securities are anti-dilutive
for all periods presented. The total numbers of shares excluded from the
calculation of diluted loss per share are as follows (in thousands):
Nine Months Ended
September 30,
1999 1998
---- ----
Stock options and warrants 708 233
Common stock subject to repurchase 11,380 5,292
Convertible preferred stock -- 14,123
------ ------
27,050 19,648
The weighted average exercise price of stock options outstanding was $6.01
and $0.07 as of September 30, 1999 and 1998, respectively.
Note 4. Comprehensive Loss
The components of comprehensive loss for the three and nine months ended
September 30, 1999 and 1998 were as follows (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
---- ---- ---- ----
Net loss $(9,601) $(2,186) $(19,455) $(4,611)
Foreign currency translation
adjustments 6 -- (26) --
------- ------- -------- -------
$(9,594) $(2,186) $(19,481) $(4,611)
Tax effects of foreign currency translation adjustments are not considered
material.
Note 5: Stockholders' Equity
On July 8, 1999, Kana issued 838,466 shares of Series D Convertible
Preferred Stock at a purchase price of $12.17 per share for total proceeds of
approximately $10.2 million. Each outstanding share was convertible into common
stock on a one-for-one basis.
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.
On September 27, 1999 Kana consummated its initial public offering in which
it sold 3,795,000 shares of Common Stock, including 495,000 shares in connection
with the exercise of the underwriters' over-allotment option, at $15 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
September 30, 1999. Upon the closing of the offering, all of Kana's remaining
preferred stock, par value $0.001 per share, automatically converted into an
aggregate of 1,769,728 shares of Common Stock.
7
Note 6. Deferred Stock-Based Compensation
Kana uses the intrinsic value method of accounting for its employee
stock-based compensation plans. Accordingly, no compensation cost is recognized
for any of its stock options when the exercise price of each option equals or
exceeds the fair value of the underlying common stock as of the grant date for
each stock option. With respect to the stock options granted since inception
through September 30, 1999, Kana recorded deferred stock-based compensation of
$23,825,000 for the difference at the grant date between the exercise price and
the fair value of the common stock underlying the options. We recorded
approximately $6.0 million of deferred stock-based compensation for the three
months ended September 30, 1999 and approximately $20.7 million of deferred
stock-based compensation for the nine months ended September 30, 1999. This
amount is being amortized in accordance with Financial Accounting Standards
Board (FASB) Interpretation No. 28 over the vesting period of the individual
options, generally 4 years.
Note 7. Legal Proceedings
On October 8, 1999, Genesys Telecommunications Laboratories, Inc.
("Genesys") filed a complaint against Kana in the United States District Court
for the District of Delaware. Genesys alleges that Kana's Customer Messaging
System 3.0 infringes 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-judgement interest. The litigation is currently in
its early stages and we have not received information or documentation other
than the filed complaint and therefore cannot fully evaluate the claim. We
intend to fight this claim vigorously and do not expect it to materially impact
the results from operations. Kana is not currently a party to any other material
legal proceedings.
Note 8. Segment Information
Kana's chief operating decision maker reviews financial information
presented on a consolidated basis, accompanied by disaggregated information
about revenues by geographic region for purposes of making operating decisions
and assessing financial performance. Accordingly, Kana considers itself to be in
a single industry segment, specifically the license, implementation and support
of its software applications. Kana's long-lived assets are primarily in the
United States. In December 1998, we established our European office. There was
no international revenue in 1998. Geographic information on revenue for the
three months and nine months ended September 30, 1999 are as follows (in
thousands):
Three Months Ended Nine Months Ended
September 30,1999 September 30,1999
----------------- -----------------
United States $ 3,187 $ 6,420
Europe 409 754
------- -------
$ 3,596 $ 7,174
During the three months ended September 30, 1998, three customers each
represented more than 10% of total revenues. During the three months ended
September 30, 1999 and nine months ended September 30, 1998 and 1999, no
customer accounted for more than 10% of total revenues.
8
Note 9. Recent Pronouncements
Statement of Financial Accounting Standards (SFAS) No. 133, ACCOUNTING FOR
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITY establishes accounting methods for
derivative financial instruments and hedging activities related to those
instruments, as well as other hedging activities. Because we do not currently
hold any derivative instruments and do not engage in hedging activities, we
expect that the adoption of SFAS No. 133 will not have a material impact on our
financial position or results of operations. We will adopt SFAS No. 133
effective during 2000.
The American Institute of Certified Public Accountants, or AICPA, issued
Statement of Position (SOP), No. 98-9, MODIFICATION OF SOP NO. 97-2, SOFTWARE
REVENUE RECOGNITION WITH RESPECT TO CERTAIN TRANSACTIONS. SOP No. 98-9 amends
SOP No. 97-2 to require an entity to recognize revenue for multiple element
arrangements by means of the "residual method" when:
there is vendor-specific evidence of the fair values of all of
the undelivered elements that are not accounted for by means of
long-term contract accounting;
vendor specific evidence of fair value does not exist for one
or more of the delivered elements; and
all revenue recognition criteria of SOP No. 97-2, other than the
requirement for vendor-specific evidence of the fair value of
each delivered element, are satisfied.
SOP No. 98-9 will be effective for our year beginning January 1, 2000. We
do not expect any material effect from the adoption of SOP No. 98-9.
9
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Except for historical information contained or incorporated by reference in this
section, the following discussion contains forward-looking statements that
involve risks and uncertainties. Kana's actual results could differ
significantly from those discussed herein. Factors that could cause or
contribute to these differences include, but are not limited to, those discussed
herein with this quarterly report on Form 10-Q and Registration statement on
Form S-1 filed with the Securities and Exchange Commission. Any forward-looking
statements speak only as of the date such statements are made.
OVERVIEW
We were incorporated in July 1996 but had no significant operations until
1997. Through January 1998, we were a development stage enterprise and had no
revenues. Our operating activities during this period related primarily to
conducting research, developing our initial products, raising capital and
building our sales and marketing organization. In February 1998, we released the
first commercially available version of the Kana platform. To date, we have
derived substantially all of our revenues from licensing our software and
related services. To date, we have sold our products worldwide primarily through
our direct sales force.
On August 13, 1999, we closed a merger with Connectify, Inc. pursuant to
which Connectify became our wholly owned subsidiary. Connectify develops,
markets and supports electronic direct marketing software for e-Businesses.
Connectify's software enables e-Businesses to profile and target potential and
existing customers and then deliver and track personalized e-mails to their
customers. By using electronic direct marketing software in this way,
e-Businesses can build customer loyalty, increase the probability of repeat
transactions and reduce customer attrition. Connectify was based in San Mateo,
California, and had 31 employees as of the merger.
In connection with the merger, we issued approximately 3,491,000 shares of
our common stock in exchange for all outstanding shares of Connectify capital
stock and reserved 208,345 shares of common stock for issuance upon the exercise
of Connectify options and warrants we assumed in connection with the merger. The
merger was accounted for as a pooling of interests.
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, 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 our products, the cost of product
documentation, the cost of the media used to deliver our products and shipping
costs. Cost of service revenue consists primarily of personnel-related expenses,
travel costs, equipment costs and overhead associated with delivering
professional services to our customers.
Our operating expenses are classified into three general categories: sales
and marketing, research and development, and general and administrative. We
classify all charges to these operating expense categories based on the nature
of the expenditures. Although each category includes expenses that are unique to
10
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 $23,825,000
through September 30, 1999. This amount represents the total difference between
the exercise prices of stock options and the deemed fair value of the underlying
common stock for accounting purposes on the date these stock options were
granted. This amount is included as a component of stockholders' equity and is
being amortized on an accelerated basis by charges to operations over the
vesting period of the options, consistent with the method described in Financial
Accounting Standards Board (FASB) Interpretation No. 28. We recorded
approximately $6.0 million of deferred stock-based compensation for the three
months ended September 30, 1999 and approximately $20.7 million of deferred
stock-based compensation for the nine months ended September 30, 1999. The
amortization of deferred stock-based compensation is classified as a separate
component of operating expenses in our consolidated statement of operations.
Since the beginning of 1997, we have incurred substantial costs to develop
our products and to recruit, train and compensate personnel for our engineering,
sales, marketing, client services and administration departments. As a result,
we have incurred substantial losses since inception and, for the nine months
ended September 30, 1999, incurred a net loss of $19.6 million. As of September
30, 1999, we had an accumulated deficit of $28.2 million. We believe our future
success is contingent upon providing superior customer service, increasing our
customer base and developing our products. We intend to invest heavily in sales,
marketing, research and development, client services and infrastructure to
support these activities. We therefore expect to continue to incur substantial
operating losses for the foreseeable future.
We had 212 full-time employees as of September 30, 1999 and intend to hire a
significant number of employees in the future. This expansion places significant
demands on our management and operational resources. To manage this rapid
growth, we must invest in and implement scaleable operational systems,
procedures and controls. We expect future expansion to continue to challenge our
ability to hire, train, manage and retain employees.
We believe that period-to-period comparisons of our historical operating
results are not necessarily meaningful and should not be relied upon as being
indicative of future performance. Our prospects must be considered in light of
the risks, expenses and difficulties frequently experienced by companies in
early stages of development, particularly companies in new and rapidly evolving
markets like ours. Although we have experienced significant revenue growth
recently, this trend may not continue. Furthermore, we may not achieve or
maintain profitability in the future.
11
RESULTS OF OPERATIONS
The following table sets forth the results of operations for the three and
nine months ended September 30, 1998 and 1999 expressed as a percentage of total
revenues.
Three Months Ended Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
---- ---- ---- ----
Revenues:
License 73.6% 83.1% 75.9% 88.8%
Service 26.4 16.9 24.1 11.2
---- ---- ---- ----
Total revenues 100.0 100.0 100.0 100.0
----- ----- ----- -----
Cost of revenues:
License 1.5 3.0 1.8 2.7
Service 46.5 32.8 39.2 20.0
---- ---- ---- ----
Total cost of revenues 48.0 35.8 41.0 22.7
---- ---- ---- ----
Gross profit 52.0 64.2 59.0 77.3
---- ---- ---- ----
Operating expenses:
Sales and marketing 118.0 201.6 128.3 209.6
Research and development 65.3 134.6 79.0 134.7
General and administrative 21.7 53.6 24.6 50.5
Amortization of deferred
stock-based compensation 90.8 61.2 88.2 63.5
Acquisition related costs 25.3 -- 12.7 --
----- ----- ----- -----
Total operating expenses 321.1 451.0 332.8 458.3
----- ----- ----- -----
Operating loss (269.1) (386.8) (273.8) (381.0)
Other income, net 2.2 6.6 2.6 6.4
------- ------- ------- -------
Net loss (266.9)% (380.2)% (271.2)% (374.6)%
======= ======= ======= =======
COMPARISON OF THE THREE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
Revenues
Total revenues increased to $3.6 million for the three months ended
September 30, 1999 from $575,000 for the three months ended September 30, 1998.
License revenue increased to $2.6 million for the three months ended September
30, 1999 from $478,000 for the three months ended September 30, 1998. This
increase in license revenue was due primarily to increased market acceptance of
our products, expansion of our product line and increased sales generated by our
expanded sales force. Total sales personnel increased to 59 people at September
30, 1999 from 11 people at September 30, 1998. License revenue represented 73.6%
of total revenues for the three months ended September 30, 1999 and 83.1% of
total revenues for the three months ended September 30, 1998.
Service revenue increased to $949,000 for the three months ended September
30, 1999 from $97,000 for the three months ended September 30, 1998. This
increase in service revenue was due primarily to the increased licensing
activity described above, resulting in increased revenue from customer
implementations, customization projects, maintenance contracts and hosted
service. Service revenue represented 26.4% of total revenues for the three
months ended September 30, 1999 and 16.9% of total revenues for the three months
ended September 30, 1998.
12
Revenue from international sales for the three months ended September 30,
1999 was 11.4% of total revenues. There was no international revenue for the
three months ended September 30, 1998.
Cost of Revenues
Cost of license revenue includes third party software royalties, product
packaging, documentation and production. Cost of license revenue increased to
$52,000 for the three months ended September 30, 1999 from $17,000 for the three
months ended September 30, 1998. The absolute dollar increase in the cost of
license revenue was due primarily to royalties. As a percentage of license
revenue, cost of license revenue was 2% for the three months ended September 30,
1999 and 3.6% for the three months ended September 30, 1998. The decrease in
cost of license revenue as a percent of license revenue was due primarily to the
increase in license revenue over the period. We anticipate that the cost of
license revenue will increase in absolute dollars as we license additional
technologies, but will decrease as a percentage of license revenue.
Cost of service revenue consists primarily of salaries and related expenses
for our customer support, implementations and training services organization and
allocation of facility costs and system costs incurred in providing customer
support. Cost of service revenue increased to $1.7 million for the three months
ended September 30, 1999 from $189,000 for the three months ended September 30,
1998. The growth in cost of service revenue was attributable primarily to an
increase in personnel and related costs associated with an increased number of
customers and recruiting fees. Cost of service revenue as a percent of service
revenue was 176% for the three months ended September 30, 1999 and 195% for the
three months ended September 30, 1998. The decrease in cost of service revenue
as a percent of service revenue was due primarily to the increase in service
revenue over the period. We anticipate that cost of service revenue will
increase in absolute dollars, but will decrease as a percentage of service
revenue.
Operating Expenses
Sales and Marketing. Sales and marketing expenses consist primarily of
compensation and related costs for sales and marketing personnel and promotional
expenditures, including public relations, advertising, trade shows, and
marketing collateral materials. Sales and marketing expenses increased to $4.2
million for the three months ended September 30, 1999 from $1.2 million for the
three months ended September 30, 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 advertising and promotional activities. As a percentage of total
revenues, sales and marketing expenses were 118% for the three months ended
September 30, 1999 and 201.6% for the three months ended September 30, 1998.
This decrease in sales and marketing expense as a percent of total revenues was
due primarily to the increase in total revenues over the period. We expect to
continue to increase our marketing and promotional efforts and hire additional
sales personnel. We further expect our sales and marketing expenses to increase
due to the Connectify merger. Accordingly, we anticipate that sales and
marketing expenses will increase in absolute dollars, but may decrease as a
percentage of total revenues from period to period.
Research and Development. Research and development expenses consist
primarily of compensation and related costs for engineering employees and
contractors responsible for new product development and for enhancement of
existing products and quality assurance activities. Research and development
expenses increased to $2.3 million for the three months ended September 30, 1999
from $774,000 for the three months ended September 30, 1998. This increase was
attributable primarily to the addition of personnel associated with product
development and related benefits, consulting and recruiting costs. As a
percentage of total revenues, research and development expenses were 65.3% for
the three months ended September 30, 1999 and 134.6% for the three months ended
13
September 30, 1998. This decrease in research and development expense as a
percent of total revenues was due primarily to the increase in total revenues
over the period. We expect to continue to make substantial investments in
research and development and anticipate that research and development expenses
will continue to increase in absolute dollars, but may decrease as a percentage
of total revenues from period to period. We further expect our research and
development expenses to increase due to the Connectify merger.
General and Administrative. General and administrative expenses consist
primarily of compensation and related costs for administrative personnel, legal,
accounting and other general corporate expenses. General and administrative
expenses increased to $782,000 for the three months ended September 30, 1999
from $308,000 for the three months ended September 30, 1998, due primarily to
increased personnel, legal and professional fees, facilities and other related
costs necessary to support our growth. As a percentage of total revenues,
general and administrative expenses were 21.7% for the three months ended
September 30, 1999 and 53.6% for the three months ended September 30, 1998. This
decrease in general and administrative expenses as a percent of total revenues
was due primarily to the increase in total revenues over the period. We expect
that general and administrative expenses will increase in absolute dollars as we
add personnel and incur additional costs related to the anticipated growth of
our business and operation as a public company. However, we expect that these
expenses may decrease as a percentage of total revenues from period to period.
Other Income, Net
Other income, net consists primarily of interest earned on cash and short-
term investments, offset by interest expense related to a note. Other income,
net was $79,000 for the three months ended September 30, 1999 and $38,000
for the three months ended September 30, 1998. The increase in other income, net
was due primarily to increased interest income earned on higher cash balances
offset by interest expense.
Provision for Income Taxes
We have incurred operating losses for all periods from inception through
September 30, 1999, and therefore have not recorded a provision for income
taxes. We have recorded a valuation allowance for the full amount of our gross
deferred tax assets, as the future realization of the tax benefit is not
currently likely.
Net Loss
Our net loss increased to $9.6 million for the three months ended September
30, 1999 from $2.2 million for the three months ended September 30, 1998. We
have experienced substantial increases in our expenditures since our inception
consistent with growth in our operations and personnel, and we anticipate that
our expenditures will continue to increase in the future. Although our revenue
has grown in recent quarters, we cannot be certain that we can sustain this
growth or that we will generate sufficient revenue for profitability.
COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
Revenues
Total revenues increased to $7.2 million for the nine months ended September
30, 1999 from $1.2 million for the nine months ended September 30, 1998. License
revenue increased to $5.4 million for the nine months ended September 30, 1999
from $1.1 million for the nine months ended September 30, 1998. This increase in
license revenue was due primarily to increased market acceptance of our
products, expansion of our product line and increased sales generated by our
expanded sales force. License revenue represented 75.9% of total revenues for
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the nine months ended September 30, 1999 and 88.8% of total revenues for the
nine months ended September 30, 1998.
Service revenue increased to $1.7 million for the nine months ended
September 30, 1999 from $138,000 for the nine months ended September 30, 1998.
This increase in service revenue was due primarily to the increased licensing
activity described above, resulting in increased revenue from customer
implementations, customization projects, maintenance contracts and hosted
service. Service revenue represented 24.1% of total revenues for the nine months
ended September 30, 1999 and 11.2% of total revenues for the nine months ended
September 30, 1998.
Revenue from international sales for the nine months ended September 30,
1999 was 10.5% of total revenues. There were no international sales for the nine
months ended September 30, 1998.
Cost of Revenues
Cost of license revenue includes third party software royalties, product
packaging, documentation and production. Cost of license revenue increased to
$124,000 for the nine months ended September 30, 1999 from $33,000 for the nine
months ended September 30, 1998. As a percentage of license revenue, cost of
license revenue was 2.3% for the nine months ended September 30, 1999 and 3% for
the nine months ended September 30, 1998. The absolute dollar increase in the
cost of license revenue was due primarily to royalties, product documentation
costs and delivery costs for shipments to customers.
Cost of service revenue consists primarily of salaries and related expenses
for our customer support, implementations and training services organization,
allocation of facility costs and system costs incurred in providing customer
support. Cost of service revenue increased to $2.8 million for the nine months
ended September 30, 1999 from $246,000 for the nine months ended September 30,
1998. The growth in cost of service revenue was attributable primarily to an
increase in personnel dedicated to support our growing number of customers and
related facility expenses and in system costs. Cost of service revenue as a
percent of service revenue was 162% for the nine months ended September 30, 1999
and 178% for the nine months ended September 30, 1998.
Operating Expenses
Sales and Marketing. Sales and marketing expenses consist primarily of
compensation and related costs for sales and marketing personnel and promotional
expenditures, including public relations, advertising, trade shows, and
marketing collateral materials. Sales and marketing expenses increased to $9.2
million for the nine months ended September 30, 1999 from $2.6 million for the
nine months ended September 30, 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. As a percentage of total revenues, sales and
marketing expenses were 128.3% for the nine months ended September 30, 1999 and
209.6% for the nine months ended September 30, 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.
Research and Development. Research and development expenses consist
primarily of compensation and related costs for engineering employees and
contractors responsible for new product development and for enhancement of
existing products and quality assurance activities. Research and development
expenses increased to $5.7 million for the nine months ended September 30, 1999
from $1.7 million for the nine months ended September 30, 1998. This increase
was attributable primarily to the addition of personnel associated with product
development and related benefits, consulting and recruiting costs. As a
15
percentage of total revenues, research and development expenses were 79% for the
nine months ended September 30, 1999 and 134.7% for the nine months ended
September 30, 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.
General and Administrative. General and administrative expenses consist
primarily of compensation and related costs for administrative personnel, legal,
accounting and other general corporate expenses. General and administrative
expenses increased to $1.8 million for the nine months ended September 30, 1999
from $622,000 for the nine months ended September 30, 1998, due primarily to
increased personnel, consultants and facilities expenses necessary to support
our growth. As a percentage of total revenues, general and administrative
expenses were 24.6% for the nine months ended September 30, 1999 and 50.5% for
the nine months ended September 30, 1998. This decrease in general and
administrative expenses as a percent of total revenues was due primarily to the
increase in total revenues over the period.
Other Income, Net
Other income, net consists primarily of interest earned on cash and short-
term investments, offset by interest expense related to a note payable and loss
from disposition of assets. Other income, net was $186,000 for the nine months
ended September 30, 1999 and $79,000 for the nine months ended September 30,
1998. The increase in other income, net was due primarily to increased interest
income earned on higher cash balances offset by a loss from disposition of
assets and interest expense.
Provision for Income Taxes
We have incurred operating losses for all periods from inception through
September 30, 1999, and therefore have not recorded a provision for income
taxes. We have recorded a valuation allowance for the full amount of our gross
deferred tax assets, as the future realization of the tax benefit is not
currently likely.
Net Loss
Our net loss increased to $19.5 million for the nine months ended September
30, 1999 from $4.6 million for the nine months ended September 30, 1998. We have
experienced substantial increases in our expenditures since our inception
consistent with growth in our operations and personnel, and we anticipate that
our expenditures will continue to increase in the future. Although our revenue
has grown in recent quarters, we cannot be certain that we can sustain this
growth or that we will generate sufficient revenue for profitability.
LIQUIDITY AND CAPITAL RESOURCES
In September 1999, we completed the initial public offering of our common
stock and realized net proceeds from the offering of approximately $51.0
million. Prior to the offering, we had financed our operations primarily from
private sales of convertible preferred stock totaling $26.6 million and, to a
lesser extent, from bank borrowings and lease financing.
Our operating activities used $7.5 million of cash for the nine months ended
September 30, 1999, which is primarily attributable to net losses experienced
during this period as we invested in the development of our products, expanded
our sales force and expanded our infrastructure to support our growth. Our
operating activities used $3.8 million of cash for the nine months ended
September 30, 1998, which is primarily attributable to net losses experienced
during this period, increases in accounts receivable and prepaid assets offset
by amortization of stock-based compensation.
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Our investing activities, consisting of purchases of computer equipment,
furniture, fixtures and leasehold improvements to support our growing number of
employees and net purchases of short-term investments, used $10.8 million of
cash for the nine months ended September 30, 1999. Our investing activities used
$759,000 of cash for the nine months ended September 30, 1998, which is
primarily due to purchases of computer equipment, furniture, fixtures and
leasehold improvements.
Our financing activities generated $62.6 million in cash for the nine months
ended September 30, 1999, primarily from the net proceeds of our initial public
offering, net proceeds from private sales of preferred stock, and to a lesser
extent, from bank borrowings. Our financing activities generated $16.1 million
in cash for the nine months ended September 30, 1998, primarily from the net
proceeds from private sales of preferred stock.
At September 30, 1999, we had cash and cash equivalents aggregating $57.2
million and short-term investments totaling $7.4 million. Our short-term
investments secure two letters of credit issued in connection with the lease of
our corporate offices. We have two lines of credit totaling $4.0 million, which
are secured by all of our assets, bear interest at the bank's prime rate (8.25%
as of September 30, 1999), and expire on March 2, 2000 and June 30, 2000. Our
total bank debt was $1.9 million at September 30, 1999.
Our capital requirements depend on numerous factors. We expect to devote
substantial resources to continue our research and development efforts, expand
our sales, support, marketing and product development organizations, establish
additional facilities worldwide and build the infrastructure necessary to
support our growth. We have experienced substantial increases in our
expenditures since our inception consistent with growth in our operations and
personnel, and we anticipate that our expenditures will continue to increase in
the future. We have spent $1.0 million on our new facility headquarters and
expect to spend a substantial amount throughout the remainder of the year. We
believe that the net proceeds from the sale of the common stock in our initial
public offering will be sufficient to meet our working capital and operating
resource expenditure requirements for the next 18 months. However, we may need
to raise additional funds in order to fund more rapid expansion, including
significant increases in personnel and office facilities; to develop new or
enhance existing services or products; to respond to competitive pressures; or
to acquire or invest in complementary businesses, technologies, services or
products. Additional funding may not be available on favorable terms or at all.
In addition, although there are no present understandings, commitments or
agreements with respect to any acquisition of other businesses, products or
technologies, we may, from time to time, evaluate potential acquisitions of
other businesses, products and technologies. In order to consummate potential
acquisitions, we may issue additional securities or need additional equity or
debt financing and any financing may be dilutive to existing investors.
YEAR 2000 READINESS DISCLOSURE
Year 2000 Compliance
Many currently installed computer systems and software products are coded to
accept or recognize only two digit entries in the date code field. These systems
and software products will need to accept four digit entries to distinguish 21st
century dates from 20th century dates. As a result, computer systems and/or
software used by many companies and governmental agencies may need to be
upgraded to comply with these Year 2000 requirements or risk system failure or
miscalculations causing disruptions of normal business activities.
In the fourth quarter of 1998 we initiated a Year 2000 compliance program.
The program is being directed by our quality assurance group. Our quality
assurance group is charged with identifying issues of potential risk within each
department and making the appropriate evaluation, modification, upgrade or
replacement. Members of our quality assurance group have worked with members of
each of our principal internal divisions in the course of assessing our Year
2000 compliance.
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Scope of Year 2000 Assessment
The scope of our Year 2000 compliance program includes testing the Kana
platform and the IT and non-IT systems used at our office in Palo Alto,
California. Our other sales offices use the same third-party hardware and
software systems as those in our Palo Alto office. Accordingly, our quality
assurance group determined that it would not conduct an independent review of
those systems. The operational areas under investigation include:
- products;
- software applications;
- facilities;
- suppliers and vendors; and
- computer systems.
We do not currently have any information concerning the Year 2000 compliance
status of our customers and do not expect to obtain any such information. If our
current or future customers fail to achieve Year 2000 compliance or if they
divert technology expenditures, especially technology expenditures that were
budgeted for our products, to address Year 2000 compliance problems, our
business could suffer.
Budget and Schedule
We have funded our Year 2000 plan from available cash and have not
separately accounted for these expenses in the past. To date, external
expenditures for Year 2000 compliance have totaled less than $20,000. Because
our products were designed to be Year 2000 compliant, most of
our expenses have related to, and are expected to continue to relate to, the
operating costs associated with time spent by employees in the internal
evaluation process and Year 2000 compliance matters generally. We may experience
unanticipated, material problems and expenses associated with Year 2000
compliance that could harm our business. Finally, we are also subject to
external forces that might generally affect industry and commerce, such as Year
2000 compliance failures by utility or transportation companies and related
service interruptions.
We have completed the evaluation of our products and our third-party
software systems.
Products
We have completed testing of the products we have shipped to date. Our
testing has determined that these products are capable of properly
distinguishing between 20th and 21st century dates, when configured and used in
accordance with the related documentation, and provided that the underlying
operating system of the host machine and any other software used with these
products are also capable of properly distinguishing between 20th and 21st
century dates.
Third-party Hardware and Software Systems and Services
We have completed the process of evaluating all of the critical third-party
systems and software we use in our business. We have received written statements
of Year 2000 compliance from substantially all of the providers of hardware used
in our business. We have identified approximately 20 different software vendors
that provide software products in our business. If any of the compliance
statements we have received from our third-party software or hardware providers
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are false, our internal systems and our ability to ship our product would be
materially harmed.
We are in the process of obtaining written compliance statements as to Year
2000 compliance from our hosting service provider and our other third-party
service providers, including our Internet service providers, cellular telephone
providers and all of our utilities. We expect to receive compliance statements
from such entities without additional expenditures by December 1, 1999.
Contingency Plan
Our compliance program has been substantially completed, except for
obtaining a few additional compliance statements from third party vendors. We do
not presently have a contingency plan for handling year 2000 problems that are
not detected and corrected prior to their occurrence and do not expect to have
one in place unless deemed necessary.
We may discover Year 2000 compliance problems in our systems that will
require substantial revision. In addition, third-party software, hardware or
services incorporated into our products and services may need to be revised or
replaced, all of which could be time-consuming and expensive and result in the
following, any of which could adversely affect our business:
- 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.
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.
RISK FACTORS ASSOCIATED WITH KANA'S BUSINESS AND FUTURE OPERATING RESULTS
Kana's 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
19
forward-looking statements. These risks and uncertainties include those
described in this "Risks Associated With Kana's Business and Future Operating
Results" and elsewhere in this report. Forward-looking statements that were true
at the time made may ultimately prove to be incorrect or false. Readers are
cautioned not to place undue reliance on forward-looking statement, which
reflect our management's view only as of the date of this report. Except as
required by law, we undertake no obligation to update any forward-looking
statement, whether as a result of new information, future events or otherwise.
Risks Related to Our Business
BECAUSE WE HAVE A LIMITED OPERATING HISTORY, IT IS DIFFICULT TO EVALUATE OUR
BUSINESS AND PROSPECTS.
We are still in the early stages of our development, and our limited
operating history makes it difficult to evaluate our business and prospects. We
were incorporated in July 1996 and we first recorded revenue in February 1998.
Thus, we have a limited operating history upon which you can evaluate our
business and prospects. Due to our limited operating history, it is difficult or
impossible for us to predict future results of operations. For example, we
cannot forecast operating expenses based on our historical results because they
are limited, and we are required to forecast expenses in part on future revenue
projections. Moreover, due to our limited operating history, any evaluation of
our business and prospects must be made in light of the risks and uncertainties
often encountered by early-stage companies in Internet-related markets. Many of
these risks are discussed in the subheadings below, and include our ability to:
- attract more customers;
- implement our sales, marketing and after-sales service initiatives,
both domestically and internationally; and
- execute our product development activities.
We may not successfully address any of these risks.
OUR QUARTERLY REVENUES AND OPERATING RESULTS MAY FLUCTUATE IN FUTURE PERIODS AND
WE MAY FAIL TO MEET EXPECTATIONS, WHICH MAY CAUSE THE PRICE OF OUR COMMON STOCK
TO DECLINE
Our quarterly revenues and operating results are difficult to predict and
may fluctuate significantly from quarter to quarter particularly because our
products and services are relatively new and our prospects uncertain. If our
quarterly revenues or operating results fall below the expectations of investors
or public market analysts, the price of our common stock could decline
substantially. Factors that might cause quarterly fluctuations in our operating
results include the factors described in the subheadings below as well as:
- the evolving and varying demand for customer communication software
products and services for e-Businesses, particularly our products and
services;
- the timing of new releases of our products;
- the discretionary nature of our customers' purchasing and
budgetary cycles;
- changes in our pricing policies or those of our competitors;
- the timing of execution of large contracts that materially affect
our operating results;
- the mix of sales channels through which our products and services
are sold;
- the mix of our domestic and international sales;
- costs related to the customization of our products;
- our ability to expand our operations, and the amount and timing
of expenditures related to this expansion;
20
- any costs or expenses related to our anticipated move to new
corporate offices; and
- global economic conditions, as well as those specific to large
enterprises with high e-mail volume.
We also often offer volume-based pricing, which may affect our operating
margins. Most of our expenses, such as employee compensation and rent, are
relatively fixed in the short term. Moreover, our expense levels are based, in
part, on our expectations regarding future revenues levels. As a result, if
total revenues for a particular quarter are below our expectations, we could not
proportionately reduce operating expenses for that quarter. Therefore, this
revenue shortfall would have a disproportionate effect on our expected operating
results for that quarter. In addition, because our service revenue is largely
correlated with our license revenue, a decline in license revenue could also
cause a decline in our service revenue in the same quarter or in subsequent
quarters.
Due to the foregoing factors, we believe that quarter-to-quarter comparisons
of our operating results are not a good indication of our future performance.
WE HAVE A HISTORY OF LOSSES AND MAY NOT BE PROFITABLE IN THE FUTURE, WHICH MAY
REDUCE THE TRADING PRICE OF OUR COMMON STOCK
Since we began operations in 1997, we have incurred substantial operating
losses in every quarter. As a result of accumulated operating losses, at
September 30, 1999, we had an accumulated deficit of approximately $28.2
million. For the three months ended September 30, 1999, we had a net loss of
$9.6 million, or 375% of revenues for that period. Since inception, we have
funded our business primarily through selling our stock, not from cash generated
by our business. Our growth in recent periods has been from a limited base of
customers, and we may not be able to sustain these growth rates. We expect to
continue to increase our operating expenses. As a result, we expect to continue
to experience losses and negative cash flows, even if sales of our products and
services continue to grow, and may not generate sufficient revenues to achieve
profitability in the future.
In addition, as a result of the Connectify merger, we expect that our losses
will increase even more significantly because of additional costs and expenses
related to:
- an increase in the number of our employees;
- an increase in research and development activities;
- an increase in sales and marketing activities; and
- assimilation of operations and personnel.
If we do achieve profitability, we may not be able to sustain or increase
any profitability on a quarterly or annual basis in the future.
WE FACE SUBSTANTIAL COMPETITION AND MAY NOT BE ABLE TO COMPETE EFFECTIVELY
The market for our products and services is intensely competitive, evolving
and subject to rapid technological change. We expect the intensity of
competition to increase in the future. Increased competition may result in price
reductions, reduced gross margins and loss of market share.
We currently face competition for our products from systems designed by in-
house and third-party development efforts. We expect that these systems will
continue to be a principal source of competition for the foreseeable future. Our
competitors include a number of companies offering one or more products for the
e-Business communications market, some of which compete directly with our
products. For example, our competitors include companies providing stand-alone
point solutions, including Annuncio, Inc., Brightware, Inc., eGain
Communications Corp., Mustang Software, Inc. and Responsys.com. In addition, we
21
may compete with companies providing customer management and communications
solutions, such as Clarify Inc. (which recently announced its proposed
acquisition by Northern Telecom), Digital Impact, Inc., Genesys
Telecommunications Laboratories, Inc. (which recently announced its proposed
acquisition by Alcatel ), Lucent Technologies, Inc., Message Media, Inc., Oracle
Corporation, Pivotal Corporation, Siebel Systems, Inc., Silknet Software, Inc.
and Vantive Corporation (which recently announced its acquisition by PeopleSoft,
Inc.).
Many of our competitors have longer operating histories, significantly
greater financial, technical, marketing and other resources, significantly
greater name recognition and a larger installed base of customers than do we. In
addition, many of our competitors have well-established relationships with our
current and potential customers and have extensive knowledge of our industry. We
may lose potential customers to competitors for various reasons, including the
ability or willingness of our competitors to offer lower prices and other
incentives that we cannot match. Accordingly, it is possible that new
competitors or alliances among competitors may emerge and rapidly acquire
significant market share. We also expect that competition will increase as a
result of the recently announced industry consolidations, as well as future
consolidations.
We may not be able to compete successfully against current and future
competitors, and competitive pressures may seriously harm our business.
OUR FAILURE TO CONSUMMATE OUR EXPECTED SALES IN ANY GIVEN QUARTER COULD
DRAMATICALLY HARM OUR OPERATING RESULTS BECAUSE OF THE LARGE SIZE OF OUR TYPICAL
ORDERS
Our sales cycle is subject to a number of significant risks, including
customers' budgetary constraints and internal acceptance reviews, over which we
have little or no control. Consequently, if sales expected from a specific
customer in a particular quarter are not realized in that quarter, we are
unlikely to be able to generate revenue from alternate sources in time to
compensate for the shortfall. As a result, and due to the relatively large size
of a typical order, a lost or delayed sale could result in revenues that are
lower than expected. Moreover, to the extent that significant sales occur
earlier than anticipated, revenues for subsequent quarters may be lower than
expected.
WE MAY NOT BE ABLE TO FORECAST OUR REVENUES ACCURATELY BECAUSE OUR PRODUCTS HAVE
A LONG AND VARIABLE SALES CYCLE
The long sales cycle for our products may cause license revenue and
operating results to vary significantly from period to period. To date, the
sales cycle for our products has taken three to 12 months in the United States
and longer in foreign countries. Our sales cycle has required pre-purchase
evaluation by a significant number of individuals in our customers'
organizations. Along with third parties that often jointly market our software
with us, we invest significant amounts of time and resources educating and
providing information to our prospective customers regarding the use and
benefits of our products. Many of our customers evaluate our software slowly and
deliberately, depending on the specific technical capabilities of the customer,
the size of the deployment, the complexity of the customer's network
environment, and the quantity of hardware and the degree of hardware
configuration necessary to deploy our products.
OUR STOCK PRICE MAY BE HIGHLY VOLATILE AND COULD DROP, PARTICULARLY BECAUSE OUR
BUSINESS DEPENDS ON THE INTERNET
The trading price of our common stock has 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 our control. In addition, the stock market has
experienced extreme price and volume fluctuations that have affected the market
prices of many technology and computer software companies, particularly
Internet-related companies, and which have often been unrelated or
22
disproportionate to the operating performance of these companies. These broad
market fluctuations could adversely affect the market price of our common stock.
DIFFICULTIES IN IMPLEMENTING OUR PRODUCTS COULD HARM OUR REVENUES AND MARGINS
Forecasting our revenues depends upon the timing of implementation of our
products. This implementation typically involves working with sophisticated
software, computing and communications systems. If we experience difficulties
with implementation or do not meet project milestones in a timely manner, we
could be obligated to devote more customer support, engineering and other
resources to a particular project. Some customers may also require us to develop
customized features or capabilities. If new or existing customers have
difficulty deploying our products or require significant amounts of our
professional services support or customized features, our revenue recognition
could be further delayed and our costs could increase, causing increased
variability in our operating results.
OUR BUSINESS DEPENDS ON THE ACCEPTANCE OF OUR PRODUCTS AND SERVICES, AND IT IS
UNCERTAIN WHETHER THE MARKET WILL ACCEPT OUR PRODUCTS AND SERVICES
Of our total revenue of $3.6 million for the three months ended September
30, 1999, $2.6 million was derived from licenses of our product and $1 million
from related services. We are not certain that our target customers will widely
adopt and deploy our products and services. Our future financial performance
will depend on the successful development, introduction and customer acceptance
of new and enhanced versions of our products and services. In the future, we may
not be successful in marketing our products and services or any new or enhanced
products.
WE MAY BE UNABLE TO HIRE AND RETAIN THE SKILLED PERSONNEL NECESSARY TO DEVELOP
OUR ENGINEERING, PROFESSIONAL SERVICES AND SUPPORT CAPABILITIES IN ORDER TO
CONTINUE TO GROW
We intend to increase our sales, marketing, engineering, professional
services and product management personnel substantially over the next 12 months.
Competition for these individuals is intense, and we may not be able to attract,
assimilate or retain highly qualified personnel in the future. Our business
cannot continue to grow if we cannot attract qualified personnel. Our failure to
attract and retain the highly trained personnel that are integral to our product
development and professional services group, which is the group responsible for
implementation and customization of, and technical support for, our products and
services, may limit the rate at which we can develop and install new products or
product enhancements, which would harm our business. We will need to increase
our staff to support new customers and the expanding needs of our existing
customers, without compromising the quality of our customer service. Hiring
qualified professional services personnel, as well as sales, marketing,
administrative and research and development personnel, is very competitive in
our industry, particularly in the San Francisco Bay Area, where Kana is
headquartered, due to the limited number of people available with the necessary
technical skills. We expect to face greater difficulty attracting these
personnel with equity incentives as a public company than we did in previous
years as a privately held company.
WE MAY FACE DIFFICULTIES IN HIRING AND RETAINING QUALIFIED SALES PERSONNEL TO
SELL OUR PRODUCTS AND SERVICES, WHICH COULD HARM OUR ABILITY TO INCREASE OUR
REVENUES IN THE FUTURE
Our financial success depends to a large degree on the ability of our direct
sales force to increase sales to a level required to adequately fund marketing
and product development activities. Therefore, our ability to increase revenues
in the future depends considerably upon our success in recruiting, training and
retaining additional direct sales personnel and the success of the direct sales
force. Also, it may take a new salesperson a number of months before he or she
becomes a productive member of our sales force. Our business will be harmed if
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we fail to hire or retain qualified sales personnel, or if newly hired
salespeople fail to develop the necessary sales skills or develop these skills
more slowly than we anticipate.
LOSS OF OUR CHIEF EXECUTIVE OFFICER AND PRESIDENT COULD HARM OUR BUSINESS
Our future success depends to a significant degree on the skills, experience
and efforts of our senior management. In particular, we depend upon the
continued services of Michael J. McCloskey, our Chief Executive Officer, and
Mark S. Gainey, our President and co-founder. The loss of the services of any of
these individuals could harm our business and operations. In addition, we have
not obtained life insurance benefiting Kana on any of our key employees or
entered into employment agreements with our key employees. If any of our key
employees left or was seriously injured and unable to work and we were unable to
find a qualified replacement, our business could be harmed.
A FAILURE TO MANAGE OUR INTERNAL OPERATING AND FINANCIAL FUNCTIONS COULD LEAD TO
INEFFICIENCIES IN CONDUCTING OUR BUSINESS AND SUBJECT US TO INCREASED EXPENSES
Our ability to offer our products and services successfully in a rapidly
evolving market requires an effective planning and management process. We have
limited experience in managing rapid growth. We are experiencing a period of
growth that is placing a significant strain on our managerial, financial and
personnel resources. Our business will suffer if this growth continues and we
fail to manage this growth. On September 30, 1999, we had a total of 212
full-time employees compared to 51 on September 30, 1998. We expect to continue
to hire new employees at a rapid pace. For example, we added 89 employees in the
third quarter of 1999, with 31 of these employees joining us as a result of the
Connectify merger. Moreover, we need to continue to assimilate Connectify's
operations into our operations. The rate of our recent growth has made
management of that growth more difficult. Any additional growth will further
strain our management, financial, personnel, internal training and other
resources. To manage any future growth effectively, we must improve our
financial and accounting systems, controls, reporting systems and procedures,
integrate new personnel and manage expanded operations. Any failure to do so
could negatively affect the quality of our products, our ability to respond to
our customers, and retain key personnel, and our business in general. We plan to
move our corporate offices to a new location in November 1999. This move may
disrupt our business and operations.
THE INTEGRATION OF OUR NEW CHIEF EXECUTIVE OFFICER, VICE PRESIDENT OF BUSINESS
DEVELOPMENT, VICE PRESIDENT OF MARKETING, VICE PRESIDENT OF ELECTRONIC DIRECT
MARKETING AND VICE PRESIDENT OF INTERNATIONAL SALES INTO OUR MANAGEMENT TEAM MAY
INTERFERE WITH OUR OPERATIONS
We have recently hired a number of new officers, including our Chief
Executive Officer, Michael J. McCloskey, who joined us in June 1999, and our
Vice President of Business Development, Vice President of Marketing, Vice
President of Electronic Direct Marketing and Vice President of International
Sales, each of whom has been with us for less than four months. To integrate
into our company, these individuals must spend a significant amount of time
learning our business model and management system, in addition to performing
their regular duties. Accordingly, the integration of new personnel has resulted
and will continue to result in some disruption to our ongoing operations.
THE CONNECTIFY MERGER MAY RESULT IN DISRUPTIONS TO OUR BUSINESS AND MANAGEMENT
DUE TO DIFFICULTIES IN ASSIMILATING PERSONNEL AND OPERATIONS
We may not realize the benefits from the Connectify merger. We may not be
able to successfully assimilate the additional personnel, operations, acquired
technology and products into our business. In particular, we will need to
assimilate and retain key professional services, engineering and marketing
personnel. Other key Connectify personnel may decide not to work for us. In
addition, Connectify's product will have to be integrated into our products, and
24
it is uncertain whether we may accomplish this easily. These difficulties could
disrupt our ongoing business, distract our management and employees or increase
our expenses.
IF WE ACQUIRE ADDITIONAL COMPANIES, PRODUCTS OR TECHNOLOGIES, WE MAY FACE RISKS
SIMILAR TO THOSE FACED IN THE CONNECTIFY MERGER
If we are presented with appropriate opportunities, we intend to make other
investments in complementary companies, products or technologies. We may not
realize the anticipated benefits of any other acquisition or investment. If we
buy another company, we will likely face the same risks, uncertainties and
disruptions as discussed above with respect to the Connectify merger.
Furthermore, we may have to incur debt or issue equity securities to pay for any
additional future acquisitions or investments, the issuance of which could be
dilutive to us or our existing stockholders. In addition, our profitability may
suffer because of acquisition-related costs or amortization costs for acquired
goodwill and other intangible assets.
DELAYS IN THE DEVELOPMENT OF NEW PRODUCTS OR ENHANCEMENTS TO EXISTING PRODUCTS
WOULD HURT OUR SALES AND DAMAGE OUR REPUTATION
To be competitive, we must develop and introduce on a timely basis new
products and product enhancements for companies with significant e-Business
customer interactions needs. Any failure to do so could harm our business. If we
experience product delays in the future, we may face:
- customer dissatisfaction;
- cancellation of orders and license agreements;
- negative publicity;
- loss of revenues;
- slower market acceptance; and
- legal action by customers against us.
In the future, our efforts to remedy this situation may not be successful
and we may lose customers as a result. Delays in bringing to market new products
or their enhancements, or the existence of defects in new products or their
enhancements, could be exploited by our competitors. If we were to lose market
share as a result of lapses in our product management, our business would
suffer.
TECHNICAL PROBLEMS WITH EITHER OUR INTERNAL OR OUR OUTSOURCED COMPUTER AND
COMMUNICATIONS SYSTEMS COULD INTERRUPT OUR KANA ONLINE SERVICE
The success of our Kana Online service depends on the efficient and
uninterrupted operation of our own and outsourced computer and communications
hardware and software systems. These systems and operations are vulnerable to
damage or interruption from human error, natural disasters, telecommunications
failures, break-ins, sabotage, computer viruses, intentional acts of vandalism
and similar adverse events. We have entered into an Internet-hosting agreement
with Exodus Communications, Inc. to maintain all of our Kana Online servers at
Exodus' data center in Santa Clara, California. Our operations depend on Exodus'
ability to protect its and our systems in its data center against damage or
interruption. Exodus does not guarantee that our Internet access will be
uninterrupted, error-free or secure. We have no formal disaster recovery plan in
the event of damage or interruption, and our insurance policies may not
adequately compensate us for any losses that we may incur. Any system failure
that causes an interruption in our service or a decrease in responsiveness could
harm our relationships with our customers and result in reduced revenues.
25
IF WE FAIL TO BUILD SKILLS NECESSARY TO SELL OUR KANA ONLINE SERVICE, WE WILL
LOSE REVENUE OPPORTUNITIES AND OUR SALES WILL SUFFER
The skills necessary to market and sell Kana Online are different than those
relating to our software products. We license our software products for a fixed
fee based on the number of concurrent users and the optional applications
purchased. We license Kana Online based on a fixed fee for installation,
configuration and training, and a variable monthly component depending on actual
customer usage. Our sales force sells both our software products and Kana
Online. Because different skills are necessary to sell Kana Online versus our
software products, our sales and marketing groups may not be able to maintain or
increase the level of sales of either Kana Online or our software products.
OUR PENDING PATENTS MAY NEVER BE ISSUED AND, EVEN IF ISSUED, MAY PROVIDE US WITH
LITTLE PROTECTION
Our success and ability to compete depend to a significant degree upon the
protection of our software and other proprietary technology rights. We regard
the protection of patentable inventions as important to our future
opportunities. We currently have four U.S. patent applications pending relating
to our software. However, none of our technology is patented outside of the
United States nor do we currently have any international patent applications
pending. It is possible that:
- our pending patent applications may not result in the issuance
of patents;
- any patents issued may not be broad enough to protect our
proprietary rights;
- any issued patent could be successfully challenged by one or more
third parties, which could result in our loss of the right to
prevent others from exploiting the inventions claimed in those
patents;
- current and future competitors may independently develop similar
technology, duplicate our products or design around any of our
patents;
- and effective patent protection may not be available in every
country in which we do business.
WE RELY UPON TRADEMARKS, COPYRIGHTS AND TRADE SECRETS TO PROTECT OUR PROPRIETARY
RIGHTS, WHICH MAY NOT BE SUFFICIENT TO PROTECT OUR INTELLECTUAL PROPERTY
We also rely on a combination of laws, such as copyright, trademark and
trade secret laws, and contractual restrictions, such as confidentiality
agreements and licenses, to establish and protect our proprietary rights. We
currently have a registered trademark, "Kana", and pending trademark
applications for our logo and "KANA COMMUNICATIONS and Design". However, none of
our trademarks is registered outside of the United States, nor do we have any
trademark applications pending outside of the United States. Moreover, despite
any precautions that we have taken:
- laws and contractual restrictions may not be sufficient to
prevent misappropriation of our 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
our marks; and
- policing unauthorized use of our products and trademarks is
difficult, expensive and time-consuming, and we may be unable
to determine the extent of this unauthorized use.
Also, the laws of other countries in which we market our products may offer
little or no effective protection of our proprietary technology. Reverse
engineering, unauthorized copying or other misappropriation of our proprietary
26
technology could enable third parties to benefit from our technology without
paying us for it, which would significantly harm our business.
WE MAY BECOME INVOLVED IN LITIGATION OVER PROPRIETARY RIGHTS, WHICH COULD BE
COSTLY AND TIME CONSUMING AND GENESYS TELECOMMUNICATIONS LABORATORIES, INC. HAS
FILED AN INFRINGEMENT SUIT AGAINST US
Substantial litigation regarding intellectual property rights exists in our
industry. We expect that software in our industry may be increasingly subject to
third-party infringement claims as the number of competitors grows and the
functionality of products in different industry segments overlaps. Third parties
may currently have, or may eventually be issued, patents that our products or
technology infringe. Any of these third parties might make a claim of
infringement against us. Many of our software license agreements require us to
indemnify our customers from any claim or finding of intellectual property
infringement. Any litigation, brought by us or others, could result in the
expenditure of significant financial resources and the diversion of management's
time and efforts. In addition, litigation in which we are accused of
infringement might cause product shipment delays, require us to develop
non-infringing technology or require us to enter into royalty or license
agreements, which might not be available on acceptable terms, or at all. If a
successful claim of infringement were made against us and we could not develop
non-infringing technology or license the infringed or similar technology on a
timely and cost-effective basis, our business could be significantly harmed.
On October 8, 1999, Genesys Telecommunications Laboratories, Inc.
("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 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-judgement interest. The litigation is currently in
its early stages and we have not received information or documentation other
than the filed complaint and therefore cannot fully evaluate the claim. We
intend to fight this claim vigorously and do not expect it to materially impact
the results from operations. Kana is not currently a party to any other material
legal proceedings.
WE MAY FACE HIGHER COSTS AND LOST SALES IF OUR SOFTWARE CONTAINS ERRORS
We face the possibility of higher costs as a result of the complexity of our
products and the potential for undetected errors. Due to the mission- critical
nature of our products and services, undetected errors are of particular
concern. We have only a few "beta" customers that test new features and
functionality of our software before we make these features and functionalities
generally available to our customers. If our software contains undetected errors
or we fail to meet our customers' expectations in a timely manner, we 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 our reputation;
- increased service and warranty costs;
- legal actions by customers against us; and
- increased insurance costs.
WE MAY FACE LIABILITY CLAIMS THAT COULD RESULT IN UNEXPECTED COSTS AND DAMAGE TO
OUR REPUTATION
Our licenses with customers generally contain provisions designed to limit
our exposure to potential product liability claims, such as disclaimers of
27
warranties and limitations on liability for special, consequential and
incidental damages. In addition, our license agreements generally cap the
amounts recoverable for damages to the amounts paid by the licensee to us for
the product or service giving rise to the damages. However, these contractual
limitations on liability may not be enforceable and we may be subject to claims
based on errors in our software or mistakes in performing our services including
claims relating to damages to our customers' internal systems. A product
liability claim, whether or not successful, could harm our business by
increasing our costs, damaging our reputation and distracting our management.
WE INTEND TO EXPAND OUR INTERNATIONAL OPERATIONS, WHICH COULD DIVERT MANAGEMENT
ATTENTION AND PRESENT FINANCIAL ISSUES
Our international operations are located in the United Kingdom and, to date,
have been limited. We plan to expand our existing international operations and
establish additional facilities in other parts of the world. We may face
difficulties in accomplishing this expansion, including finding adequate
staffing and management resources for our international operations. The
expansion of our existing international operations and entry into additional
international markets will require significant management attention and
financial resources. In addition, in order to expand our international sales
operations, we will need to, among other things:
- expand our international sales channel management and
support organizations;
- customize our products for local markets; and
- develop relationships with international service providers
and additional distributors and system integrators.
Our investments in establishing facilities in other countries may not
produce desired levels of revenues. Even if we are able to expand our
international operations successfully, we may not be able to maintain or
increase international market demand for our products. In addition, we have only
licensed our products internationally since January 1999 and we have limited
experience in developing localized versions of our software and marketing and
distributing them internationally. Localizing our products may take longer than
we anticipate due to difficulties in translation and delays we may experience in
recruiting and training international staff.
OUR GROWTH COULD BE LIMITED IF WE FAIL TO EXECUTE OUR PLAN TO EXPAND
INTERNATIONALLY
For the three months ended September 30, 1999, we derived approximately
11.4% of our total revenues from sales outside North America. We also have
established an office in the United Kingdom. As of September 30, 1999 we had 17
employees in our United Kingdom office. The United Kingdom office oversees and
processes all orders for our products and services in Europe. As a result, we
face risks from doing business on an international basis, any of which could
impair our internal revenues. Although our international sales have not yet been
materially affected by the following risks, we could, in the future, encounter
greater difficulty in accounts receivable collection, longer sales cycles and
collection periods or seasonal reductions in business activity. In addition, our
international operations could cause our average tax rate to increase. Any of
these events could harm our international sales and results of operations.
INTERNATIONAL LAWS AND REGULATIONS MAY EXPOSE US TO POTENTIAL COSTS AND
LITIGATION
Our international operations will increase our exposure to international
laws and regulations. If we cannot comply with foreign laws and regulations,
which are often complex and subject to variation and unexpected changes, we
could incur unexpected costs and potential litigation. For example, the
governments of foreign countries might attempt to regulate our products and
services or levy sales or other taxes relating to our activities. In addition,
foreign countries may impose tariffs, duties, price controls or other
restrictions on foreign currencies or trade barriers, any of which could make it
more difficult to conduct our business. The European Union, in which we have a
sales office, recently enacted its own privacy regulations that may result in
28
limits on the collection and use of certain user information, which, if applied
to the sale of our products and services, could negatively impact our results of
operations.
WE MAY SUFFER FOREIGN EXCHANGE RATE LOSSES
Our international revenues are denominated in local currency. Therefore, a
strengthening of other currencies versus the U.S. dollar could make our products
less competitive in foreign markets. We do not currently engage in currency
hedging activities. We have not yet but may in the future experience foreign
exchange rate losses, especially to the extent that we do not engage in hedging.
OUR PROSPECTS FOR OBTAINING ADDITIONAL FINANCING, IF REQUIRED, ARE UNCERTAIN AND
FAILURE TO OBTAIN NEEDED FINANCING COULD AFFECT OUR ABILITY TO PURSUE FUTURE
GROWTH
We may need to raise additional funds to develop or enhance our products or
services, to fund expansion, to respond to competitive pressures or to acquire
complementary products, businesses or technologies. We do not have a long enough
operating history to know with certainty whether our existing cash and the
proceeds of this offering will be sufficient to finance our anticipated growth.
Additional financing may not be available on terms that are acceptable to us. If
we raise additional funds through the issuance of equity or convertible debt
securities, the percentage ownership of our stockholders would be reduced and
these securities might have rights, preferences and privileges senior to those
of our current stockholders. If adequate funds are not available on acceptable
terms, our ability to fund our expansion, take advantage of unanticipated
opportunities, develop or enhance products or services, or otherwise respond to
competitive pressures would be significantly limited.
OUR EXECUTIVE OFFICERS AND DIRECTORS EXERCISE CONTROL OVER STOCKHOLDER VOTING
MATTERS
Our executive officers and directors, their affiliates and other substantial
stockholders together control approximately 56.4% of the outstanding common
stock. As a result, these stockholders, if they act together, are able to
control all matters requiring approval of a majority of our stockholders,
including the election of directors and significant corporate transactions. This
concentration of ownership may delay, prevent or deter a change in control of
Kana, could deprive our 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 our common stock.
WE HAVE ADOPTED ANTI-TAKEOVER DEFENSES THAT COULD DELAY OR PREVENT AN
ACQUISITION OF OUR COMPANY
The board of directors have 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 have the authority to determine the price,
rights, preferences, privileges and restrictions of the preferred stock. This
preferred stock, if issued, might have preference over and harm the rights of
the holders of common stock. Although the issuance of this preferred stock will
provide us with flexibility in connection with possible acquisitions and other
corporate purposes, this issuance may make it more difficult for a third party
to acquire a majority of our outstanding voting stock. We currently have no
plans to issue preferred stock.
Our certificate of incorporation, bylaws and equity compensation plans
include provisions that may deter an unsolicited offer to purchase 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, our board of directors will be divided into three classes, only one
of which will be elected each year. Directors will only be 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.
29
Risks Related to Our Industry
OUR FAILURE TO MANAGE MULTIPLE TECHNOLOGIES AND TECHNOLOGICAL CHANGE COULD HARM
OUR FUTURE PRODUCT DEMAND
Future versions of hardware and software platforms embodying new
technologies and the emergence of new industry standards could render our
products obsolete. The market for e-Business customer communication software is
characterized by:
- rapid technological change;
- frequent new product introductions;
- changes in customer requirements; and
- evolving industry standards.
Our products are designed to work on a variety of hardware and software
platforms used by our customers. However, our software may not operate correctly
on evolving versions of hardware and software platforms, programming languages,
database environments and other systems that our customers use. For example, the
server component of the current version of our products runs on the Windows NT
operating system from Microsoft, and we must develop products and services that
are compatible with UNIX and other operating systems to meet the demands of our
customers. If we cannot successfully develop these products in response to
customer demands, our business could suffer. Also, we must constantly modify and
improve our products to keep pace with changes made to these platforms and to
database systems and other back-office applications and Internet-related
applications. This may result in uncertainty relating to the timing and nature
of new product announcements, introductions or modifications, which may cause
confusion in the market and harm our business. If we fail to modify or improve
our products in response to evolving industry standards, our products could
rapidly become obsolete, which would harm our business.
IF WE FAIL TO RESPOND TO CHANGING CUSTOMER PREFERENCES IN OUR MARKET, DEMAND FOR
OUR PRODUCTS AND OUR ABILITY TO ENHANCE OUR REVENUES WILL SUFFER
We must continually improve the performance, features and reliability of our
products, particularly in response to competitive offerings. Our success
depends, in part, on our ability to enhance our existing software and to develop
new services, functionality and technology that address the increasingly
sophisticated and varied needs of our prospective customers. If we do not
properly identify the feature preferences of prospective customers, or if we
fail to deliver features that meet the requirements of these customers, our
ability to market our products successfully and to increase our revenues could
be impaired. The development of proprietary technology and necessary service
enhancements entails significant technical and business risks and requires
substantial expenditures and lead time.
IF THE INTERNET AND E-MAIL FAIL TO GROW AND BE ACCEPTED AS A MEDIUM OF
COMMUNICATION, DEMAND FOR OUR PRODUCTS AND SERVICES WILL DECLINE
We sell our products and services primarily to organizations that receive
large volumes of e-mail and Web-based communications. Consequently, our future
revenues and profits, if any, substantially depend upon the continued acceptance
and use of the Internet and e-mail, which is evolving as a medium of
communication. Rapid growth in the use of e-mail is a recent phenomenon and may
not continue. Many of our customers have business models that are based on the
continued growth of the Internet. As a result, a broad base of enterprises that
use e-mail as a primary means of communication may not develop or be maintained.
In addition, the market may not accept recently introduced products and services
that process e-mail, including our products and services. Moreover, companies
that have already invested significant resources in other methods of
communications with customers, such as call centers, may be reluctant to adopt a
new strategy that may limit or compete with their existing investments. If
30
businesses do not continue to accept the Internet and e-mail as a medium of
communication, our business would suffer.
FUTURE REGULATION OF THE INTERNET MAY SLOW ITS GROWTH, RESULTING IN DECREASED
DEMAND FOR OUR PRODUCTS AND SERVICES AND INCREASED COSTS OF DOING BUSINESS
Due to the increasing popularity and use of the Internet, it is possible
that state, federal and foreign regulators could adopt laws and regulations that
impose additional burdens on those companies that conduct business online. These
laws and regulations could discourage communication by e-mail or other Web-based
communications, particularly targeted e-mail of the type facilitated by the
Connectify product, which could reduce demand for our products and services.
The growth and development of the market for online services may prompt
calls for more stringent consumer protection laws or laws that may inhibit the
use of Internet-based communications or the information contained in these
communications. The adoption of any additional laws or regulations may decrease
the expansion of the Internet. A decline in the growth of the Internet,
particularly as it relates to online communication, could decrease demand for
our products and services and increase our costs of doing business, or otherwise
harm our business. Our costs could increase and our growth could be harmed by
any new legislation or regulation, the application of laws and regulations from
jurisdictions whose laws do not currently apply to our business, or the
application of existing laws and regulations to the Internet and other online
services.
YEAR 2000 ISSUES PRESENT TECHNOLOGICAL RISKS, COULD CAUSE DISRUPTION TO OUR
BUSINESS AND COULD HARM SALES OF OUR 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 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.
Any failure of our material systems, our customers' material systems or the
Internet to be Year 2000 compliant would have material adverse consequences for
us. We are currently assessing the Year 2000 readiness of the software, computer
technology and other services that we use that may not be Year 2000 compliant.
We have not completed all operational tests on our internal systems.
Accordingly, we are unable to predict to what extent our business may be
affected if our software, the systems that operate in conjunction with our
software or our internal systems experience a material Year 2000 failure. See
"Year 2000 Readiness Disclosure".
Item 3: Quantitative and Qualitative Disclosures About Market Risk
We develop products in the United States and sell these products in North
America, Europe, Asia and Australia. Generally, our sales are made in local
currency. As a result, our financial results could be affected by factors such
as changes in foreign currency exchange rates or weak economic conditions in
foreign markets. We do not currently use derivative instruments to hedge our
foreign exchange risk.
Our exposure to market rate risk for changes in interest rates relates
primarily to our investment portfolio. Our investments consist primarily of
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.
31
PART II: OTHER INFORMATION
Item 1. Legal Proceedings
On October 8, 1999, Genesys Telecommunications Laboratories, Inc.
("Genesys") filed a complaint against Kana in the United States District Court
for the District of Delaware. Genesys alleges that Kana's Customer Messaging
System 3.0 infringes 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-judgement interest. The litigation is currently in
its early stages and we have not received information or documentation other
than the filed complaint and therefore cannot fully evaluate the claim. We
intend to fight this claim vigorously and do not expect it to impact results.
Kana is not currently a party to any other material legal proceedings. See "Risk
Factors -- We may become involved in litigation over proprietary rights, which
could be costly and time consuming and Genesys Telecommunications Laboratories,
Inc. has filed an infringement suit against us."
Item 2. Changes in Securities and Use of Proceeds
(d) Use of Proceeds from Sales of Registered Securities.
On September 27, 1999, Kana consummated its initial public offering of its
Common Stock, $0.001 par value. The managing underwriters in the offering were
Goldman Sach & Co, Hambrecht & Quist LLC and Wit Capital Corporation (the
"Underwriters"). 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 (the "Registration Statement") (Reg. No. 333-82587) that was declared
effective by the SEC on September 21, 1999. All 3,795,000 shares of Common Stock
registered under the Registration Statement, including shares covered by an
overallotment option that was exercised, were sold at a price to the public of
$15.00 per share. The aggregate offering amount registered was $56,925,000,000.
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 estimate of all expenses incurred in connection with the offering,
other than underwriting discounts. All amounts shown are estimated except for
the registration fees of the SEC and the National Association of Securities
Dealers, Inc. ("NASD").
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
----------
$1,946,000
==========
Kana currently used the net proceeds from its initial public offering of
Common Stock to invest in short-term, interest bearing, investment grade
securities and has used its existing cash balances to fund the general
operations of Kana. We currently estimate that we will use the 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.
In addition, we may use a portion of the net proceeds to acquire or invest
in complementary businesses or products or to obtain the right to use
complementary technologies. Pending these uses, the net proceeds of the offering
will be invested in short-term, interest-bearing, investment-grade instruments.
32
As of the date of this report, we can only estimate the particular uses for the
net proceeds received upon completion of the offering. However, we currently
have no formal plan for use of the expected offering proceeds, nor have we
sought the advice of or received reports from any of our professional advisors
regarding the use of the offering proceeds. As a result, the above estimates and
our use of proceeds are subject to change at our management's discretion. The
amounts actually expended for each of the purposes listed above may vary
significantly depending upon a number of factors, including the progress of our
marketing programs, capital spending requirements, and developments in Internet
commerce.
Item 4. Submission of Matters to a Vote of Security Holders
By action by written consent of the majority of shareholders of Kana on June
17, 1999, the holders of 20,450,735 shares of outstanding capital stock approved
an amendment to the 1997 Stock Option/Stock Issuance Plan increasing the
authorized number of shares of common stock reserved for issuance thereunder
under by 2,000,000 shares.
By action by written consent of the majority of shareholders of Kana on July
8, 1999, the holders of 21,911,310 shares of outstanding capital stock (i)
approved the Fourth Amended and Restated Articles of Incorporation and (ii)
waived notice and preemptive rights under the Second Restated and Amended
Shareholder' Agreement.
By action by written consent of the majority of shareholders of Kana on
August 12, 1999, the holders of 21,022,654 shares of outstanding capital stock
approved the following actions: (i) the Certificate of Amendment to the Fourth
Amended and Restated Articles of Incorporation; (ii) the Amendment to the
Amended and Restated Bylaws; and (iii) an amendment to the 1997 Stock
Option/Stock Issuance Plan increasing the authorized number of shares of common
stock reserved for issuance thereunder by 1,000,000 shares.
By action by written consent of the majority of shareholders of Kana on
August 23, 1999, the holders of 20,719,933 shares of outstanding capital stock
approved the following actions: (i) the reincorporation in the State of Delaware
by creating a wholly owned subsidiary under the laws of the State of Delaware to
acquire all of the assets and assume all of the liabilities of Kana pursuant to
a statutory merger; (ii) the amendment to the Amended and Restated Certificate
of Incorporation, effecting a two-for-three reverse stock split; (iii) the 1999
Stock Incentive Plan; (iv) the 1999 Employee Stock Purchase Plan; (v) an
indemnification agreement for Kana's current and future officers and directors;
and (vi) the public company Certificate of Incorporation and Bylaws to be filed
or adopted, as applicable, at the closing of the initial public offering.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
27 Financial Data Schedule
(b) Reports on Form 8-K: None.
33
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
November 15, 1999 Kana Communications, Inc.
/S/ MICHAEL J. MCCLOSKEY
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Michael J. McCloskey
Chief Executive Officer and Director
/S/ JOSEPH D. MCCARTHY
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Joseph D. McCarthy
Vice President, Finance and Operations
(Principal Financial and Accounting Officer)
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EXHIBIT INDEX TO KANA COMMUNICATIONS, INC.
Quarterly Report on Form 10-Q
For the Quarter Ended September 30, 1999
Exhibit Number Description
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27 Financial Data Schedule
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