~~[ TABLE OF CONTENTS]~~

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

~~QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934~~

~~For the Quarterly Period Ended September 30, 2001~~

o		~~TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934~~

		~~For the transition period from ____________ to ____________~~

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2002

[ ] 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~~file number: 000-27163

KANA Software, Inc.
(Exact ~~Name~~name of Registrant as Specified in its Charter)

Delaware
77-0435679
~~(State~~ (State or Other Jurisdiction of Incorporation or Organization) (I.R.S. Employer Identification ~~No.)~~
~~Incorporation or Organization)~~ Number)

181 Constitution Drive
Menlo Park, California 94025
(Address of Principal Executive Offices including Zip Code)

~~181 Constitution Drive~~

(650) 614-8300
~~Menlo Park, California 94025~~

(~~Address of Principal Executive Offices)~~

Registrant's Telephone Number, Including Area ~~Code: (650) 614-8300~~Code)

Indicate by check mark whether the ~~registrant:~~registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file ~~such~~ reports), and (2) has been subject to such filing requirements for the past 90 days. YES x[X] NO o[ ]

On ~~October 30, 2001,~~ May 13, 2002, approximately ~~182,316,634~~22,803,848 shares of the Registrant's Common Stock, $0.001 par value, were outstanding.

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KANA Software, Inc.
Form 10-Q
Quarter Ended ~~September 30, 2001~~March 31, 2002 Index

~~Index~~

~~Part I: Financial Information~~PART I. FINANCIAL INFORMATION	Page No.

Item 1:1. Financial Statements

	Unaudited Condensed Consolidated Balance Sheets at ~~September 30, 2001~~ March 31, 2002 and December 31, ~~2000~~2001	3

	Unaudited Condensed Consolidated Statements of Operations for the ~~Three months and Nine~~three months ended ~~September 30,~~March 31, 2002 and 2001 ~~and 2000~~	4

	Unaudited Condensed Consolidated Statements of Cash Flows for the ~~Nine~~three months ended ~~September 30,~~March 31, 2002 and 2001 ~~and 2000~~	5

	Notes to ~~the~~ Unaudited Condensed Consolidated Financial Statements	6

Item 2:2. Management's Discussion and Analysis of Financial Condition and Results of Operations	1311

Item 3:3. Quantitative and Qualitative Disclosures About Market Risk	3833

~~Part II: Other Information~~

~~Item 1. Legal Proceedings~~PART II. OTHER INFORMATION	39

Item 1: Legal Proceedings	34

Item 2: Changes in Securities and Use of Proceeds	34

Item 3: Defaults Upon Senior Secuirites	34

Item 4. Submission of Matters to a Vote of Security Holders	3934

Item 5. Other Information	34

Item 6. Exhibits and Reports on Form 8-K	3934

~~Signatures~~Signature	40

		36

Part I: Financial Information

Item 1: Financial Statements

KANA ~~SOFTWARE, INC.~~Software, ASSETS Current assets: Cash and cash equivalents............................. $ Short-term investments................................ Accounts receivable, net.............................. Prepaid expenses and other current assets............. Total current assets................................ Restricted cash........................................ Property and equipment, net............................ Goodwill, net.......................................... Intangible assets, net................................. Other assets........................................... Total assets....................................... $ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current portion of notes payable...................... $ Accounts payable...................................... Accrued liabilities................................... Accrued restructuring and merger costs................ Deferred revenue...................................... Total current liabilities............................ Accrued restructuring, less current portion............ Notes payable, less current portion.................... Total liabilities.................................. Stockholders' equity: Common stock.......................................... Additional paid-in capital............................ Deferred stock-based compensation..................... Notes receivable from stockholders.................... Accumulated other comprehensive losses................ Accumulated deficit................................... Total stockholders' equity......................... Total liabilities and stockholders' equity......... $ Inc.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)

March 31, December 31, 2002 2001 ------------ ------------ 34,920 $ 25,476 16,328 14,654 18,836 15,942 6,910 6,442 ------------ ------------ 76,994 62,514 10,851 11,018 19,270 19,382 62,448 58,547 5,053 6,253 2,839 2,958 ------------ ------------ 177,455 $ 160,672 ============ ============ 1,381 $ 1,363 7,108 6,276 16,416 25,292 8,033 21,100 24,409 22,180 ------------ ------------ 57,347 76,211 16,827 17,514 18 108 ------------ ------------ 74,192 93,833 ------------ ------------ 225 192 4,274,753 4,237,325 (17,208) (22,209) (208) (799) (1,134) (1,285) (4,153,165) (4,146,385) ------------ ------------ 103,263 66,839 ------------ ------------ 177,455 $ 160,672 ============ ============
September 30,
2001 December 31,
2000
ASSETS
Current assets:
Cash and cash equivalents $ 21,438 $ 76,202
Short-term investments 30,489 297
Accounts receivable, net 19,223 43,393
Prepaid expenses and other current assets 10,670 14,866
Total current assets 81,820 134,758
Restricted cash 11,018 —
Property and equipment, net 15,778 40,095
Goodwill and identifiable intangibles, net 80,464 800,000
Other assets 4,977 5,271
Total assets $ 194,057 $ 980,124
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of notes payable $ 1,463 $ 1,456
Accounts payable 16,078 17,980
Accrued liabilities 32,256 35,846
Accrued restructuring and merger costs 28,349 —
Deferred revenue 24,106 25,242
Total current liabilities 102,252 80,524
Accrued restructuring, less current portion 18,027 —
Notes payable, less current portion 300 148
Total liabilities 120,579 80,672
Stockholders' equity:
Common stock 182 94
Additional paid-in capital 4,222,571 4,130,231
Deferred stock-based compensation (24,914 ) (21,639 )
Notes receivable from stockholders (798 ) (5,367 )
Accumulated other comprehensive loss (1,343 ) (377 )
Accumulated deficit (4,122,220 ) (3,203,490 )
Total stockholders' equity 73,478 899,452
Total liabilities and stockholders' equity $ 194,057 $ 980,124
See accompanying notes to unaudited condensed consolidated financial statements.

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KANA SOFTWARE, INCSoftware, Inc.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTSTATEMENTS OF OPERATIONS
(In thousands, except per share data)amounts)

Three Months Ended
March 31,
--------------------
2002 2001
--------- ---------
Revenues:
License........................................ $ 15,129 $ 11,857
Service........................................ 10,014 11,614
--------- ---------
Total revenues...................................... 25,143 23,471
--------- ---------
Cost of revenues:
License........................................ 965 633
Service (excluding stock-based compensation
of $383 and $431, respectively)............. 3,907 16,403
--------- ---------
Total cost of revenues.............................. 4,872 17,036
--------- ---------
Gross profit........................................ 20,271 6,435
--------- ---------
Operating expenses:
Sales and marketing (excluding stock-based
compensation of $2,033 and $1,865, respective 10,305 26,534
Research and development (excluding
stock-based compensation of $1,897
and $434, respectively)...................... 6,638 12,949
General and administrative (excluding
stock-based compensation of $5,574
and $1,382, respectively).................... 3,220 6,068
Restructuring costs............................ -- 19,930
Amortization of stock-based compensation....... 9,887 4,112
Amortization of goodwill and identifiable
intangibles.................................. 1,200 86,852
Goodwill impairment............................ -- 603,446
--------- ---------
Total operating expenses............................ 31,250 759,891
--------- ---------
Operating loss...................................... (10,979) (753,456)
Other income, net................................... 298 302
--------- ---------
Loss from continuing operations..................... (10,681) (753,154)
Discontinued operation:
Income from operations of discontinued
operation........................................ -- 258
Cumulative effect of accounting change related
to the elimination of negative goodwill........... 3,901 --
--------- ---------
Net loss............................................ $ (6,780) $(752,896)
========= =========
Basic and diluted net loss per share:

Loss from continuing operations................... $ (0.51) $ (82.30)
Income from discontinued operation................ -- 0.03
Cumulative effect of accounting change.............. 0.19 --
--------- ---------
Net loss.......................................... $ (0.32) $ (82.27)
========= =========

Shares used in computing basic and
diluted net loss per share........................ 21,071 9,152
========= =========

Three Months Ended Nine Months Ended
September 30, September 30,
2001 2000 2001 2000
Revenues:
License $ 2,891 $ 23,730 $ 24,335 $ 46,633
Service 14,507 15,312 37,705 26,097
Total revenues 17,398 39,042 62,040 72,730
Cost of revenues:
License 503 918 1,789 1,719
Service (excluding stock-based compensation of
$311, $655, $1,019 and $2,345, respectively) 20,224 14,824 43,047 27,675
Total cost of revenues 20,727 15,742 44,836 29,394
Gross profit (loss) (3,329 ) 23,300 17,204 43,336
Operating expenses:
Sales and marketing (excluding stock-based
compensation of $1,653, $2,250, $5,117 and
$5,175, respectively) 19,205 25,749 59,528 58,297
Research and development (excluding stock-based
compensation of $1,542, $658, $2,254 and $2,357,
respectively) 10,236 12,993 29,458 29,291
General and administrative (excluding stock-based
compensation of $671, $227, $2,149 and $826,
respectively) 9,500 6,347 18,091 11,929
Restructuring costs 32,081 — 86,338 —
Merger and transition related costs 4,841 — 11,517 6,564
Amortization of deferred stock-based compensation 4,177 3,790 10,539 10,703
Amortization of goodwill and identifiable intangibles 13,551 312,865 114,133 559,908
Goodwill impairment — — 603,446 —
In process research and development — — — 6,900
Total operating expenses 93,591 361,744 933,050 683,592
Operating loss (96,920 ) (338,444 ) (915,846 ) (640,256 )
Other income, net 858 2,039 908 3,930
Loss from continuing operations (96,062 ) (336,405 ) (914,938 ) (636,326 )
Discontinued operation:
Income (loss) from operations of discontinued operation — 71 (125 ) 603
Loss on disposal, including provision of $1.1 million
for operating losses during phase-out period — — (3,667 ) —
Net loss $ (96,062 ) $ (336,334 ) $ (918,730 ) $ (635,723 )
Basic and diluted net loss per share:
Loss from continuing operations $ (0.53 ) $ (3.81 ) $ (7.55 ) $ (7.58 )
Income (loss) from discontinued operation $ — $ — $ (0.03 ) $ 0.01
Net loss $ (0.53 ) $ (3.81 ) $ (7.58 ) $ (7.57 )
Shares used in computing basic and diluted net loss per share 180,376 88,388 121,143 83,949
See accompanying notes to unaudited condensed consolidated financial statements.
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KANA SOFTWARE, INCSoftware, Inc.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)

Three Months Ended
March 31,
--------------------
2002 2001
--------- ---------
Cash flows from operating activities:
Net loss.............................................. $ (6,780) $(752,896)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation........................................ 2,264 3,911
Amortization of stock-based compensation, goodwill,
and identifiable intangible assets ............... 11,087 90,964
Goodwill impairment................................. -- 603,446
Elimination of negative goodwill.................... (3,901) --
Other non-cash charges.............................. -- 7,302
Changes in operating assets and liabilities,
net of effects from acquisitions:
Accounts receivable............................. (2,894) 16,177
Prepaid and other current assets................ (1,485) 1,965
Other assets.................................... 119 --
Accounts payable and accrued liabilities........ (8,044) (3,382)
Accrued restructuring and merger................ (13,639) --
Deferred revenue................................ 2,229 (1,917)
--------- ---------
Net cash used in operating activities............... (21,044) (34,430)
--------- ---------
Cash flows from investing activities:
(Purchases) sales of short-term investments........... (1,674) 22
Property and equipment purchases...................... (2,152) (8,166)
Payments related to past acquisition.................. -- (13,098)
Restricted cash....................................... 167 --
--------- ---------
Net cash used in investing activities........... (3,659) (21,242)
--------- ---------
Cash flows from financing activities:
Payments on notes payable............................. (72) (63)
Proceeds from issuance of common stock and
warrants............................................ 33,477 160
Payments on stockholders' notes receivable............ 591 843
--------- ---------
Net cash provided by financing activities....... 33,996 940
--------- ---------
Effect of exchange rate changes on cash and cash
equivalents............................................. 151 (746)
--------- ---------
Net increase (decrease) in cash and cash equivalents..... 9,444 (55,478)
Cash and cash equivalents at beginning of period......... 25,476 76,202
--------- ---------
Cash and cash equivalents at end of period............... $ 34,920 $ 20,724
========= =========
Supplemental disclosure of cash flow information:
Cash paid during the period for interest.............. $ 18 $ 45
========= =========
Cash paid during the period for income taxes.......... $ 72 $ --
========= =========
Non-cash activities:
Issuance of warrants to non-employees................. $ 4,749 $ --
========= =========

Nine Months Ended
September 30,
2001 2000
Cash flows from operating activities:
Net loss $ (918,730 ) $ (635,723 )
Adjustments to reconcile net loss to net cash used operating activities:
Depreciation 8,117 5,869
Other non-cash charges 755,764 577,511
Changes in operating assets and liabilities, net of effects from acquisitions:
Accounts receivable 38,149 (23,877 )
Prepaid and other current assets 9,043 (9,552 )
Other assets (830 ) —
Accounts payable and accrued liabilities 1,397 4,701
Accrued restructuring and merger 20,053 —
Deferred revenue (9,794 ) 16,584
Other liabilities (233 ) —
Net cash used in operating activities (97,064 ) (64,487 )
Cash flows from investing activities:
Sales of short-term investments, net 24,752 32,128
Property and equipment purchases (11,121 ) (23,782 )
Acquisitions, net of cash acquired 33,556 27,165
Restricted cash (7,800 ) —
Net cash provided by investing activities 39,387 35,511
Cash flows from financing activities:
Payments on notes payable (287 ) (3,093 )
Proceeds from issuance of common stock and warrants 1,486 124,794
Payments on stockholders' notes receivable 2,677 699
Net cash provided by financing activities 3,876 122,400
Effect of exchange rate changes on cash and cash equivalents (963 ) 766
Net increase (decrease) in cash and cash equivalents (54,764 ) 94,190
Cash and cash equivalents at beginning of period 76,202 18,695
Cash and cash equivalents at end of period $ 21,438 $ 112,885
Supplemental disclosure of cash flow information and noncash activities:
Cash paid during the year for interest $ 117 $ 225
Issuance of common stock and assumption of options
and warrants related to acquisitions $ 94,064 $ —
Issuance of warrants and common stock to non-employees $ 1,305 $ 15,800
See accompanying notes to unaudited condensed consolidated financial statements.
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KANA SOFTWARE, INC. AND SUBSIDIARIES

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
KANA Software, Inc.
Notes to Condensed Consolidated Financial Statements
(unaudited)Note 1. Basis of Presentation and Liquidity
The unaudited condensed consolidated financial statements have been prepared by KANA Software, Inc. ("KANA" or the "Company"), previously KANA Communications, Inc. and reflect all adjustments (all of which are normal and recurring in nature) that, in the opinion of management, are necessary for a fair presentation of the interim financial information. The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for any subsequent quarter or for the entire year ending December 31, 2001.2002. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted accounting principlesin the United States of America have been condensed or omitted under the Securities and Exchange Commission's ("SEC") rules and regulations. These unaudited condensed consolidated financial statements and notes included herein should be read in conjunction with KANA's audited consolidated financial statements and notes included in KANA's annual report on Form 10-K for the year ended December 31, 2000.2001.
The Company's consolidated financial statements have been presented on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company has incurred a consolidated net loss of approximately $919 million for the nine months ended September 30, 2001. Included in the aggregate net loss is an impairment charge to reduce goodwill of approximately $603 million recorded in the first quarter of the year.
The Company is evaluating various initiatives to improve its cash position, including raising additional funds to finance its business, implementing further restrictions on spending, negotiating the early release of certain restricted cash, and other cash flow initiatives. Additional financing may not be available on terms that are acceptable to the Company, especially in the uncertain market climate, and the Company may not be successful in implementing or negotiating such other arrangements to improve its cash position. If the Company raises additional funds through the issuance of equity or convertible debt securities, the percentage ownership of its stockholders would be reduced and these securities might have rights, preferences and privileges senior to those of its current stockholders. Any such financing will be dilutive to existing stockholders. If adequate funds are not available on acceptable terms, the Company's ability to achieve or sustain positive cash flows, maintain current operations, fund any potential expansion, take advantage of unanticipated opportunities, develop or enhance products or services, or otherwise respond to competitive pressures would be significantly limited.
Note 2. Investments
The Company considers all investments with an original maturity greater than three months and less than one year to be short-term investments. All investments with maturities greater than one year are categorized as long-term investments.
Note 3.2. Net Loss per Share
Basic net loss per share from continuing operations is computed using the weighted–averageweighted-average number of outstanding shares of common stock, excluding common stock subject to repurchase. Diluted net loss per share from continuing operations is computed using the weighted-average number of outstanding shares of common stock and, when dilutive, potential common shares from options and warrants using the treasury stock method to purchase common stock and common stock subject to repurchase using the treasury stock method.repurchase. The following table presents the calculation of basic and diluted net loss per share:share from continuing operations (in thousands, except net loss per share):
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Three Months Ended
September 30, Nine Months Ended
September 30,
2001 2000 2001 2000
Numerator: (in thousands, except per share amounts)
Loss from continuing operations $ (96,062 ) $ (336,405 ) $ (914,938 ) $ (636,326 )
Denominator:
Weighted-average shares of common stock outstanding 180,975 93,420 122,849 89,729
Less weighted-average shares subject to repurchase 599 5,032 1,706 5,780
Denominator for basic and diluted calculation 180,376 88,388 121,143 83,949
Basic and diluted net loss per share $ (0.53 ) $ (3.81 ) $ (7.55 ) $ (7.58 )

Three Months Ended
March 31,
--------------------
2002 2001
--------- ---------
Numerator:
Loss from continuing operations before
cumulative effect of accounting change .................... $ (10,681) $(753,154)
--------- ---------
Denominator:
Weighted-average shares of common stock outstanding ......... 21,096 9,423
Less weighted-average shares subject to repurchase .......... 25 271
--------- ---------
Denominator for basic and diluted calculation ............... 21,071 9,152
--------- ---------

Basic and diluted net loss per share from continuing
operations before cumulative effect of accounting change .. $ (0.51) $ (82.30)
========= =========

All warrants, outstanding stock options and shares subject to repurchase by KANA have been excluded from the calculation of diluted net loss per share because all such securities arewere anti-dilutive for all periods presented. The total number of shares excluded from the calculation of diluted net loss per share are as follows (in thousands):
Nine Months Ended
September 30,
2001 2000
Stock options and warrants 44,182 21,875
Common stock subject to repurchase 501 4,690
44,683 26,565

Three Months Ended
March 31,
--------------------
2002 2001
--------- ---------
Stock options and warrants .......... 6,632 2,133
Common stock subject to repurchase .. 22 240
--------- ---------
6,654 2,373
========= =========
The weighted average exercise price of stock options and warrants outstanding was $14.71$48.50 and $57.71$390.00 as of September 30,March 31, 2002 and 2001, and 2000, respectively.
Note 4.3. Comprehensive Loss
Comprehensive loss comprises the net loss and foreign currency translation adjustments. Comprehensive loss was $96.3$6.6 million and $335.3$753.6 million for the three months ended September 30,March 31, 2002 and 2001, and 2000, respectively. Comprehensive loss was $915.9 million and $634.7 million for the nine months ended September 30, 2001 and 2000, respectively.
Note 5.4. Stock-Based Compensation
In September 2000, the Company issued to Accenture 40,000 shares of common stock and a warrant to purchase up to 72,500 shares of common stock at $371.25 per share pursuant to a stock and warrant purchase agreement in connection with its global strategic alliance. The shares of the common stock issued were fully vested, and the Company recorded a deferred stock-based compensation charge of approximately $14.8 million to be amortized over the four-year term of the agreement. As of March 31, 2002, 33,077 shares of common stock subject to the warrant were fully vested and 19,423 had been forfeited, with the remainder to become vested upon the achievement of certain performance goals. The vested portion of the warrant was valued using the Black-Scholes model resulting in charges totaling $2.0 million of which $1.0 million is being amortized over the remaining term of the agreement and $1.0 million was immediately expensed in the fourth quarter of 2000. The Company will incur a charge to stock-based compensation for the unvested portion of the warrant when and if annual performance goals are achieved.
In June 2001, the Company entered into an agreement to issue to a customer a fully vested and exercisable warrant to purchase up to 250,00025,000 shares of common stock at $40.00 per share pursuant to a warrant purchase agreement. The Company has recorded deferred stock-based compensation of $330,000 for the warrant using the Black-Scholes model. This amount is being amortized as service is rendered as a reduction to revenue.
In September 2000, the Company issued to Accenture 400,000 shares of common stock and a warrant to purchase up to 725,000 shares of common stock pursuant to a stock and warrant purchase agreement in connection with its global strategic alliance. The shares of the common stock issued were fully vested and the Company has recorded a charge of approximately $14.8 million which is being amortized over the four-year term of the agreement. The portion of the warrant to purchase 125,000 shares of common stock is fully vested with the remainder becoming vested upon the achievement of certain performance goals. The vested warrants were valued using the Black-Scholes model resulting in a charge of $1.0 million which is being amortized over the four-year term of the agreement. The Company will incur a charge to stock-based compensation for the unvested portion of the warrant when performance goals are achieved. As of September 30, 2001, 430,000 shares of common stock under the warrant which are unvested had a fair value of approximately $18,600 based upon the fair market value of the Company's common stock at such date.
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In September, 2001, the Company issued to Accenture a warrant to purchase up to 1,500,000 shares of common stock pursuant to a warrant purchase agreement in connection with its global strategic alliance. The warrant is fully vested and exercisable as of September 2001. The warrants were valued using the Black-Scholes model resulting in a charge of approximately $946,000 which is being amortized over the four-year term of the agreement.
In September 8, 2001, the Company issued to a customer a warrant to purchase up to 50,0005,000 shares of common stock at $7.50 per share pursuant to a warrant purchase agreement. The warrant fully vests in September 2006 and has a provision for acceleration of vesting 12,5001,250 shares annually over four years if certain marketing criteria are met by the customer. The warrants werewarrant was valued using the Black-Scholes model resulting in a deferred stock-based compensation charge of approximately $29,000 which is being amortized over the five-year term of the agreement.
In September 2001, the Company issued to Accenture an additional warrant to purchase up to 150,000 shares of common stock pursuant to a warrant purchase agreement in connection with its global strategic alliance. The warrants were valued using the Black-Scholes model resulting in a deferred stock-based compensation charge of approximately $946,000 which is being amortized over the four-year term of the agreement. The warrants were exercised in March 2002.
In December 2001, the Company issued to two investment funds warrants to purchase up to 193,059 shares of common stock at $10.00 per share pursuant to proposed financing expected to be funded upon stockholder approval in February 2002. The warrants were valued using the Black-Scholes model resulting in a charge of approximately $1.0 million. On February 1, 2002, the stockholders voted against the proposed financing, which resulted in the Company terminating the share purchase agreement and , requiring the issuance of additional warrants to purchase up to 193,059 shares of common stock at $10.00 per share. The stockholder vote followed an announcement on January 14, 2002 of the decision by the Company's Board of Directors to withdraw its recommendation that its stockholders vote in favor of the proposed preferred stock transaction. Using the Black-Scholes model, the warrants issued in December 2001 were re-valued as of February 1, 2001, and the warrants issued on February 1, 2002 were valued as of such date, resulting in a charge totaling approximately $4.7 million which was reflected as amortization of stock-based compensation in the statement of operations in the first quarter of 2002.
As of March 31, 2002, there was approximately $17.2 million of total deferred stock-based compensation remaining to be amortized relating to the above warrants and past employee option grants.
Note 6.5. Legal Proceedings
In April 2001, Office Depot, Inc. filed a complaint against the Company claiming the Company has breached its license agreement with Office Depot. Office Depot is seeking relief in the form of a refund of license fees and maintenance fees paid to teh Company, attorneys' fees and costs. The litigation is currently in its early stages. The Company intends to defend this claim vigorously and doed not expect it to have a material impact on its results of operations or cash flow.
The Company's underwriters for our initial public offering, Goldman Sachs & Co., Lehman Bros, Hambrecht & Quist LLC, Wit Capital Corp as well as the Company and certain current and former officers of the Company have been named as defendants in federal securities class action lawsuits filed in the United States District Court for the Southern District of New York. The cases allege violations of Section 11, 12(a)(2) and Section 15 of the Securities Act of 1933 and violations of Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934, on behalf of a class of plaintiffs who purchased the Company's stock between September 21, 1999 and December 6, 2000 in connection with the Company's initial public offering. Specifically, the complaints alleged that the underwriter defendants engaged in a scheme concerning sales of KANA'sthe Company 's securities in the initial public offering and in the aftermarket. These cases are stayed pending selection of lead counsel for the plaintiff class. Although theThe Company is in the early stages of analyzing the claims alleged against KANA and the individual defendants, the Company believes that it has good and valid defenses to these claims. The Companyclaims and intends to defend the action vigorously.
On April 24, 2001, Office Depot, Inc. ("Office Depot")16, 2002, Davox Corporation filed a complaintan action against KANAthe Company in the CircuitSuperior Court, forMiddlesex, Commonwealth of Massachusetts, in relation to an OEM Agreement between Davox and the 15th DistrictCompany under which Davox has paid a total of the Stateapproximately $1.6 million in fees, asserting breach of Florida claiming that KANA has breached its license agreement with Office Depot. Office Depotcontract, breach of implied covenant of good faith and fair dealing, unjust enrichment, misrepresentation, and unfair trade practices. Davox seeks actual and punitive damages in an amount to be determined at trial, and award of attorneys' fees. This action is seeking relief in the form of a refund of license fees and maintenance fees paid to KANA, attorneys' fees and costs. The litigation is currently in its early stages and the Company has not received material information or documentation. KANAyet been served upon the Company. The Company is in the early stages of its review of these claims and intends to defend itself from this claim vigorouslythe matter vigorously.
The ultimate outcome of any litigation is uncertain, and does not expect iteither unfavorable or favorable outcomes could have a material negative impact on our results of operations, consolidated balance sheet and cash flows, due to materially impact its results from operations.
KANA is not currently a party to anydefense costs, diversion of management resources and other material legal proceedings.factors.
Note 7.6. Restructuring costs
For the three and nine months ended September 30,In 2001, the Company incurred restructuring charges of approximately $32.1 million and $86.3 million, respectively, related to the reductions in its workforce and costs associated with certain excess leased facilities and asset impairments.
For the three and nine months ended September 30, 2001, the Company recorded charges As of $1.9 million and $18.9 million, respectively, for the assets disposed of or removed from operations. Assets disposed of or removed from operations consisted primarily of leasehold improvements, computer equipment and related software, office equipment, and furniture and fixtures.
For the three and nine months ended September 30, 2001, the Company recorded charges of $6.0 million and $23.6 million, respectively, for severance, benefits and related costs due to the reduction in workforce. For the nine months ended September 30, 2001, the Company reduced its workforce by approximately 1,210 people, or 74% of our employee base. All functional areas have been affected by the reductions.
For the three and nine months ended September 30, 2001, the Company recorded charges of $24.2 million and $43.8 million, respectively, due to the Company's decision to exit and reduce some facilities. The estimated facility costs are based on current comparable rates for leases in the respective markets. Should facilities operating lease rental rates continue to decrease in these markets or should it take longer than expected to find a suitable tenant to sublease these facilities, the actual loss could exceed this estimate. Future cash outlays are anticipated through February 2011 unless the Company negotiates to exit the leases at an earlier date.
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For the nine months ended September 30, 2001, of the $86.3 million charge, $26.2 million relates to non-cash charges, cash payments totaled $29.6 million and $30.5March 31, 2002, $24.1 million in restructuring liabilities remain at September 30, 2001. The restructuring liability is included on the consolidated balance sheet in accrued restructuring and merger costs. Cash payments during the three months ended March 31, 2002 totaled $4.3 million. A summary of restructuring payments and liabilities during the first quarter of 2002 is as follows (in thousands):

Restructuring Restructuring
Accrual at Accrual at
December 31, March 31,
2001 Payments 2002
------------ --------- ------------
Severance......... $ 913 $ 565 $ 348
Facilities........ 27,418 3,702 23,716
------------ --------- ------------
Total ............ $ 28,331 $ 4,267 $ 24,064
============ ========= ============

Note 7. Goodwill and Purchased Intangible Assets
On January 1, 2002, the Company adopted Statement of Financial Accounting Standards No. 142,Goodwill and Other Intangible Assets("SFAS 142"). SFAS 142 requires goodwill to be tested for impairment under certain circumstances, written down when impaired, and requires purchased intangible assets other than goodwill to be amortized over their useful lives unless these lives are determined to be indefinite.
The Company ceased amortizing goodwill as of the beginning of fiscal 2002. If the non-amortization of goodwill provisions of SFAS 142 had been effective in 2001, net loss and basic and diluted net loss per share for the three months ended March 31, 2001, would have been $667,244, and $72.91, respectively. In addition, as part of the adoption of SFAS No. 142, negative goodwill, net of amortization, was eliminated and recognized as the cumulative effect of accounting. This amounted to approximately $3.9 million recognized in the first quarter of 2002.
Purchased intangible assets are carried at cost less accumulated amortization. Amortization is computed over the estimated useful lives of the respective assets, which is three years. The Company expects amortization expense on purchased intangible assets to be $4.8 million for fiscal 2002, and $1.5 million in fiscal 2003, at which time purchased intangible assets will be fully amortized.
The Company will also be required to perform a transition impairment analysis. The Company is currently in the process of completing the transitional impairment analysis, which it expects to complete by June 30, 2002 and currently does not foresee any impairment charge as a result. In addition, the Company will be required to perform an annual impairment test, which it expects to perform in the second quarter of each year.
Note 8. Goodwill impairment
The Company has performed an impairment assessment of the identifiable intangibles and goodwill recorded in connection with the acquisition of Silknet. The assessment was performed primarily due to the significant and sustained decline in the Company's stock price since the valuation date of the shares issued in the Silknet acquisition resulting in the Company's net book value of its assets prior to the impairment charge significantly exceeding the Company's market capitalization, the overall decline in the industry growth rates, and the Company's lower than projected operating results. As a result, the Company recorded an impairment charge of approximately $603 million to reduce goodwill in the quarter ended March 31, 2001. The charge was based upon the estimated discounted cash flows over the remaining useful life of the goodwill using a discount rate of 20%. The assumptions supporting the cash flows, including the discount rate, were determined using the Company's best estimates as of such date. The remaining goodwill balance excluding negative goodwill,is approximately $62.4 million, net of approximately $82.4 millionamortization, as of September 30, 2001 is being amortized over its remaining useful life.March 31, 2002.
Note 9. Segment Information
The Company'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, the Company considers itself to be in a single industry segment, specifically the license, implementation and support of its software applications. The Company's long-livedlong- lived assets are primarily in the United States. Geographic information on revenue for the three months ended March 31, 2002 and nine months ended September 30, 2001 and 2000 are as follows (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
2001 2000 2001 2000
United States $ 14,930 $ 33,526 $ 52,806 $ 63,195
International 2,468 5,516 9,234 9,535
$ 17,398 $ 39,042 $ 62,040 $ 72,730
Three Months Ended
March 31,
--------------------
2002 2001
--------- ---------
United States ....................... $ 15,088 $ 20,024
International ....................... 10,055 3,447
--------- ---------
$ 25,143 $ 23,471
========= =========

During the three and nine months ended September 30, 2001, no customerMarch 31, 2002, Company A represented more than 10%22% of total revenues. During the three months ended March 31, 2001, Company B represented 13% of total revenues.
Note 10. Notes Payable and Commitments
TheAs of March 31, 2002, the Company hasmaintains a line of credit providing for borrowings of up to $5.0$4.0 million as of September 30, 2001 to be used for qualified equipment purchases or working capital needs. Borrowings under the line of credit are collateralizedfacility which is secured by all of the Company'sits assets, and bearbears interest at the bank's prime rate plus .5% (6.5%...25%, and expires in March 2003 at which time the entire balance under the line of September 30, 2001).credit is due. Total borrowings as of September 30, 2001March 31, 2002 were $1,187,000 and theapproximately $1.1 million under this line of credit also supported letters of credit totaling $1.3 million.credit. The line of credit contains certain financial covenants.a covenant that requires the Company to maintain at least a $6.0 million dollar balance in any account with the bank. In lieu of this minimum balance covenant the Company may also cash-secure the facility with funds equivalent to 115% of the outstanding debt obligation. The line of credit also requires that the Company maintain at all times a minimum of $20.0 million as short-term unrestricted cash and cash equivalents. As of September 30, 2001,March 31, 2002 the Company was in compliance with its financialall covenants as amended. Thisof its line of credit expires on November 30, 2001. The Company is in discussions with the bank regarding the renewal of this line of credit, and KANA currently believes that it will be available for renewal should the Company so desire. However, there can be no assurance the bank will renew the line of credit and no guarantee the terms will be acceptable to the Company.agreement.
In the quarter ended September 30, 2001, the Company issued a letter of credit totaling $5.8 million in connection with a contractual agreement. During the quarter ended September 30, 2001 the Company transferred $5.8 million to support a letter of credit and also transferred $2.0 million of cash into an escrow account to fulfill certain contractual agreements. These amounts are reflected in restricted cash in the accompanying condensed consolidated balance sheet.
Note 11. Discontinued Operation
As of the quarter ended June 30, 2001, the Company adopted a plan to discontinue the KANA Online business. The Company will no longer seekseeks new business but will continuecontinued to service all ongoing contractual obligations it hashad to its existing customers.customers through April 2002. Accordingly, KANA Online is reported as a discontinued operation for the three and nine months ended September 30,
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2001March 31, 2002 and 2000. Net assets of the discontinued operation at September 30, 2001, consisted primarily of computers and servers.2001. The estimated loss on the disposal of KANA Online is $3.7 million, consisting of an estimated loss on disposal of the assets of $2.6 million and a provision of $1.1 million for the anticipated operating losses during the phase-out period. The loss on disposal was recorded in the second quarter of 2001. This operation has been presented as a discontinued operation for all periods presented. The KANA Online operating results are as follows (in thousands):
Three Months
Ended Nine Months
Ended
September 30 September 30,
2001 2000 2001 2000
Revenues $ 208 $ 1,601 $ 3,161 $ 4,086
Income (loss) from operations of discontinued operation $ — $ 71 $ (125 ) $ 603
Loss on disposal — — (3,667 ) —
Total income (loss) on discontinued operations $ — $ 71 $ (3,792 ) $ 603

Three Months Ended
March 31,
2002 2001
--------- ---------
Revenues .............................................. $ -- $ 1,642
========= =========

Total income from operations of discontinued operation $ -- $ 258
========= =========

Note 12. Acquisition of Broadbase
On June 29, 2001, the Company finalizedcompleted the acquisition of Broadbase. In connection with the merger, each share of Broadbase common stock outstanding immediately prior to the consummation of the merger was converted into the right to receive 1.050.105 shares of KANA common stock (the "Exchange Ratio") and KANA assumed Broadbase's outstanding stock options and warrants based on the Exchange Ratio, issuing approximately 86.78.7 million shares of KANA common stock and assuming options and warrants to acquire approximately 26.62.7 million shares of KANA common stock. The transaction was accounted for using the purchase method of accounting.
The preliminary allocation of the purchase price at September 30, 2001March 31, 2002 to assets acquired and liabilities assumed is as follows (in thousands):
Tangible assets acquired $ 125,144
Deferred compensation 15,485
Liabilities assumed (37,111 )
Deferred credit – negative goodwill (2,146 )
Net assets acquired $ 101,372

Tangible assets acquired .................................... $ 125,144
Deferred compensation ....................................... 15,485
Liabilities assumed ......................................... (34,975)
Deferred credit - negative goodwill ......................... (4,282)
-----------
Net assets acquired ......................................... $ 101,372
===========

Deferred compensation recorded in connection with the merger will be amortized over a four-year period. NegativeOn January 1, 2002, negative goodwill, willnet of amortization, totaled $3.9 million and was eliminated and recognized as the effect of accounting change in the first quarter of 2002 upon adoption of SFAS 142.
In connection with the acquisition, the Company incurred $13.4 million of merger-related expenses including professional fees, integration and transition costs in 2001. As of March 31, 2002, approximately $0.8 million of these costs remain on the consolidated balance sheet in accrued restructuring and merger costs and are expected to be amortized over its estimated useful life of three years.paid in 2002.
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The estimated purchase price was approximately $101.4 million, measured as the average fair market value of KANA's outstanding common stock from April 7 to April 11, 2001, two trading days before and after the merger agreement was announced plus the Black-Scholes calculated value of the options and warrants of Broadbase assumed by KANA in the merger, and other costs directly related to the merger is as follows (in thousands):
Fair market value of common stock $ 81,478
Fair market value of options and warrants assumed 12,586
Acquisition–related costs 7,308
Total $ 101,372
In connection with the Broadbase merger, KANA recorded $11.5 million

Fair market value of merger-related integration expensescommon stock ........................... $ 81,478
Fair market value of options and transitionwarrants assumed ........... 12,586
Acquisition-related costs during the nine months ended September 30, 2001. These amounts consisted primarily of transitional personnel of $5.3 million and duplicate facility and insurance costs, redundant assets, and professional fees associated with the merger of $6.2 million.
................................... 7,308
-----------
Total ....................................................... $ 101,372
===========

The following unaudited pro forma net revenues, net loss and net loss per share data for the ninethree months ended September 30,March 31, 2001 and 2000 are based on the respective historical financial statements of the Company and Broadbase. The pro forma data reflects the consolidated results of operations as if the merger with Broadbase occurred at the beginning of each of the periods indicated and includes the amortization of the resulting negative goodwill and deferred compensation. The pro forma results include the results of pre-acquisition periods for companies acquired by Broadbase prior to its acquisition by KANA. The pro forma financial data presented are not necessarily indicative of the Company's results of operations that might have occurred had the transaction been completed at the beginning of the periods specified, and do not purport to represent what the Company's consolidated results of operations might be for any future period.period (in thousands, except per share amount).
(Unaudited Pro forma)
Nine Months Ended
September 30,
2001 2000
(In thousands, except per share amounts)
Net revenues $ 88,517 $ 139,911
Net loss $ (1,940,910 ) $ (1,130,724 )
Basic and diluted net loss per share $ (10.85 ) $ (6.20 )
Shares used in basic and diluted net loss per share calculation 178,929 182,281

Pro Forma
Three
Months
Ended
March 31,
2001
-----------
(Unaudited)
Net revenues ................................................ $ 37,008
Net loss .................................................... $(1,745,172)
Basic and diluted net loss per share ........................ $ (98.21)

Shares used in basic and
diluted net loss per share calculation .................... 17,769

Note 13. Recent Accounting Pronouncements
In JulyNovember 2001, the Financial Accounting Standards BoardEmerging Issues Task Force ("FASB"EITF") concluded that reimbursements for out-of-pocket-expenses incurred should be included in revenue in the income statement and subsequently issued SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 addresses financial accounting and reportingEITF 01-14, "Income Statement Characterization of Reimbursements Received for business combinations and supercedes Accounting Principals Board ("APB") No.16, Business Combinations. The provisions of SFAS No.141 are required to be adopted July 1, 2001. The most significant changes made by SFAS No.141 are: (1) requiring that the purchase method of accounting be used for all business combinations initiated after June 30, 2001, (2) establishing specific criteria for the recognition of intangible assets separately from goodwill, and (3) requiring unallocated negative goodwill to be written off immediately as an extraordinary gain.
SFAS No.142 primarily addresses the accounting for goodwill and intangible assets subsequent to their acquisition and supercedes APB No.17, Intangible Assets. The provisions of SFAS No. 142 are required to be adopted as of`Out-of- Pocket' Expenses Incurred" in January 1, 2002 for calendar year entities. The most significant changes made by SFAS No. 142 are: (1) goodwill and indefinite lived intangible assets will no longer be amortized, (2) goodwill will be tested for impairment at least annually at the reporting unit level, (3) intangible assets deemed to have an indefinite life will be tested for impairment at least annually, and (4) the amortization period of intangible assets with finite lives will no longer be limited to forty years.
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2002. The Company adopted SFAS No.141 effective July 1, 2001 which will result in the Company accounting for any business combination consummated on or after that date under the purchase method of accounting. The Company will also apply the non-amortization provisions of SFAS No. 142 for any business combination consummated on or after July 1, 2001. The adoption of SFAS No. 141 will not change the method of accounting used in previous business combinations.
The Company is required upon adoption of SFAS No. 142EITF 01-14 effective January 1, 2002 which will resultand has reclassified comparative financial statements for prior periods to comply with the guidance in the Company no longer amortizing its existing goodwill. At September 30, 2001, goodwill was $80.5this EITF. The adoption of this issue resulted in approximately $107,000 and $1.5 million of reimbursable expenses reflected in both service revenue and goodwill amortization expense was $13.6 million and $114.1 millioncost of service revenue for the three and nine months ended September 30,March 31, 2002 and 2001, respectively. In addition, the Company will be required to measure goodwill for impairment effective January 1, 2002 as part of the transition provisions. Any impairment resulting from the transition provisions will be recorded as of January 1, 2002 and will be recognized as the effect of a change in accounting principle. The Company will not be able to determine if an impairment will be required until completion of such impairment test. In addition, at September 30, 2001, negative goodwill approximated $2.1 million. The Company will be required as part of the adoption of SFAS No. 142 to immediately recognize the unamortized negative goodwill that exists on January 1, 2002. This adjustment will be recognized as the effect of a change in accounting principle.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", which is required to be applied starting with fiscal years beginning after December 15, 2001. SFAS No. 144 requires, among other things, the application of one accounting model for long-lived assets that are impaired or to be disposed of by sale. The adoption of SFAS No. 144 is not expected to have a significant impact on the Company's financial statements or results of operations.
Note 14. Subsequent Event
In October 2001, the Board of Directors approved a resolution authorizing a one for ten reverse stock split. At a stockholders' meeting to be held in December 2001, the stockholders will vote on this resolution. This one for ten reverse stock split has not been reflected in the accompanying unaudited condensed financial statements or notes thereto.
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Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations
ThisThe following discussion of our financial condition and results of operations and other parts of this report containscontain 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","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 uncertainties,other factors, some of which are beyond our control, are difficult to predict and could cause actual results to differ materially fromfrom" those expressed or forecasted in the forward-looking statements. These risks and uncertainties include those described in under the heading "Risk Factors Associated with KANA's Business and Future Operating Results"Factors" 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,statements, which reflect our management's view only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise.
Overview
We are a leading provider of enterprise Customer Relationship Management (eCRM) software solutions that deliver integrated communication and business applications built on a Web-architectured platform. Our software helps our customers to better service, market to, and understand their customers and partners, while improving results and decreasing costs in contact centers and marketing departments. We offer a multi-channel customer relationship management solution that combines our KANA eCRM Architecture with customer-focused service, marketing and commerce software applications. These applications enable organizations to improve customer and partner relationships by allowing them to interact with their customers and partners through Web contact, Web collaboration, e-mail and telephone.
We were incorporated in July 1996 in California and were reincorporated in Delaware in September 1999. We had no significant operations until 1997. In February 1998, we released the first commercially available version of the KANA platform. To date, we have derived substantially all of our revenues from licensing our software and related services, and we have sold our products worldwide primarily through our direct sales force.
Our customers range from Global 2000 companies pursuing an e-business strategy to growing companies.
On June 29, 2001, we completed a merger with Broadbase under which Broadbase became our wholly–owned subsidiary. Broadbase is a leading provider of software solutions that enable companies to conduct highly effective, intelligent customer interactions through the Internet and traditional business channels, thereby providing the basis for businesses to improve their customer acquisition, retention and profitability. Broadbase's web-based product suite combines operational marketing and service applications with customer analytics.
In connection with the merger, each share of Broadbase common stock outstanding immediately prior to the consummation of the merger was converted into the right to receive 1.05 shares of KANA common stock (the "Exchange Ratio") and KANA assumed Broadbase's outstanding stock options and warrants based on the Exchange Ratio, issuing approximately 86.7 million shares of KANA common stock and assuming options and warrants to acquire approximately 26.6 million shares of KANA common stock. TheBroadbase. This transaction was accounted for using the purchase method of accounting. The aggregate consideration approximated $101.4 million which includes KANA common stock issued to Broadbase's stockholders as well as assumed options and warrants and acquisition-related costs.
In April 2000, we acquired Silknet Software, Inc. and the transaction was accounted for using the purchase method of accounting.
In the third quarter of 1999, we initiated our KANA Online business. Our KANA Online business provided a hosted environment of our software to customers. Our servers for this business are maintained by third-party service providers. In the second quarter of 2001, we adopted a plan to discontinue the KANA Online business. We have accounted for our KANA Online business as a discontinued operation.
We derive our revenues from the sale of software product licenses and from professional services including implementation, consulting, training, education and maintenance. License revenue is recognized when persuasive evidence of an agreement exists, the product has been delivered, the arrangement does not involve significant customization of the software by us, the license fee is fixed or determinable and collection of the fee is probable.reasonably assured. If the arrangement involves significant customization of the software by us, the fee, excluding the portion attributable to maintenance, is recognized using the percentage-of-completion method. Service revenue includes revenues from maintenance contracts, implementation, consultingtraining and hostingconsulting services. Revenue from maintenance contracts is recognized ratably over the term of the contract. Revenue from implementation, consultingtraining, and hostingconsulting services is recognized as the
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services are provided. Revenue under arrangements where multiple products or services are sold together is allocated to each element based on their relative fair values.
Our cost of license revenue includes royalties due to third parties for technology integrated into some of our products, the cost of product documentation, the cost of the media used to deliver our products and shipping costs. Cost of service revenue consists primarily of personnel–related expenses, subcontracted consultants, travel costs, equipment costs and overhead associated with delivering professional services to our customers.
Our operating expenses are classified into three general categories: sales and marketing, research and development, and general and administrative. We classify all charges to these operating expense categories based on the nature of the expenditures. Although each category includes expenses that are unique to the category, some expenditures, such as compensation, employee benefits, recruiting costs, equipment costs, travel and entertainment costs, facilities costs and third–party professional services fees, occur in each of these categories.
Since 1997, we have incurred substantial operating costs to develop our products and expenses, as well as noncash charges.to recruit, train and compensate personnel for our engineering, sales, marketing, client services and administration departments. As a result, we have incurred substantial losses since inception. For the ninethree months ended September 30, 2001,March 31, 2002, we have incurred a consolidated net loss of $6.8 million. Included in the net loss is a gain of approximately $919$3.9 million related to the write-off of negative goodwill as the cumulative effect of accounting change, and approximately $11.1 million of amortization expense related to non-cash stock compensation and amortization of intangibles. As of March 31, 2002, we had an accumulated deficit of approximately $4.1$4.2 billion. We believeexpect our future success is contingent upon providing superior customer service, increasing our customer base and revenues, controlling our costs, and developing our products.operating losses in 2002 to continue to be less than comparative periods in 2001.
In order to streamline operations, reduce costs and bring our staffing and structure in line with industry standards, we restructured our organization in each quarter ofthroughout 2001 with net workforce reductions totaling approximately 1,210772 employees. With the acquisition of Broadbase, we added approximately 400896 employees. As of September 30, 2001,March 31, 2002, we had approximately 425 employees.
We believe that our prospects must be considered in light of the risks, expenses and difficulties frequently experienced by companies in early stages of development, particularly companies in new and rapidly evolving markets like ours. Although we have experienced revenue growth in the past, our revenues hashave declined in recent periods, and we may not be able to achieve revenue growth in the future, particularly in light of increasing competition in our markets, the weak economy, and declines incontinued low corporate expenditures on enterprise software products. Furthermore, we may not achieve or maintain profitability in the future.
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Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect our reported assets, liabilities, revenues and expenses, and our related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to revenue recognition, collectibility of receivables, goodwill and intangible assets, contract loss reserve, product warranties, income taxes, and restructuring. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. This forms the basis of judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
We believe the following critical accounting policies and the related judgments and estimates significantly affect the preparation of our consolidated financial statements:
Revenue recognition. In addition to determining our results of operations for a given period, our revenue recognition determines the timing of certain expenses, such as commissions and royalties. Revenue recognition rules for software companies are very complex, and certain judgments affect the application of our revenue policy. The amount and timing of our revenue is difficult to predict, and any shortfall in revenue or delay in recognizing revenue could cause our operating results to vary significantly from quarter to quarter and could result in future operating losses.
License revenue is recognized when there is persuasive evidence of an arrangement, delivery to the customer has occurred, the arrangement does not require significant customization of the software, the fee is fixed or determinable and collectibility is reasonably assured.
In software arrangements that include rights to multiple software products and/or services, we allocate the total arrangement fee among each of the deliverables using the residual method, under which revenue is allocated to undelivered elements based on vendor-specific objective evidence of fair value of such undelivered elements and the residual amounts of revenue are allocated to delivered elements. Elements included in multiple element arrangements could consist of software products, maintenance (which includes customer support services and unspecified upgrades), or consulting services. Vendor-specific objective evidence is based on the price charged when an element is sold separately or, in the case of an element not yet sold separately, the price established by authorized management, if it is probable that the price, once established, will not change before market introduction. Determining whether vendor-specific objective evidence exists is subject to judgment, and resulting fair values used in determining the value of undelivered elements is also subject to judgment and estimates.
Probability of collection is based upon the assessment of the customer's financial condition through the review of their current financial statements or credit reports. For follow-on sales to existing customers, prior payment history is also used to evaluate probability of collection.
Revenues from customer support services are recognized ratably over the term of the contract, typically one year. Consulting revenues are primarily related to implementation services performed on a time-and-materials basis or, in certain situations, on a fixed-fee basis, under separate service arrangements. Implementation services are periodically performed under fixed-fee arrangements and in such cases, consulting revenues are recognized on a percentage-of- completion basis. Revenues from consulting and training services are recognized as services are performed.
Reserve for Loss Contract. We are party to a contract with a customer that involves a fixed fee as payment for services upon meeting certain milestone criteria. We estimate the total expected costs of providing services necessary to complete the contract and compare these costs to the fees expected to be received under the contract. As a result of our recent restructuring in 2001, substantially all of the remaining services are being provided by a third party. Since the costs are expected to exceed the associated fees received, loss reserves are recorded and expensed in cost of service revenues. Estimates of applicable costs are subject to revision and could vary materially from estimates, resulting in either increases or decreases in the estimated loss reserve which could have a material impact on cost of service revenues in future periods.
Collectibility of Receivables. A considerable amount of judgment is required to assess the ultimate realization of receivables, including assessing the probability of collection and the current credit-worthiness of each customer. We have recorded significant increases in the allowance for doubtful accounts in fiscal 2001 due to the rapid downturn in the economy, and in the technology sector in particular. There is no assurance that we will not need to record increases to the allowance in the future.
Accounting for Internal Use Software. Software development costs, including costs incurred to purchase third party software are capitalized beginning when we have determined factors are present, including among others, that technology exists to achieve the performance requirements, buy versus internal development decisions have been made and the we have authorized the funding for the project. Capitalization of software costs ceases when the software is substantially complete and is ready for its intended use and is amortized over its estimated useful life of generally five years using the straight-line method. As of March 31, 2002, we had $6.5 million of capitalized costs of internal use software.
When events or circumstances indicate the carrying value of internal use software might not be recoverable, we will assess the recoverability of these assets by determining whether the amortization of the asset balance over its remaining life can be recovered through undiscounted future operating cash flows. The amount of impairment, if any, is recognized to the extent that the carrying value exceeds the projected discounted future operating cash flows and is recognized as a write down of the asset. In addition, if it is no longer probable that computer software being developed will be placed in service, the asset will be adjusted to the lower of its carrying value or fair value, if any, less direct selling costs. Any such adjustment would result in an expense in the period recorded, which could have a material adverse effect on our consolidated statement of operations.
Restructuring. During 2001, we recorded significant reserves in connection with our restructuring program. These reserves include estimates pertaining to contractual obligations related to excess leased facilities. We have worked with external real estate advisors in each of the markets where the properties are located so that we may estimate the amount of the accrual. This process involves significant judgments regarding these markets. If the real estate market continues to worsen, additional adjustments to the reserve may be required, which would result in additional restructuring expenses in the period in which such determination is made. Likewise, if the real estate market strengthens, and we are able to sublease the properties earlier or at more favorable rates than projected, adjustments to the reserve may be required that would increase income in the period in which such determination is made.
Goodwill and Intangible Assets. Consideration paid in connection with acquisitions is required to be allocated to the acquired assets, including identifiable intangible assets, and liabilities acquired. Acquired assets and liabilities are recorded based on our estimate of fair value, which requires significant judgment with respect to future cash flows and discount rates. For intangible assets, we are required to estimate the useful life of the asset and recognize its cost as an expense over the useful life. We use the straight-line method to expense long-lived assets, which results in an equal amount of expense in each period. We regularly evaluate acquired businesses for potential indicators of impairment of goodwill and intangible assets. Our judgments regarding the existence of impairment indicators are based on market conditions, operational performance of our acquired businesses and identification of reporting units. Future events could cause us to conclude that impairment indicators exist and that goodwill and other intangible assets associated with our acquired businesses are impaired. Beginning in fiscal 2002, the methodology for assessing potential impairments of intangibles changed based on new accounting rules issued by the Financial Accounting Standards Board. Any resulting impairment loss could have a material adverse impact on our financial condition and results of operations.
Warranty Allowance. We must make estimates of potential warranty obiligations. We actively monitor and evaluate the quality of our software and analyze any historical warranty costs when we evaluate the adequacy of our warranty allowance. Significant management judgments and estimates must be made and used in connection with establishing the warranty allowance in any accounting period. Material differences may result in the amount and timing of our expenses for any period if management made different judgments or utilized different estimates. To date our provisions for warranty allowance have been immaterial.
Income taxes. We are required to estimate our income taxes in each of the jurisdictions in which we operate as part of the process of preparing our consolidated financial statements. This process involves us estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as deferred revenue, for tax and accounting purposes. These differences result in deferred tax assets and liabilities. We must then assess the likelihood that our net deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not likely, we must establish a valuation allowance. While we have considered future taxable income in assessing the need for the valuation allowance, in the event we were to determine that we would be able to realize our deferred tax assets in the future in excess of its net recorded amount, an adjustment to the deferred tax asset would be made, increasing income in the period in which such determination was made.
Contingencies and Litigation. We are subject to proceedings, lawsuits and other claims. We assess the likelihood of any adverse judgments or outcomes to these matters as well as ranges of probable losses. A determination of the amount of loss contingency required, if any, for these matters are made after careful analysis of each individual matter. The required loss contingencies may change in the future as the facts and circumstances of each matter changes.
Selected Results of Operations Data
The following table sets forth selected data for periods indicated expressed as a percentage of total revenues.
Three Months
Ended September 30, Nine Months
Ended September 30,
2001 2000 2001 2000
Revenues:
License 17 % 61 % 39 % 64 %
Service 83 39 61 36
Total revenues 100 100 100 100
Cost of revenues:
License 3 2 3 2
Service 116 38 69 38
Total cost of revenues 119 40 72 40
Gross profit (loss) (19) 60 28 60
Selected operating expenses:
Sales and marketing 110 66 96 80
Research and development 59 33 47 40
General and administrative 55 % 16 % 29 % 16 %Three and Nine Months Ended
September 30,March 31,
------------------------------
2002 2001
Revenues: ------------- ---------------
License...................... $ 15,129 60 % $ 11,857 51 %
Service...................... 10,014 40 11,614 49
-------- ---- -------- ----
Total revenues.................... 25,143 100 23,471 100
-------- ---- -------- ----

Cost of revenues:
License...................... 965 4 633 3
Service...................... 3,907 16 16,403 70
-------- ---- -------- ----
Total cost of revenues............ 4,872 19 17,036 73
-------- ---- -------- ----
Gross profit...................... 20,271 81 6,435 27
-------- ---- -------- ----

Selected operating expenses:
Sales and 2000
marketing.......... 10,305 41 26,534 113
Research and development..... 6,638 26 12,949 55
General and administrative... $ 3,220 13 % $ 6,068 26 %

Three Months Ended March 31, 2002 and 2001

Revenues

~~License revenue decreased 88%~~Total revenues increased 7% for the three months ended ~~September 30, 2001~~March 31, 2002 compared to the same period in the prior year, primarily as a result of sales of products and maintenance services formerly offered by Broadbase, as discussed below.

License revenue increased 28% for the three months ended March 31, 2002 compared to the same period in the prior year due ~~primarily~~ to ~~a decrease~~sales of products formerly offered by Broadbase, which were not included in ~~the number of license transactions. We believe this is due~~our revenues prior to the ~~overall weakness in the economy and external market factors, particularly the uncertainty in the market subsequent to the events of September 11, 2001. For the nine months ended September 30,~~June 2001 ~~compared to the same period in the prior year, license revenue decreased by 48%. This year-to-date decrease is primarily due to the overall weakness in the economy in 2001.~~merger. As a percentage of total revenue, license revenue comprised ~~17% and 39%~~60% of total revenues during the three ~~and nine~~ months ended ~~September 30, of 2001, respectively,~~March 31, 2002, compared to ~~61% and 64%, respectively,~~51% for the same ~~periods~~period last year. ~~The decrease~~This increase is due to ~~the overall decrease in~~ our ~~license business, which is more susceptible~~decision to ~~rapid market changes than~~focus on sales of licenses and to leverage third party integrators for providing implementation services to our ~~service revenue.~~customers. We anticipate license revenue will increase as a percentage of total revenue in the future due to our shift to leverage third party integrators for providing implementation services to our customers. We expect this shift towards a greater proportion of license fees to improve our overall gross margin percentage in 2002 from 2001.

Service revenue decreased by 5%14% for the three months ended ~~September 30, 2001~~March 31, 2002 compared to the same period in the prior year. This primarily results from the reduction in license revenue from the second quarter of 2001 compared to the second quarter of 2000. For the nine months ended September 30, 2001 compared to the same period in the prior year, service revenue increased by 44%. This was a result of the increased revenue from customer implementations, system integration projects and maintenance contracts during the first six months of 2001. We anticipate that service revenue will decrease in ~~absolute dollars in the future due to~~services personnel throughout 2001 and our shift to leverage third party integrators for providing implementation services to our customers.

Revenues from international sales were ~~$2.5~~$10.1 million and ~~$5.5~~$3.4 million in the three months ended ~~September 30, 2001~~March 31, 2002 and ~~2000 and $9.2 million and $9.5 million for the nine months ended September 30, 2001 and 2000.~~2001. The ~~decrease during the third quarter of 2001~~increase in 2002 in international revenues is ~~related~~primarily a result of revenues recognized from one new customer in the United Kingdom which accounted for approximately $5.5 million in revenue in the three months ended March 31, 2002. We expect that the percentage of international revenues for the remainder of 2002 to be lower than in the three months ended March 31, 2002, but greater than in the same periods in 2001.

Cost of Revenues

Total cost of revenues decreased by 71% for the three months ended March 31, 2002 compared to the same ~~economic factors impacting our total revenues. Our international~~period in the prior year, due to decreased cost of services revenues ~~were derived from sales in Europe, Canada, Asia Pacific and Latin America.~~

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~~Cost of Revenues~~as discussed below.

Cost of license revenue consists primarily of third party software royalties, product packaging, documentation, and production and delivery costs for shipments to customers. Cost of license revenue as a percentage of license revenue was ~~higher than usual at 17%~~6% for the three months ended ~~September 30, 2001~~March 31, 2002 compared to 4%5% in the same period in the prior year. ~~For the nine months ended September 30, 2001 compared~~The increase in 2002 was due to the ~~same period~~change in the ~~prior year,~~mix of products shipped. We expect that cost of license revenue ~~increased~~ as a percentage of license ~~revenue to 7% from 4%. The increases in 2001 are~~revenues will fluctuate within a few percentage points throughout 2002 due to the ~~reduced license revenue and fixed nature of some of the license costs,~~current royalty agreements which entail various royalties calculations based upon units shipped, as well as ~~an increase in royalties from the prior year periods.~~revenue recognized.

Cost of service revenue consists primarily of salaries and related expenses for our customer support, implementation and training services organization and allocation of facility costs and system costs incurred in providing customer support. Cost of service revenue ~~increased~~decreased to ~~139%~~39% of service revenue for the three months ended ~~September 30, 2001~~March 31, 2002 compared to ~~97%~~141% for the same period in the prior year. This is primarily due to ~~a change~~the shift in service revenue mix following the ~~estimated costs to complete recorded~~decision late in the third quarter of ~~2001. Cost~~2001 to increase use of third-party integrators to provide implementation services to our customers. As a result, support revenues, which have yielded better margins than training and consulting revenues , constituted a larger percentage of service revenue increased to 114% of service revenues for the nine months ended September 30, 2001 compared to 106% the same period in the prior year. This is primarily due to the change in the estimated costs to complete recorded in the third quarter of 2001.revenues.

We anticipate that cost of service revenue will decrease in absolute dollars in ~~the future~~2002 compared to comparative periods in 2001 due to net reductions of 108 positions, or 59%, in services personnel ~~in preparation for our shift~~from 183 as of March 31, 2001 to ~~leverage third party integrators for providing implementation services to our customers.~~75 as of March 31, 2002.

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,~~lead-generation programs and marketing collateral materials. Sales and marketing expenses decreased by ~~$6.5~~$16.2 million for the three months ended ~~September 30, 2001~~March 31, 2002 compared to the same period in the prior ~~year~~year. This decrease was attributable primarily ~~as a result of~~to the net reduction of 163 sales ~~and~~positions (56%) from 290 as of March 2001 to 127 as of March 2002, as well as 38 marketing ~~personnel, and~~positions (66%) from 58 as of March 31, 2001 to ~~a lesser extent,~~20 as of March 31, 2002, mostly due to our restructuring activities throughout 2001. In addition, there were decreases ~~in sales commissions associated with decreased revenues and decreases in marketing costs, primarily~~ in advertising and promotional ~~activities. Sales and marketing expenses increased by $1.2 million for~~activities in the ~~nine~~three months ended ~~September 30, 2001~~March 31, 2002 compared to the same period in the prior ~~year due to higher personnel and operating costs in the first three months of 2001 to support the growth in that period.~~year.

We anticipate that sales and marketing expenses will decrease in absolute dollars in the ~~fourth quarter~~second and third quarters of 2002 compared to comparative periods in 2001 and thereafter may increase or decrease, depending primarily on the volume of future revenues and our assessment of market opportunities and sales channels.

Research and Development. Research and development expenses consist primarily of compensation and related costs for research and development employees and contractors and enhancement of existing products and quality assurance activities. Research and development expenses decreased ~~$2.8~~by $6.3 million for the three months ended ~~September 30, 2001~~March 31, 2002 compared to the same period in the prior year attributable primarily to the net reduction of 114 research and development positions (44%), from 257 as of March 31, 2001 to 143 as of March 31, 2002, primarily due to ~~the reduction of personnel~~our restructuring activities throughout 2001, and related ~~benefits and~~decreases in our facility costs. Research and development expenses were slightly higher by $0.2 million for the nine months ended September 30, 2001 compared to the same period in the prior year due to higher personnel and operating costs in the first three months of 2001 to support the growth in that period.

We anticipate that research and development expenses ~~will decrease~~may increase slightly in absolute dollars in the ~~fourth quarter~~second and third quarters of ~~2001~~2002 and thereafter may increase or decrease, depending primarily on the volume of future revenues, customer needs, and our assessment of market demand.

General and ~~Administrative~~.Administrative. General and administrative expenses consist primarily of compensation and related costs for administrative personnel, bad debt expenses, and of legal, accounting and other general corporate expenses. General and administrative expenses ~~increased~~decreased $2.8 million for the three months ended ~~September 30, 2001~~March 31, 2002 compared with the same period in the prior year attributable primarily to a net decrease of 33 general and administrative positions (35%), from 93 as of March 31, 2001 to 60 as of March 31, 2002, primarily due to an increase in bad debt expense. General and administrative expenses were higher for the nine months ended September 30, 2001 compared to the same period in the prior year due to higher personnel and operating costs in the first three months of 2001 to support the growth in that period.our restructuring activities throughout 2001.

We anticipate that general and administrative expenses will ~~decrease~~be fairly consistent with the first quarter of 2002 in absolute dollars infor the ~~fourth quarter of 2001~~next two quarters and thereafter may increase or decrease, depending primarily on the volume of future revenues and corporate infrastructure requirements including insurance, professional services, bad debt expense and other administrative costs.

Restructuring Costs. For the three ~~and six~~ months ended ~~September 30,~~March 31, 2001, we incurred restructuring charges of approximately ~~$32.1~~$19.9 million ~~and $86.3 million, respectively,~~ related to the reduction in workforce and costs associated with certain excess leased facilities and asset impairments.

~~For the three and nine months ended September 30, 2001, we recorded charges~~ As of $1.9 million and $18.9 million, respectively, for the assets disposed of or removed from operations. Assets disposed of or removed from operations consisted primarily of leasehold improvements, computer equipment and related software, office equipment, furniture and fixtures.

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For the three and nine months ended September 30, 2001, we recorded charges of $6.0 million and $23.6 million, respectively, for severance, benefits and related costs due to the reduction in workforce. For the nine months ended September 30, 2001, we reduced our workforce by approximately 1,210 people, or 74% of our employee base. All functional areas have been affected by the reductions.

For the three and nine months ended September 30, 2001, we recorded charges of $24.2 million and $43.8 million, respectively, due to the Company's decision to exit and reduce some facilities. The estimated facility costs are based on the Company's contractual obligations, net of assumed sublease income based on current comparable rates for leases in the respective markets. Should facilities operating lease rental rates continue to decrease in these markets or should it take longer than expected to find a suitable tenant to sublease these facilities, the actual loss could exceed this estimate. Future cash outlays are anticipated through February 2011 unless we negotiate to exit the leases at an earlier date.

~~For the nine months ended September 30, 2001, of the $86.3 million charge, $26.2 million relates to non-cash charges, cash payments totaled $29.6 million and $30.5~~March 31, 2002, $24.1 million in restructuring liabilities remain ~~at September 30, 2001. The restructuring liability is included~~ on the consolidated balance sheet in accrued restructuring and merger costs.

~~Merger and Transition Related Costs.~~ ~~In connection with the Broadbase merger, for~~ Cash payments during the three ~~and nine~~ months ended ~~September 30, 2001, we recorded $4.8 million~~March 31, 2002 totaled $4.3 million. A summary of restructuring payments and ~~$11.5 million, respectively, of transition costs and merger–related integration expenses. For~~liabilities during the three and nine months ended September 30, 2001, the estimated costs include transitional personnel costs of $3.1 million and $5.3 million, respectively. For the three and nine months ended September 30, 2001, the estimated costs include duplicate facility and insurance costs, redundant assets, and professional fees associated with the merger of $1.7 million and $6.2 million, respectively.

~~In connection with the Silknet merger, we recorded $6.6 million of merger–related integration expenses in the second~~first quarter of ~~2000. These amounts consisted primarily of merger–related advertising and announcements of $4.5 million and duplicate facility costs of $1.0 million.~~2002 is as follows (in thousands):


                           Restructuring             Restructuring
                            Accrual at                Accrual at
                           December 31,                March 31,
                                2001      Payments        2002
                           ------------   ---------  ------------
      Severance.........  $        913  $      565  $        348
      Facilities........        27,418       3,702        23,716
                           ------------   ---------  ------------
      Total ............  $     28,331  $    4,267  $     24,064
                           ============   =========  ============

Amortization of Deferred ~~Stock–Based Compensation~~.Stock-Based Compensation. We are amortizing deferred stock-based compensation on an accelerated basis by charges to operations over the vesting period of the options, consistent with the method described in FASB Interpretation No. 28.

As of ~~September 30, 2001,~~March 31, 2002, there was approximately ~~$24.9~~$17.2 million of total ~~unearned~~ deferred stock-based compensation remaining to be ~~amortized.~~amortized related to warrants and past employee option grants.

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


                                         Three Months Ended
                                              March 31,
                                           2002       2001
                                        ---------  ---------
Cost of service ...................... $     383  $     431
Sales and marketing ..................     2,033      1,865
Research and development .............     1,897        434
General and administrative ...........     5,574      1,382
                                        ---------  ---------
Total ................................ $   9,887  $   4,112
                                        =========  =========

Three Months
Ended September 30,
Nine Months
Ended September 30,
2001
2000
2001
2000
Cost of service $ 311 $ 655 $ 1,019 $ 2,345
Sales and marketing 1,653 2,250 5,117 5,175
Research and development 1,542 658 2,254 2,357
General and administrative 671 227 2,149 826

Total $ 4,177 $ 3,790 $ 10,539 $ 10,703

Amortization of Goodwill and Identifiable ~~Intangibles~~.Intangibles. Amortization of goodwill and identifiable intangibles for the three months ended ~~September 30, 2001~~March 31, 2002 was ~~$13.6~~$1.2 million compared to ~~$312.9 million in the same period in the prior year. Amortization for the nine months ended September 30, 2001 was $114.1 million compared to $559.9~~$86.9 million in the same period in the prior year. This decrease iswas primarily related to the ~~impairment charges~~adoption of FAS 142 effective January 1, 2002 which requires that goodwill is no longer amortized. The amortization in 2002 relates to ~~goodwill~~purchased technology recorded as an intangible asset in connection with the merger with Silknet. We expect amortization of intangible assets to be $1.2 million in each quarter of 2002 unless intangible assets are purchased in the ~~fourth quarter of 2000 and first quarter of 2001.~~future.

Goodwill Impairment. We performed an impairment assessment of the identifiable intangibles and goodwill recorded in connection with the acquisition of Silknet. The assessment was performed primarily due to the significant sustained decline in our stock price since the valuation date of the shares issued in the Silknet acquisition resulting in our net book value of our assets prior to the impairment charge significantly exceeding our market capitalization, the overall decline in the industry growth rates, and our lower than projected operating results. As a result,

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we recorded an impairment charge of approximately $603 million to reduce goodwill in the first quarter of 2001. The charge was based upon the estimated discounted cash flows over the remaining useful life of the goodwill using a discount rate of 20%. The assumptions supporting the cash flows, including the discount rate, were determined using our best estimates. The remaining goodwill balance, ~~excluding negative goodwill,~~net of amortization, was approximately ~~$82.4~~$62.4 million ~~is being amortized over its remaining useful life.~~at March 31, 2002.

~~In Process Research and Development.~~ ~~In connection with the merger of Silknet, net intangibles of $6.9 million were allocated to in process research and development in the second quarter of 2000.~~

Other Income, Net.

Other income, net during the three ~~and nine~~ months ended ~~September 30,~~March 31, 2002 and 2001 ~~and 2000~~ consists primarily of interest income earned on cash and investments, offset by interest expense relating to operating and capital leases. We expect other income to fluctuate in accordance with our cash balances as well as the prime interest rate.

Provision for Income ~~Taxes.~~ Taxes

We have incurred operating losses for all periods from inception through ~~September 30, 2001,~~March 31, 2002, 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.

Discontinued ~~Operation.~~Operation

During the second quarter of 2001, we adopted a plan to discontinue the KANA Online business. We will no longer seek new business but will continue to service all ongoing contractual obligations we have to our existing customers. Accordingly, KANA Online is reported as a discontinued ~~operation for the three and nine months ended September 30, 2001 and 2000.~~operation. Net assets of the discontinued operation at ~~September 30, 2001,~~March 31, 2002, consisted primarily of ~~computers and servers.~~accounts receivable. The estimated loss on the disposal of KANA Online recorded during the second quarter of 2001 was $3.7 million, consisting of an estimated loss on disposal of the business of $2.6 million and a provision of $1.1 million for the anticipated operating losses during the phase-out period.

There was no revenue from our discontinued operation for the three months ended March 31, 2002. Revenues from our discontinued operation for the three months ended ~~September 30,~~March 31, 2001, were ~~$208,000 compared to~~ $1.6 ~~million in the same period in the prior year. Revenues for the nine months ended September 30, 2001 were $3.2 million compared to $4.1 million in the same period in the prior year.~~million.

Net ~~Loss.~~ Loss

Our net loss was approximately ~~$96.1~~$6.8 million for the three months ended ~~September 30, 2001~~March 31, 2002 and approximately ~~$4.1~~$4.2 billion since inception. In the past, we ~~have~~ experienced substantial increases in our expenditures consistent with growth in our operations and personnel through the first quarter of 2001. In addition, goodwill impairment, amortization of goodwill and identifiable intangibles, restructuring costs and stock-based compensation charges ~~have~~ contributed to the significant increase in net loss during ~~2001.~~ We2001 and 2000. Although we anticipate that our expenditures will ~~decrease~~be lower in 2002 than in 2001 due to ~~the recent~~ cost reduction ~~initiatives.~~initiatives, we cannot be certain that we will attain profitability.

Liquidity and Capital Resources

As of March 31, 2002, we had $51.2 million in cash, cash equivalents and short-term investments and working capital of $19.6 million. In addition, as of March 31, 2002, we had $10.9 million in restricted cash. This is comprised of amounts related to a letter of credit totaling $5.8 million and $2.0 million of cash escrowed in order to fulfill certain contractual obligations. In addition, restricted cash included $3.1 million deposited as collateral on our leased facilities and other long-term deposits.

Our operating activities used ~~$97.1~~$21.0 million of cash for the ~~nine~~three months ended ~~September 30, 2001, primarily due~~March 31, 2002, including $13.6 million in payments relating to merger and restructuring liabilities, an $8.0 million decrease in accounts payable and accrued liabilities and the ~~$918.7~~$6.8 million net loss experienced during the period offset by ~~$763.9~~$9.5 million in non-cash charges. Other working capital changes totaled a $2.0 million, net, resulting in a net decrease in cash. Our operating activities used $34.4 million of cash for the three months ended March 31, 2001, due to the $752.9 million net loss experienced during the period offset by $705.6 million in non-cash charges and ~~$57.8~~$12.8 million, ~~increase~~net, in ~~operating assets and liabilities, primarily accounts receivable and accrued restructuring and merger costs.~~other working capital decreases.

Our investing activities ~~provided $39.4~~used $3.7 million of cash for the ~~nine~~three months ended ~~September 30, 2001,~~March 31, 2002, resulting from ~~a net of $46.7~~$2.2 million of acquired cash from the acquisition of Broadbase offset by Silknet acquisition related payments of $13.1 million, and net maturities of short-term investments of $24.8 million, offset by $11.1 million in purchases of property and equipment purchases and ~~$7.8~~$1.7 million of short-term investment purchases. Our investing activities used $21.2 million of cash for the three months ended March 31, 2001 due to $13.1 million paid in ~~restricted cash.~~connection with acquisitions and $8.2 million of property and equipment purchases.

Our financing activities provided ~~$3.9~~$34.0 million in cash for the ~~nine~~three months ended ~~September 30,~~March 31, 2002, primarily due to net proceeds from the private placement of 2,910,000 shares of our common stock, which raised net proceeds of approximately $31.4 million. Our financing activities provided $1.0 million in cash for the three months ended March 31, 2001, primarily due to ~~proceeds from~~ payments on stockholders' notes ~~receivable and issuance of common stock in connection with employee option exercises and employee stock purchase plans.~~receivable.

At ~~September 30, 2001,~~March 31, 2002, we had ~~cash and cash equivalents aggregating $21.4 million and short–term investments totaling $30.5 million.~~

~~We have~~ a line of credit totaling ~~$5.0~~$4.0 million, which is ~~secured~~collateralized by all of our assets, bears interest at the bank's prime rate plus ~~.5% (6.5%~~0.25% (5.0% as of ~~September 30, 2001).~~March 31, 2002), and expires in March 2003 at which time the entire balance under the line of credit is due. Total borrowings as of ~~September 30, 2001~~March 31, 2002 were ~~$1,187,000~~approximately $1.1 million under this line of credit. The line of credit requires that we maintain at least a $6.0 million dollar balance in any account at the bank or that we provide cash collateral with funds equivalent to 115% of the outstanding debt obligation. The line of credit also requires that we maintain at all times a minimum of $20.0 million as short-term unrestricted cash and cash equivalents. If we default under this line of credit, including through a violation of this covenant, the entire balance under the line of credit ~~supported letters of credit totaling $1.3 million. The line of credit contains certain financial covenants.~~will become immediately due and payable. As of ~~September 30, 2001,~~March 31, 2002, we were in compliance with ~~the~~all covenants ~~as amended. This line~~ of ~~credit expires on~~

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November 30, 2001. We are in discussions with the bank regarding the renewal of this line of credit, and we currently believe that it will be available for renewal should we so desire. However, there can be no assurance the bank will renew the line of credit ~~and no guarantee the terms will be acceptable~~agreement.

Throughout 2001, to us. In the quarter ended September 30, 2001, we issued a letter of credit totaling $5.8 million in connection with a contractual agreement. During the quarter ended September 30, 2001 we transferred $5.8 million to support a letter of credit and also transferred $2.0 million of cash into an escrow account to fulfill certain contractual agreements. These amounts are reflected in restricted cash in the accompanying condensed consolidated balance sheet.

In the past, we have experienced substantial increases in expenditures consistent with growth in our operations and personnel. Our independent accountants have included a paragraph in their report for the year ended December 31, 2000, indicating that substantial doubt exists as to our ability to continue as a going concern. To reduce our expenditures, we restructured in several areas, including reduced staffing, expense management and capital spending. ~~For the first nine months, we reduced our~~This restructuring included net workforce byreductions of approximately ~~74%,~~772 employees, which were implemented in order to streamline operations, eliminate redundant positions after the merger with Broadbase, and reduce costs and bring our staffing and structure in line with industry ~~standards.~~standards and current economic conditions. These reductions have been significant, particularly in light of the increase of approximately 896 employees upon our merger with Broadbase in June of 2001. Our most recent reduction in force, ~~was announced to employees on September 28, 2001,~~ which reduced staff by approximately 365 positions across all ~~departments.~~departments, was announced on September 28, 2001. We expect our cash and cash equivalents and short-term investments on hand will be sufficient to meet our working capital and capital expenditure needs for the next 12 months. ~~We expect to continue to experience negative cash flows through the first quarter of 2002.~~ Significant expected cash ~~flows~~outflows through the ~~second quarter~~remainder of 2002 include approximately ~~$20~~$6.0 million in payments relating to accrued merger and restructuring costs, as well as approximately $7$8.0 million of expenditures on certain corporate ~~infrastructure. We are evaluating various initiatives to improve~~infrastructure including internal-use software. If we experience a decrease in demand for our ~~cash position, including raising additional funds to finance our business, implementing further restrictions on spending, negotiating~~products from the ~~early release of certain restricted cash and other cash flow initiatives. Additional financing may not be available on terms that are acceptable to us, especially~~level experienced in the ~~uncertain market climate, and~~first quarter of 2002, then we ~~may not be successful in implementing~~would need to reduce expenditures to a greater degree than anticipated, or ~~negotiating such other arrangements to improve our cash position. 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 were not available on acceptable terms, our ability to achieve or sustain positive cash flows, maintain current operations, fund any potential expansion, take advantage of unanticipated opportunities, develop or enhance products or services, or otherwise respond to competitive pressures would be significantly limited.if possible.

Our expectations as to when we can achieve positive cash flows, and as to our future cash balances, are subject to a number of assumptions, including assumptions regarding anticipated increases in our revenue, improvements in general economic conditions and customer purchasing and payment patterns, many of which are beyond our control.

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RISKS ASSOCIATED WITH KANA'S BUSINESS AND FUTURE OPERATING RESULTS

Our future operating results may vary substantially from period to period. The price of our common stock will fluctuate in the future, and an investment in our common stock is subject to a variety of risks, including but not limited to the specific risks identified below. The risks described below are not the only ones facing our company. Additional risks not presently known to us, or that we currently deem immaterial, may become important factors that impair our business operations. Inevitably, some investors in our securities will experience gains while others will experience losses depending on the prices at which they purchase and sell securities. Prospective and existing investors are strongly urged to carefully consider the various cautionary statements and risks set forth in this report and our other public filings. ~~In particular, this "Risk Factors Associated with KANA's~~

Risks Related to Our Business and Future Operating Results" contains cautionary statements that identify important factors that could cause actual results to differ materially from those anticipated in the forward-looking statements in this report.

Because we have a limited operating history, there is limited information upon which you can evaluate our business.

We are still in the early stages of our development, and our limited operating history makes it difficult to evaluate our business and prospects. 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. We were incorporated in July 1996 and first recorded revenue in February 1998. Thus, we have a limited operating history upon which you can evaluate our business and prospects. Due to our limited operating history, it is difficult or impossible to predict future results of operations. For example, we cannot forecast operating expenses based on our historical results because they are limited, and we are required to forecast expenses in part on future revenue projections. Moreover, due to our limited operating history and evolving product offerings, our insights into trends that may emerge and affect our business are limited. In addition, in June 2001, we completed our ~~acquisition of~~merger with Broadbase. Because we have limited experience operating as a combined company, our business is even more difficult to evaluate. In addition, our business is subject to a number of risks, any of which could unexpectedly harm our results of operations. 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;~~

		~~execute our product development activities;~~

		~~anticipate and adapt to the changing Internet market;~~

		~~attract, retain and motivate qualified personnel;~~

		~~respond to actions taken by our competitors;~~

		~~continue to build an infrastructure to effectively manage growth and handle any future increased usage; and~~

		~~integrate acquired businesses, technologies, products and services.~~

attract more customers;
implement our sales, marketing and after-sales service initiatives, both domestically and internationally;
execute our product development activities;
anticipate and adapt to the changing Internet market;
attract, retain and motivate qualified personnel;
respond to actions taken by our competitors;
continue to build an infrastructure to effectively manage growth and handle any future increased usage; and
integrate acquired businesses, technologies, products and services.

Our quarterly revenues and operating results may fluctuate in future periods and we may fail to meet the expectations of investors and public market analysts, which could 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 are uncertain. We believe that period-to-period comparisons of our operating results may not be meaningful and you should not rely on these comparisons as an indication of our future performance. If quarterly revenues or operating results fall below the expectations of investors or public market analysts, the price of our common stock could decline

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substantially. Factors that might cause quarterly fluctuations in our operating results include the factors described inunder the subheadings ~~below~~of this "Risks Associated with KANA's Business and Future Operating Results" section as well as:

		~~the evolving and varying demand for customer communication software products and services for e-businesses, particularly our products and services;~~

		~~budget and spending decisions by information technology departments of our customers;~~

		~~costs associated with integrating Broadbase and our other recent acquisitions, and costs associated with any future acquisitions;~~

		~~our ability to manage our expenses;~~

		~~the timing of new releases of our products;~~

		~~changes in our pricing policies or those of our competitors;~~

		~~the timing of execution of large contracts that materially affect our operating results;~~

		~~uncertainty regarding the timing of the implementation cycle for our products;~~

		~~changes in the level of sales of professional services as compared to product licenses;~~

		~~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;~~

		~~decisions by customers and potential customers to delay purchasing our products;~~

		~~a trend of continuing consolidation in our industry; and~~

		~~global economic conditions, as well as those specific to our customers or our industry.~~

the evolving and varying demand for our customer communication software products and services for e-businesses;
budget and spending decisions by information technology departments of our customers;
costs associated with integrating Broadbase and our other recent acquisitions, and costs associated with any future acquisitions;
our ability to manage our expenses;
the timing of new releases of our products;
changes in our pricing policies or those of our competitors;
the timing of execution of large contracts that materially affect our operating results;
uncertainty regarding the timing of the implementation cycle for our products;
changes in the level of sales of professional services as compared to product licenses;
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;
decisions by customers and potential customers to delay purchasing our products;
a trend of continuing consolidation in our industry; and
global economic and political conditions, as well as those specific to our customers or our industry.

We also often offer volume-based pricing, which may affect operating margins.

In addition, Broadbase, which we recently acquired, has experienced seasonality in its revenues, with the fourth quarter of the year typically having the highest revenue for the year. We believe that this seasonality primarily results ~~primarily~~ from customer budgeting cycles. We expect that this seasonality will continue, and could increase. In addition, the average size of our license transactions has increased in recent periods as we have focused on larger enterprise customers and on licensing our more comprehensive integrated products, and as our revenues become dependent on fewer transactions, they become less predictable. Customers' decisions to purchase our products and services are discretionary and subject to their internal budgets and purchasing processes. Due to the continuing slowdown in the general economy and the uncertainties resulting from recent acts of terrorism, we believe that many existing and potential customers are reassessing or reducing their planned technology and ~~internet-related~~Internet-related investments and deferring purchasing decisions. ~~As a result, there is increased uncertainty with respect to our expected revenues in the remainder of 2001 and in 2002, and further~~Further delays or reductions in business spending for information technology could have a material adverse effect on our revenues and operating results. As a result, there is increased uncertainty with respect to our expected revenues.

Our revenues in any quarter depend on a relatively small number of relatively large orders.

Our quarterly revenues are especially subject to fluctuation because they depend on the completion of relatively large orders for our products and related services. The average size of our license transactions has increased in recent periods as we have focused on larger enterprise customers and on licensing our more comprehensive integrated products. We expect the percentage of larger orders as related to total orders to increase. This dependence on large orders makes our net revenue and operating results more likely to vary from quarter to quarter because the loss of any particular large order is significant. As a result, our operating results could suffer if any large orders are delayed or cancelled in any future period.

Our expenses are generally fixed and we will not be able to reduce these expenses quickly if we fail to meet our revenue forecasts.

Most of our expenses, such as employee compensation and rent, are relatively fixed in the short term. Moreover, our ~~expense levels are~~budget is based, in part, on our expectations regarding future revenue levels. As a result, if total revenues for a particular quarter are below expectations, we

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could not proportionately reduce operating expenses for that quarter. ~~Therefore, this~~Accordingly, such a revenue shortfall would have a disproportionate effect on our expected operating results for that quarter.

~~We have a history of losses and may not be profitable in the future and may not be able to generate sufficient revenue or funding to continue as a going concern.~~

Since we began operations in 1997, our revenues have not been sufficient to support our operations, and we have incurred substantial operating losses in every quarter. As of September 30, 2001, our accumulated deficit was approximately $4.1 billion. Our history of losses has caused some of our potential customers to question our viability, which has in turn hampered our ability to sell some of our products. Although our revenues grew significantly in 2000, we have experienced a significant decline in sales over the nine months ended September 30, 2001. Our revenue has been affected by the increasingly uncertain economic conditions both generally and in our market and our revenue may decline, or fail to grow, in future periods. Although we have restructured our operations to reduce operating expenses, we will need to significantly increase our revenue to achieve profitability and positive cash flows. Our expectations as to when we can achieve positive cash flows, and as to our future cash balances, are subject to a number of assumptions, including assumptions regarding improvements in general economic conditions and customer purchasing and payment patterns, many of which are beyond our control. In addition we may require additional financing, which might not be available on acceptable terms, if at all. Our independent accountants have included a paragraph in their report for the year ended December 31, 2000 indicating that substantial doubt exists as to our ability to continue as a going concern.

As a result of uncertainties in our business, we have experienced and expect to continue to experience difficulties in collecting outstanding receivables from our customers and attracting new customers. As a result, we may continue to experience losses, even if sales of our products and services grow.

We recently reduced the size of our professional services team and, as a result, expect to rely more on independent third-party providers for customer services such as product installations and support. However, if third parties do not provide the support our customers need, we may be required to hire subcontractors to provide these professional services. Increased use of subcontractors would harm our revenues and margins because it costs us more to hire subcontractors to perform these services than to provide the services ourselves.

Our failure to complete our expected sales in any given quarter could dramatically harm our operating results because of the large size of typical orders.

Our sales cycle is subject to a number of significant risks, including customers' budgetary constraints and internal acceptance reviews, over which we have little or no control. Consequently, if sales expected from a specific customer in a particular quarter are not realized in that quarter, we are unlikely to be able to generate revenue from alternate sources in time to compensate for the shortfall. As a result, and due to the relatively large size of a typical order, a lost or delayed sale could result in revenues that are lower than expected. Moreover, to the extent that significant sales occur earlier than anticipated, revenues for subsequent quarters may be lower than expected. Consequently, we face difficulty predicting the quarter in which sales to expected customers will ~~occur. This~~occur, which contributes to the uncertainty of our future operating results.

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 anywhere from 3 to 12 months in the United States and longer in foreign countries. Consequently, we face difficulty predicting the quarter in which expected sales ~~to expected customers~~ will actually occur. This contributes to fluctuations in our future operating results. Our sales cycle has required pre-purchase evaluation by a significant number of individuals in our customers' organizations. Along with third parties that often jointly market our software with us, we invest significant amounts of time and resources educating and providing information to prospective customers 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

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configuration necessary to deploy our products. In the event that the current economic downturn were to continue, the sales cycle for our products may become longer and we may require more resources to complete ~~sales.~~sales

We have a history of losses and may not be profitable in the future and may not be able to generate sufficient revenue to achieve and maintain profitability.

Since we began operations in 1997, our revenues have not been sufficient to support our operations, and we have incurred substantial operating losses in every quarter. As of March 31, 2002, our accumulated deficit was approximately $4.2 billion. Our history of losses has previously caused some of our potential customers to question our viability, which has in turn hampered our ability to sell some of our products. Although this concern has been mitigated by our recently completed financing in February 2002, we may continue to encounter such customer concerns in the future. Additionally, our revenue has been affected by the increasingly uncertain economic conditions both generally and in our market. As a result of these conditions, we have experienced and expect to continue to experience difficulties in collecting outstanding receivables from our customers and attracting new customers, which means that we may continue to experience losses, even if sales of our products and services grow. Although our revenues grew significantly in 2000, we experienced a significant decline in sales for the fiscal year ended December 31, 2001. Although we have restructured our operations to reduce operating expenses, we will need to increase our revenue to achieve profitability and positive cash flows, and our revenue may decline, or fail to grow, in future periods. Our expectations as to when we can achieve positive cash flows, and as to our future cash balances, are subject to a number of assumptions, including assumptions regarding improvements in general economic conditions and customer purchasing and payment patterns, many of which are beyond our control.

We reduced the size of our professional services team in 2001 and, as a result, expect to rely more on independent third-party providers for customer services such as product installations and support. However, if third parties do not provide the support our customers need, we may be required to hire subcontractors to provide these professional services. Increased use of subcontractors would harm our revenues and margins because it costs us more to hire subcontractors to perform these services than to provide the services ourselves.

If we fail to expand our direct and indirect sales channels, we will not be able to increase revenues.

In order to grow our business, we need to increase market awareness and sales of our products and services. To achieve this goal, we need to increase the size, and enhance the productivity, of our direct sales force and indirect sales channels. If we fail to do so, this failure could harm our ability to increase revenues. The expansion of our sales and marketing department will require the hiring and retention of personnel for whom there is a high demand. We plan to hire additional sales personnel, but competition for qualified sales people is intense, and we might not be able to hire a sufficient number of qualified sales people. See "-We may face difficulties in hiring and retaining qualified sales personnel to sell our products and services, which could impair our revenue growth." Furthermore, while historically we have received substantially all of our revenues from direct sales, we intend to increase sales through indirect sales channels by selling our software through systems integrators, or SIs. These SIs offer our software products to their customers together with consulting and implementation services or integrate our software solutions with other software. We expect to increase our reliance on SIs and other indirect sales channels in licensing our products. If this strategy is successful, our dependence on the efforts of third parties will increase. Our reliance upon third parties for these functions will reduce our control over such activities andcould make us dependentupon them. SIs are not bound to sell our products exclusively, and may act as indirect sales channelsfor ou r competitors. In addition, SIs are not required to sell any fixed quantities of our products. If for some reason our SI partners do not adequately promote our products, we will lack a sufficient internal sales infrastructure to do so ourselves, andour product visibility, sales and revenues would decline .

Difficulties in implementing our products could harm our revenues and margins.

We generally recognize revenue from a customer sale 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 or determinable and collection of the fee is probable. If an arrangement requires significant customization or implementation services from KANA, recognition of the associated license and service revenue could be delayed. The timing of the commencement and completion of the these services is subject to factors that may be beyond our control, as this process requires access to the customer's facilities and coordination with the customer's personnel after delivery of the software. In addition, customers could delay product implementations. 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.

We may incur non-cash charges resulting from acquisitions and equity issuances, which could harm our operating results.

In connection with outstanding stock options and warrants to purchase shares of our common stock, as well as other equity rights we may issue, we are incurring and may incur substantial charges for stock-based compensation. Accordingly, significant increases in our stock price could result in substantial non-cash ~~accounting~~ charges and variations in our results of operations. For example, in the first quarter of 2002, we incurred a stock-based compensation charge of approximately $4.7 million associated with warrants issued pursuant to an equity financing agreement that was terminated. Furthermore, we will continue to incur charges to reflect amortization and any impairment of ~~goodwill and other~~identified intangible assets acquired in connection with our acquisition of Silknet, ~~in April 2000,~~ and we may make other acquisitions or issue additional stock or other securities in the future that could result in further accounting charges. In ~~particular,~~addition, a new standard for accounting for goodwill acquired in a business combination has recently been adopted. This new standard ~~which we will adopt for 2002,~~ requires recognition of goodwill as an asset but does not permit amortization of goodwill. Instead goodwill must be separately tested for impairment. As a result, our goodwill amortization charges ~~will cease~~ceased in 2002. However, ~~it is possible that~~ in the future, we ~~would~~may incur less frequent, but potentially larger, impairment charges related to the goodwill already recorded, as well as goodwill arising out of any future acquisitions. Current and future accounting charges like these could result in significant losses and delay our achievement of net income.

~~We have appointed an entirely new executive team, and the integration of these officers may interfere~~The reductions in force associated with our ~~operations.~~

As a result of the merger, most of Broadbase's executives have been appointed to corresponding positions with us, replacing most of our executive team. We appointed Chuck Bay as Chief Executive Officer and President, replacing James C. Wood and David B. Fowler, respectively, both of whom were appointed to their respective positions in January 2001. We also appointed Brett White as Chief Financial officer, replacing Art M. Rodriguez who was appointed on an interim basis in February 2001. In addition to Chuck Bay and Brett White, our current management team consists of Tom Doyle as Chief Operating Officer and Executive Vice President, Worldwide Sales, Services, Bud Michael as Executive Vice President, Products, Chris Maeda as Chief Technology Officer and Vicki Amon-Higa as Vice President, Integration, and all of whom were employees and officers of Broadbase. The transitions of Mssrs. Bay, White and the other executive team members have resulted and will continue to result in disruption to our ongoing operations. These transitions may materially harm the way that the market perceives us, which could cause a decline in the price of our common stock.

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~~Our workforce reduction and financial performance~~cost-reduction initiatives may adversely affect the morale and performance of our personnel and our ability to hire new personnel.

In connection with our effort to streamline operations, reduce costs and bring our staffing and structure in line with industry standards, ~~KANA and Broadbase~~we restructured ~~their organizations~~our organization in ~~the first nine months of~~ 2001, ~~with~~an effort that included substantial reductions in ~~their collective~~our workforce. ~~KANA has continued to restructure operations subsequent to the merger of KANA and Broadbase, during the third quarter of 2001.~~ There have been and may continue to be substantial costs associated with the workforce ~~reduction related to~~reductions, including severance and other employee-related costs, and our restructuring plan may yield unanticipated consequences, such as attrition beyond our planned reduction in workforce. As a result of these reductions, our ability to respond to unexpected challenges may be impaired and we may be unable to take advantage of new opportunities. We also reduced our employees' salaries in the fourth quarter of 2001 in order to bring employee compensation in-line with current market conditions. If market conditions change, we may find it necessary to raise salaries in the future beyond the anticipated levels, or issue additional stock-based compensation, which would be dilutive to shareholders.

In addition, many of the employees who were terminated possessed specific knowledge or expertise that may prove to have been important to our operations. In that case, their absence may create significant difficulties. This personnel reduction may also subject us to the risk of litigation, which may adversely impact our ability to conduct our operations and may cause us to incur significant expense.

We may be unable to hire and retain the skilled personnel necessary to develop and grow our business.

~~Recently, we restructured our organization and terminated a significant number of employees in the process. This reduction~~Our recent reductions in force and salary levels may reduce employee morale and may create concern among existing employees about job security, which ~~may~~could lead to increased turnover and reduce our ability to meet the needs of our current and future customers. As a result of the ~~reduction~~reductions in force, we may also 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.~~customers. Although a number of technology companies have recently implemented lay-offs, ~~there remains~~ substantial competition for experienced personnel remains, particularly in the San Francisco Bay Area, where we are headquartered, due to the limited number of people available with the necessary technical skills. Because our stock price has recently suffered a significant decline, stock-based compensation, including options to purchase our common stock, may have diminished effectiveness as employee hiring and retention devices. Further, our ability to hire and retain qualified personnel might be diminished as a result of the acquisition of Broadbase. Employees may experience uncertainty about their future role with us until post-merger personnel strategies are executed. KANA and Broadbase have different corporate cultures, and employees of either company may not want to work for us as a combined company. In addition, competitors may recruit employees during our integration of Broadbase, as is common in high technology mergers. If we are unable to retain qualified personnel, ~~that are critical to the successful integration of the companies,~~ we could face disruptions to operations, loss of key information, expertise or know-how and unanticipated additional recruitment and training costs. If employee turnover increases, our ability to provide client service and execute our strategy would be negatively affected.

~~We may face difficulties in hiring and retaining qualified sales personnel to sell our products and services, which could impair our revenue growth.~~

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~~our direct sales force. We might not be successful in these efforts. Our products and services require sophisticated sales efforts. There is a shortage of sales personnel with the requisite qualifications, and competition for such qualified personnel is intense in our industry. Also, it may take a new salesperson a number of months to become a productive member of our sales force. Our business will be harmed if we fail to hire or retain qualified sales personnel, or if newly hired salespeople fail to develop the necessary sales skills or develop these skills more slowly than anticipated. In addition, we recently announced the departure of our Chief Financial Officer. Turnover in management can cause disruptions to ongoing operations, and transitioning to a new Chief Financial Officer, or any other executive officer, could create negative perceptions of us among our customers and investors.

If our relationships with systems integrators are unsuccessful, our ability to market and sell our product will be limited.

We expect a significant percentage of our revenues to be derived from our relationships with domestic and international systems integrators, or SIs, that market and sell our products. If these SIs do not successfully market our products, our operating results will be materially harmed. In addition, many of our direct sales are to customers that will be relying on SIs to implement our products, and if SIs are not familiar with our ty=echnology or able to successfully implement our products, our operating results will be materially harmed. Because our relationships with SIs are relatively new, we cannot predict the degree to which the SIs will succeed in marketing and selling our solution. In addition, because the SI model for selling software is relatively new and unproven in the eCRM industry, we cannot predict the degree to which our potential customers will accept this delivery model. If the SIs fail to deliver and support our solution, end-users could decide not to subscribe, or cease subscribing, for our solution. The SIs typically offer our solution in combination with other products and services, some of which may compete with our solution.

We rely on marketing, technology and distribution relationships for the sale, installation and support of our products that may generally be terminated at any time, and if our current and future relationships are not successful, our growth might be limited.

We rely on marketing and technology relationships with a variety of companies that, in part, generate leads for the sale of our products. These marketing and technology relationships include relationships with:

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		~~system integrators and consulting firms;~~

		~~vendors of e-commerce and Internet software;~~

		~~vendors of software designed for customer relationship management or for management of organizations' operational information;~~

		~~vendors of key technology and platforms; and~~

		~~demographic data providers.~~

system integrators and consulting firms;
vendors of e-commerce and Internet software;
vendors of software designed for customer relationship management or for management of organizations' operational information;
vendors of key technology and platforms; and
demographic data providers.

If we cannot maintain successful marketing and technology relationships or if we fail to enter into additional marketing and technology relationships, we could have difficulty expanding the sales of our products and our growth might be limited. While some of these companies do not resell or distribute our products, we believe that many of our direct sales are the result of leads generated by vendors of e-business and enterprise software and we expect to continue relying heavily on sales from these relationships in future periods. Our marketing and technology relationships are generally not documented in writing, or are governed by agreements that can be terminated by either party with little or no prior notice. In addition, companies with which we have marketing, technology or distribution relationships may promote products of several different companies including those of our competitors. If these companies choose not to promote our products or if they develop, market or recommend software applications that compete with our products, our business will be harmed.

In addition, we rely on distributors, value-added resellers, systems integrators, consultants and other third-party resellers to recommend our products and to install and support these products. Our ~~recent~~ reduction in the size of our professional services team ~~increases~~in 2001 increased our reliance on third parties for product installations and support. If the companies providing these services fail to implement our products successfully for our customers, we might be unable to complete implementation on the schedule required by the customers and we may have increased customer dissatisfaction or difficulty making future sales as a result. We might not be able to maintain these relationships and enter into additional relationships that will provide timely and cost-effective customer support and service. If we cannot maintain successful relationships with our indirect sales channel partners around the world, we might have difficulty expanding the sales of our products and our international growth could be limited.

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. In recent periods, some of our competitors reduced the prices of their products and services (substantially in certain cases) in order to obtain new customers. Competitive pressures could make it difficult for us to acquire and retain customers and could require us to reduce the price of our products. Our customers' requirements and the technology available to satisfy those requirements are continually changing. Therefore, we must be able to respond to these changes in order to remain competitive. Changes in our products may also ~~impact the ability of~~make it more difficult for our sales force to sell effectively. In addition, changes in customers' demand for the ~~perceived needs of customers for~~ specific products, product features and services of other companies' may result in our products becoming uncompetitive. 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 may not be able to compete successfully against current and future competitors, and competitive pressures may seriously harm our business.

Our competitors vary in size and in the scope and breadth of products and services offered. 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~~major source of competition for the foreseeable future. Our competitors include a number of companies offering one or more products for the e-business communications and relationship management market, some of which compete directly with our products. For example, our competitors include companies providing stand-alone point solutions, including Accrue Software, Inc., Annuncio,Inc., AskJeeves, Inc., Avaya, Inc., Brightware, Inc.(which was acquired by Firepond, Inc.), Digital Impact, Inc., eGain Communications Corp., E.piphany, Inc., Inference

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Corp., Live Person, Inc., Marketfirst Software, Inc., and ~~Responsys.com.~~Responsys, Inc. In addition, we compete with larger, more established companies providing ~~traditional, client-server based~~ customer management and communications solutions, such as Clarify Inc. (which was acquired by ~~Northern Telecom)~~Amdocs Limited), Alcatel, ~~Cisco Systems, Inc., Lucent Technologies, Inc., Message Media, Inc.,~~ Oracle ~~Corporation, Pivotal~~ Corporation, Siebel Systems, Inc. and ~~Vantive Corporation (which was acquired by~~ PeopleSoft, Inc.) (which acquired Vantive Corporation).

The level of competition we encounter has increased as a result of our acquisition of Broadbase. As we have combined and ~~enhance~~enhanced the KANA and Broadbase product lines to offer a more comprehensive ~~e-Business~~e- business software solution, we are increasingly competing with large, established providers of customer management and communication solutions such as Siebel Systems, Inc. as well as other competitors. Our combined product line may not be sufficient to successfully compete with the product offerings available from these companies, which could slow our growth and harm our business.

Many of our competitors have longer operating histories, significantly greater financial, technical, marketing and other resources, significantly greater name recognition and a larger installed base of customers than we have. In addition, many of our competitors have well-established relationships with our current and potential customers and have extensive knowledge of our industry. We may lose potential customers to competitors for various reasons, including the ability or willingness of competitors to offer lower prices and other incentives that we cannot match. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. We also expect that competition will increase as a result of recent industry consolidations, as well as future consolidations.

Our stock price has been highly volatile and has experienced a significant decline, and may continue to be volatile and decline.

The trading price of our common stock has fluctuated widely in the past and is expected to continue to do so in the future, as a result of a number of factors, many of which are outside our control, such as:

		variations in our actual and anticipated operating results; changes in our earnings estimates by analysts; the volatility inherent in stocks within the emerging sector within which we conduct business; and ~~anticipated operating results;~~

		~~changes in our earnings estimates by analysts;~~

		~~the volatility inherent in stocks within the emerging sector within which we conduct business; and~~

		the volume of trading in ~~our common stock, including sales of substantial amounts of common stock issued upon the exercise of outstanding options and warrants.~~

~~The trading price of~~ our common stock, ~~may decline as a result~~including sales of ~~our acquisition~~substantial amounts of ~~Broadbase if, for example, we do not achieve~~common stock issued upon the ~~perceived benefits~~exercise of the merger as rapidly or to the extent anticipated by financial or industry analysts or investors; or the effect of the merger on our financial results is not consistent with the expectations of financial or industry analysts or investors

outstanding options and warrants.

In addition, the stock market, particularly the Nasdaq National Market, has experienced extreme price and volume fluctuations that have affected the market prices of many technology and computer software companies, particularly Internet-related ~~companies, and that~~companies. Such fluctuations have often been unrelated or disproportionate to the operating performance of these companies. These broad market fluctuations could adversely affect the market price of our common stock. In the past, following periods of volatility in the market price of a particular company's securities, securities class action litigation has often been brought against that company. Securities class action litigation could result in substantial costs and a diversion of our management's attention and resources. Since our common stock began trading publicly in September 1999, our common stock reached a closing high ~~of $175.50~~equivalent to $1,698.10 per share and ~~traded as~~ low ~~as $0.36~~equivalent to $3.60 per share through ~~November 13, 2001.~~May 14, 2002. The last reported sales price of our shares on ~~November 13, 2001~~May 14, 2002 was ~~$1.40~~$7.61 per share.

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Our business depends on the acceptance of our products and services, and it is uncertain whether the market will accept our products and services.

Our ability to achieve increased revenue depends on overall demand for ~~e-Business~~e- business software and related services, and in particular for ~~customer-focused~~customer- relationship applications. We expect that our future growth will depend significantly on revenue from licenses of our e-business applications and related services. ~~There are significant risks inherent in introducing Internet-based systems applications.~~ Market acceptance of these products will depend on the growth of the market for e-business solutions. This growth might not occur. Moreover, our target customers might not widely adopt and deploy our products and services. Our future financial performance will depend on the successful development, introduction and customer acceptance of new and enhanced versions of our products and services. In the future, we may not be successful in marketing our products and services, including any new or enhanced products.

The effectiveness of our products depends in part on the widespread adoption and use of these products by customer support personnel. Some of our customers who have made initial purchases of this software have deferred or suspended implementation of these products due to slower than expected rates of internal adoption by customer support personnel. If more customers decide to defer or suspend implementation of these products in the future, our ability to increase our revenue from these customers through additional licenses or maintenance agreements will also be impaired, and our financial position could be seriously 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 have experienced a period of growth in connection with the mergers we have completed that has placed a significant strain on our managerial, financial and personnel resources. For example, as a result of our merger with Broadbase in June 2001, we increased our total number of full-time employees by approximately 400 people. ~~In September 2001, we reduced our workforce by approximately 365 people. Our business will suffer if we fail to manage these changes successfully or to assimilate substantially all of Broadbase's~~ operations into our operations. 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 depend on increased business from new customers, and if we fail to grow our customer base or generate repeat business, our operating results could be harmed.

Our business model generally depends on the sale of our products to new customers as well as on expanded use of our products within our customers' organizations. If we fail to grow our customer base or generate repeat and expanded business from our current and future customers, our business and operating results will be seriously harmed. In some cases, our customers initially make a limited purchase of our products and services for pilot programs. These customers may not purchase additional licenses to expand their use of our products. If these customers do not successfully develop and deploy initial applications based on our products, they may choose not to purchase deployment licenses or additional development licenses.

In addition, as we introduce new versions of our products or new ~~products,~~product lines, our current customers might not require the functionality of our new products and might not ultimately license these products. Because the total amount of maintenance and support fees we receive in any period depends in large part on the size and number of licenses that we have previously sold, any downturn in our software license revenue would negatively affect our future services revenue. In addition, if customers elect not to renew their maintenance agreements, our services revenue could decline significantly. Further, some of our customers are ~~Internet- based~~Internet-based companies, which have been forced to significantly reduce their operations in light of limited access to sources of

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financing and the current economic slowdown. If customers were unable to pay for their current products or are unwilling to purchase additional products, our revenues would decline.

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.

If we do not continue to improve our products and develop new products that keep pace with competitive product introductions and technological developments, satisfy diverse and rapidly evolving customer requirements and achieve market acceptance, we might be unable to attract new customers. The development of proprietary technology and necessary service enhancements entails significant technical and business risks and requires substantial expenditures and lead-time. We might not be successful in marketing and supporting recently released versions of our products, or developing and marketing other product enhancements and new products that respond to technological advances and market changes, on a timely or cost-effective basis. In addition, even if these products are developed and released, they might not achieve market acceptance. We have ~~in the past~~ experienced delays in releasing new products and product enhancements in the past and could experience similar delays in the future. These delays or problems in the installation or implementation of our new releases could cause ~~customers~~us to ~~forego purchases of our products.~~lose customers.

Our failure to manage multiple technologies and technological change could reduce demand for our products.

Rapidly changing technology and operating systems, changes in customer requirements, and evolving industry standards might impede market acceptance of our products. Our products are designed based upon currently prevailing technology 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. If new technologies emerge that are incompatible with our products, or if competing products emerge that are based on new technologies or new industry standards and that perform better or cost less than our products, our key products could become obsolete and our existing and potential customers could seek alternatives to our products. 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. For example, our analytics products were designed to work with databases such as Oracle and Microsoft SQL Server. Any changes to those databases, or increasing popularity of other databases, could require us to modify our analytics products, and could cause us to delay releasing future products and enhancements. Furthermore, software adapters are necessary to integrate our analytics products with other systems and data sources used by our customers. We must develop and update these adapters to reflect changes to these systems and data sources in order to maintain the functionality provided by our products. As a result, uncertainties related to the timing and nature of new product announcements, introductions or modifications by vendors of operating systems, databases, customer relationship management software, web servers and other enterprise and Internet-based applications could delay our product development, increase our product development expense or cause customers to delay evaluation, purchase and deployment of our analytics products. If we fail to modify or improve our products in response to evolving industry standards, our products could rapidly become obsolete.

~~Failure to successfully develop versions and updates of our products that run on the operating systems used by our current and prospective customers could reduce our sales.~~

Many of our products currently run only on the Windows NT operating system. Any change to our customers' operating systems could require us to modify our products and could cause us to delay product releases. In addition, any decline in the market acceptance of the Windows NT operating system may force us to ensure that all of our products and services are compatible with other operating systems to meet the demands of our customers. If potential customers do not want to use the Windows NT operating system, we will need to develop more products that run on other operating systems such as Windows 2000, the successor to Windows NT, or any of the UNIX based systems. If we cannot successfully develop these products in response to customer demands, our business could suffer. The development of new products in response to these

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risks would require us to commit a substantial investment of resources, and we might not be able to develop or introduce new products on a timely or cost-effective basis, or at all, which could lead potential customers to choose alternative products.

Failure to license necessary third party software incorporated in our products could cause delays or reductions in our sales.

We license third party software that we incorporate into our products. These licenses may not continue to be available on commercially reasonable terms or at all. Some of this technology would be difficult to replace. The loss of any such license could result in delays or reductions of our applications until we identify, license and integrate or develop equivalent software. If we are required to enter into license agreements with third parties for replacement technology, we could ~~be subject to~~face higher royalty payments and ~~a loss of product differentiation.~~our products may lose certain attributes or features. In the future, we might need to license other software to enhance our products and meet evolving customer needs. If we are unable to do this, we could experience reduced demand for our products.

~~Delays in the development of~~Failure to develop new products or enhancements to existing products on a timely basis 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. Our ability to deliver competitive products may be ~~impacted~~negatively affected by the diversion of resources ~~we have~~ to ~~devote to the~~development of our suite of products, ~~the rate of change of~~and responding to changes in competitive products and ~~required company responses to changes~~ in the demands of our customers. ~~Any failure to do so could harm our business.~~ If we experience product delays in the future, we may face:

	customer dissatisfaction;	~~customer dissatisfaction;~~

		cancellation of orders ~~and license agreements;~~

		~~negative publicity;~~

		~~loss of revenues;~~

		~~slower market acceptance; and~~

		~~legal action by customers.~~

~~In the future, our efforts to remedy this situation may not be successful~~ and ~~we may lose customers as a result. Delays~~license agreements;

negative publicity;

loss of revenues;

slower market acceptance; and

legal action by customers.

Furthermore, 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. IfThe development of new products in response to these risks would require us to commit a substantial investment of resources, and we ~~were~~might not be able to ~~lose market share as~~develop or introduce new products on a ~~result of lapses in our product management, our business would suffer.~~timely or cost-effective basis, or at all, which could lead potential customers to choose alternative products.

~~We may face increased costs or customer disputes as a result of our recent decision to eliminate our KANA Online service.~~

We recently eliminated our KANA Online service and as a result, we may face customer dissatisfaction, negative publicity, and legal action by customers resulting from the lack of availability of the KANA Online service. KANA Online customer agreements generally contain provisions designed to limit our exposure to potential claims, such as disclaimers of warranties and limitations on liability for special, consequential and incidental damages. In addition, KANA Online customer 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, any claim by a KANA Online customer, whether or not successful, could harm our business by increasing our costs, damaging our reputation and distracting our management. In addition, we may face additional costs resulting from the termination of the KANA Online service including costs related to the termination of employees, the disposition of hardware and the termination of our service contracts related to the KANA Online service.

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Our pending patents may never be issued and, even if issued, may provide little protection.

Our success and ability to compete depend to a significant degree upon the protection of our software and other proprietary technology rights. We regard the protection of patentable inventions as important to our future opportunities. We currently have one issued U.S. patent and multiple U.S. patent applications pending relating to our software. Although we have filed international patent applications corresponding to some of our U.S. patent applications, none of our technology is patented outside of the United States. 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.~~

our pending patent applications may not result in the issuance of patents;
any issued patents may not be broad enough to protect our proprietary rights;
any issued patents 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. In the United States, we currently have a registered trademark, "KANA," and several pending trademark applications. Outside of the United States, we have trademark registrations and pending applications in the European Union, Australia, Canada, India, Japan, South Korea and Taiwan. However, despite the 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.~~

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 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.

Substantial litigation regarding intellectual property rights exists in our industry. We expect that software in our industry may be increasingly subject to third-party infringement claims as the number of competitors grows and the functionality of products in different industry segments overlaps. Third parties may currently have, or may eventually be issued, patents upon which our

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current or future products or technology infringe. Any of these third parties might make a claim of infringement against us. For example, we have been contacted by a company that has asked us to evaluate the need for a license of certain patents that this company holds, relating to certain call-center applications. Although the patent holder has not filed any claims against us, we cannot assure you that it will not do so in the future. The patent holder may also have applications on file in the United States covering related subject matter, which are confidential until the patent or patents, if any, are issued. 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 others, or us 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.

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 many of our products and services, errors are of particular concern. In the past, we have discovered software errors in some of our products after their introduction. 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 we are not able to detect and correct errors in our products or releases before commencing commercial shipments, ~~KANA~~we could ~~divert~~face:

loss of or delay in revenues expected from the ~~attention~~new product and an immediate and significant loss of ~~management~~market share;
loss of existing customers that upgrade to the new product and ~~key personnel, could be expensive~~of new customers;
failure to ~~defend~~achieve market acceptance;
diversion of development resources;
injury to our reputation;
increased service and ~~could result in adverse settlements~~warranty costs;

legal actions by customers; and ~~judgments.~~

		~~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; and~~

		~~increased insurance costs.~~

increased insurance costs.

We may face liability claims that could result in unexpected costs and damages to our reputation.

Our licenses with customers generally contain provisions designed to limit our exposure to potential product liability claims, such as disclaimers of warranties and limitations on liability for special, consequential and incidental damages. In addition, our license agreements generally cap the amounts recoverable for damages to the amounts paid by the licensee to us for the product or service giving rise to the damages. However, all domestic and international jurisdictions may not enforce these contractual limitations on liability. 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 could divert the attention of management and key personnel, could be expensive to defend and could result in adverse settlements and judgments.

In April 2001, Office Depot, Inc. filed a complaint against KANA claiming that KANA has breached its license agreement with Office Depot. Office Depot is seeking relief in the form of a refund of license fees and maintenance fees paid to KANA, attorneys' fees and costs. The litigation is currently in its early ~~stages and we have not received material information or documentation.~~stages. We intend to defend this claim vigorously and do not expect it to ~~materially~~have a material impact on our results ~~from operations. However,~~of operations and cash flow.

On April 16, 2002, Davox Corporation filed an action against KANA in the Superior Court, Middlesex, Commonwealth of Massachusetts, in relation to an OEM Agreement between Davox and KANA under which Davox has paid a total of approximately $1.6 million in fees, asserting breach of contract, breach of implied covenant of good faith and fair dealing, unjust enrichment, misrepresentation, and unfair trade practices. Davox seeks actual and punitive damages in an amount to be determined at trial, and award of attorneys' fees. This action is in the early stages and has not yet been served upon KANA. KANA is in the early stages of its review of these claims and intends to defend the matter vigorously.

The ultimate outcome of any litigation is uncertain, and

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either unfavorable or favorable outcomes could have a material negative impact on our results of operations, consolidated balance sheet and cash flows, due to defense costs, diversion of management resources and other factors.

~~Our~~Growth in our international operations exposes us to additional risks.

Sales outside North America represented 17% of our total revenues in 2000, 16% of our total revenues in the 2001, and 40% of our revenues in the first quarter of 2002. We have established offices in the United Kingdom, Germany, Japan, Holland, France, Austria, Belgium, Australia, Hong Kong and South Korea. Sales outside North America could ~~divert management attention and present financial issues.~~

~~Our international operations are located throughout Europe, Australia, and Asia, and,~~increase as a percentage of total revenues as we attempt to ~~date, have been limited. We may~~ 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~~Any expansion of our existing international operations and entry into additional international markets will require significant management attention and financial ~~resources. In addition, in order~~resources, as well as additional support personnel. For any such expansion, we will also need to, among other things 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~~channel management and support organizations and develop relationships with international service providers and additional distributors and system integrators. In addition, as international operations successfully, we may not be able to maintain or increase international market demand for our products. In addition, we have only licensed our products internationally since January 1999 and have limited experience in developing localized versionsbecome a larger part of our ~~software~~business, we could encounter, on average, greater difficulty with collecting accounts receivable, longer sales cycles and ~~marketing~~collection periods, greater seasonal reductions in business activity and ~~distributing them internationally. Localizing~~increases in 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.~~

Sales outside North America represented 16% of our total revenues in 2000 and 15% of our total revenues in the first nine months of 2001. As a result of our acquisition of Broadbase, we expect sales outside North America to increase as a percentage of total revenues. We have established offices in the United Kingdom, Australia, Germany, Japan, Holland, France, Spain, Sweden, Singapore and South Korea. As a result, we face risks from doing business on an international basis, any of which could impair our international revenues. Ourtax rates. Furthermore, products must be localized, or customized to meet the needs of local users, before they can be sold in particular foreign countries. Developing localized versions of our products for foreign markets is difficult and can take longer than we anticipate. We have only licensed our products internationally since January 1999 and have limited experience in ~~localizing~~developing localized versions of our ~~products~~software and marketing and distributing them internationally. Our investments in ~~testing whether these localized products will be accepted~~establishing facilities in ~~the targeted countries. Our localization efforts~~other countries may not produce desired levels of revenues. Even if we are able to expand our international operations successfully, we may not be ~~successful. In addition, we could, in the future, encounter greater difficulty with collecting accounts receivable, longer sales cycles and collection periods~~able to maintain or ~~seasonal reductions in business activity. In addition,~~increase international market demand for our ~~international operations could cause our average tax rate to increase. Any of these events could harm our international sales and results of operations.~~products.

International laws and regulations may expose us to potential costs and litigation.

Our international operations increase our exposure to international laws and regulations. If we cannot comply with foreign laws and regulations, which are often complex and subject to variation and unexpected changes, we could incur unexpected costs and potential litigation. For example, the governments of foreign countries might attempt to regulate our products and services or levy sales or other taxes relating to our activities. In addition, foreign countries may impose tariffs, duties, price controls or other restrictions on foreign currencies or trade barriers, any of which could make it more difficult for us to conduct our business. The European Union has enacted ~~our~~its own privacy regulations that may result in limits on the collection and use of certain user information, which, if applied to the sale of our products and services, could negatively impact our results of operations.

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We may suffer foreign exchange rate losses.

Our international revenues and expenses are denominated in local currency. Therefore, a weakening of other currencies compared to the U.S. dollar could make our products less competitive in foreign markets and could negatively affect our operating results and cash flows. We do not currently engage in currency hedging activities. We have not yet experienced, but may in the future experience, significant foreign currency transaction losses, especially ~~to the extent that~~because we do not engage in currency hedging.

~~Our prospects for obtaining additional financing, if required, are uncertain and failure~~Failure to obtain needed financing could affect our ability to maintain current operations and pursue future ~~growth.~~growth, and the terms of any financing we obtain may impair the rights of our existing stockholders.

~~We expect~~In the future, we may be required to seek additional financing to fund our operations or growth. Factors such as the commercial success of our existing products and services, the timing and success of any new products and services, the progress of our research and development efforts, our results of operations, the status of competitive products and services, and the timing and success of potential strategic alliances or potential opportunities to acquire or sell technologies or assets may require us to seek additional funding sooner than we expect. In the event that we require additional cash, ~~and cash equivalents and short term investments on hand will be sufficient to meet our working capital and capital expenditure needs for the next 12 months. To reduce our expenditures,~~ we restructured in several areas, including reduced staffing, expense management and capital spending. For the first nine months, we reduced our workforce by approximately 74%, in order to streamline operations, reduce costs and bring our staffing and structure in line with industry standards. Our most recent reduction in force was announced to employees on September 28, 2001, which reduced staff by approximately 365 positions across all departments. We expect our cash and cash equivalents and short-term investments on hand will be sufficient to meet our working capital and capital expenditure needs for the next 12 months. We expect to continue to experience negative cash flows through the first quarter of 2002. Significant expected cash flows through the second quarter of 2002 include approximately $20 million in payments relating to accrued merger and restructuring costs, as well as approximately $7 million of expenditures on certain corporate infrastructure. We are evaluating various initiatives to improve our cash position, including raising additional funds to finance our business, implementing further restrictions on spending, negotiating the early release of certain restricted cash and other cash flow initiatives. Additional financing may not be ~~available~~able to secure additional financing on terms that are acceptable to us, especially in the uncertain market climate, and we may not be successful in implementing or negotiating such other arrangements to improve our cash position. 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~~the securities we issue might have rights, preferences and privileges senior to those of our current stockholders. For example, in November 2001, we sold approximately 1,000,000 shares of our common stock at a price per share of $10.00 and in February 2002, we sold 2,910,000 million shares of our common stock at a price per share of $11.85 per share (in each case, representing a discount from the price per share at which our common stock was then trading). These issuances represented approximately 17.3% of our outstanding stock (based on 22,632,876 shares outstanding as of March 31, 2002). If adequate funds were not available on acceptable terms, our ability to achieve or sustain positive cash flows, maintain current operations, fund any potential expansion, take advantage of unanticipated opportunities, develop or enhance products or services, or otherwise respond to competitive pressures would be significantly limited.

In addition, our expectations as to when we can achieve positive cash flows, and as to our future cash balances, are subject to a number of assumptions, including assumptions regarding anticipated increases in our revenue, improvements in general economic conditions and customer purchasing and payment patterns, many of which are beyond our control.

We have completed a number of mergers, and those mergers may result in disruptions to our business and management due to difficulties in assimilating personnel and operations.

We may not realize the benefits from the significant mergers we have completed. In August 1999, we acquired Connectify, in December 1999, we acquired netDialog and Business Evolution, and in April 2000, we acquired Silknet. In June 2001, we completed our merger with Broadbase. Similarly, prior to its ~~acquisition by~~merger with us, Broadbase also acquired several companies, including Rubric, Servicesoft, Decisionism and Panopticon. We may not be able to successfully assimilate the additional personnel, operations, acquired technology and products into our business. In particular, we will need to assimilate and retain key professional services, engineering and marketing personnel. This is particularly difficult with Business Evolution, Servicesoft and Silknet, since their operations are located on the ~~east~~East coast and we are headquartered on the West coast. Key personnel from the acquired companies have in certain instances decided, and they may in the future decide, that they do not want to work for us. In addition, products of these companies will have to be integrated into our products, and it is uncertain whether we may accomplish this easily or at all.

The integration of acquired companies has been and will continue to be a complex, time consuming and expensive process and might disrupt our business if not completed efficiently or in a timely manner. We must demonstrate to customers and suppliers that these recent acquisitions will not result in adverse changes in customer service standards, or dilution of or distraction to our business focus. The difficulties of integrating other businesses could be greater than we anticipate, and could disrupt our ongoing business, disrupt our management and

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employees and increase our expenses. Acquisitions are inherently risky and we may also face unexpected costs, which may adversely affect operating results in any quarter.

~~If we do not successfully integrate the operations of Broadbase in a timely manner, we may not achieve the benefits we expect from that merger.~~

The integration of Broadbase into our business will be a complex, time consuming and expensive process and may disrupt our business if not completed in a timely and efficient manner. We must operate as a combined organization utilizing common information and communication systems, operating procedures, financial controls and human resources practices. In addition, we must integrate Broadbase's product development operations, products and technologies with our own. We may encounter substantial difficulties, costs and delays involved in integrating Broadbase's operations into our own, including:

		~~potential conflicts in distribution, marketing or other important relationships;~~

		~~difficulties in coordinating different development and engineering teams;~~

		~~potential incompatibility of business cultures;~~

		~~perceived adverse changes in business focus; and~~

		~~the loss of key employees and diversion of the attention of management from other ongoing business concerns.~~

The merger may also have the effect of disrupting customer relationships. Our customers may not continue their current buying patterns. Customers may defer purchasing decisions as they evaluate the likelihood of successful integration of Broadbase's products and services with ours, and our future product and service strategy. Also, because of the broader product and service offering that we will now offer as a result of the merger, some of our customers may view us as more of a direct competitor than they did KANA or Broadbase as independent companies, and may therefore cancel or fail to place additional orders.

Integration may take longer than expected, and we may be required to expend more resources on integration than anticipated. The need to expend additional resources on integration would reduce the resources that would otherwise be spent on developing our products and technologies. If we cannot successfully integrate Broadbase's operations, products and technologies with our own, or if this integration takes longer than anticipated, we may not be able to operate efficiently or realize the expected benefits of the merger. In addition, failure to complete the integration successfully could result in the loss of key personnel and customers.

~~To achieve the anticipated benefits of the Broadbase acquisition, we must develop and introduce new products that use the assets of both companies.~~

We expect to develop and introduce new products, and enhanced versions of our currently existing analytic and eCRM products, that interoperate as a single platform. In particular, we plan to increase the level of integration of Kana's and Broadbase's products so that they function as a unified solution from a common database. The timely development and introduction of new products and versions that work effectively together and allow customers to achieve the benefits of a broader product offering presents significant technological, market and other obstacles in addition to the risks inherent in the development and introduction of new products. For example, our products have historically operated on a variety of operating platforms, including UNIX and Windows NT, while most of Broadbase's products have historically operated only on Windows NT. This may create integration issues between the technologies and challenges in selling the combined product line. We may not be able to overcome these obstacles. In addition, because our market is characterized by rapidly shifting customer requirements, we may not be able to assess these requirements accurately, or our joint products may not sufficiently satisfy these requirements or achieve market acceptance. Further, the introduction of these anticipated new products and versions may result in longer sales cycles and product implementations, which may cause revenue and operating income to fluctuate and fail to meet expectations.

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In addition, we intend to offer our current products to Broadbase customers, and Broadbase's current products to our existing customers. The customers of either company may not have an interest in the other company's products and services. The failure of cross-marketing efforts would diminish our ability to achieve the benefits of the merger.

The role of acquisitions in our future growth may be limited, which could seriously harm our continued operations.

In the past, acquisitions have been an important part of the growth strategy for us. To gain access to key technologies, new products and broader customer bases, we have acquired companies in exchange for shares of our common stock. Because the recent trading prices of our common stock have been significantly lower than in the past, the role of acquisitions in our growth may be substantially limited. If we are unable to acquire companies in exchange for our common stock, we may not have access to new customers, needed technological advances or new products and enhancements to existing products. This would substantially impair our ability to respond to market opportunities.

If we acquire additional companies, products or technologies, we may face risks similar to those faced in our other mergers.

If we are presented with appropriate opportunities, we intend to make other investments in complementary companies, products or technologies. We may not realize the anticipated benefits of any other acquisition or investment. If we acquire another company, we will likely face the same risks, uncertainties and disruptions as discussed above with respect to our other completed mergers. Furthermore, we may have to incur debt or issue equity securities to pay for any additional future acquisitions or investments, the issuance of which could be dilutive to our existing stockholders or us. In addition, our profitability may suffer because of acquisition-related costs or amortization costs for acquired goodwill and other intangible assets.

We have adopted anti-takeover defenses that could delay or prevent an acquisition of the company.

Our board of directors has the authority to issue up to 5,000,000 shares of preferred stock. Without any further vote or action on the part of the stockholders, the board of directors has the authority to determine the price, rights, preferences, privileges and restrictions of the preferred stock. This preferred stock, if issued, might have preference over and harm the rights of the holders of common stock. Although the issuance of this preferred stock will provide us with flexibility in connection with possible acquisitions and other corporate purposes, this issuance may make it more difficult for a third party to acquire a majority of our outstanding voting stock. We currently have no plans to issue preferred stock.

Our certificate of incorporation, bylaws and equity compensation plans include provisions that may deter an unsolicited offer to purchase us. These provisions, coupled with the provisions of the Delaware General Corporation Law, may delay or impede a merger, tender offer or proxy contest involving us. Furthermore, our board of directors is divided into three classes, only one of which is elected each year. Directors are removable by the affirmative vote of at least 66 2/3% of all classes of voting stock. These factors may further delay or prevent a change of control of us.

~~Failure~~Risks Related to ~~comply with Nasdaq's listing standards could result in our delisting by Nasdaq from the Nasdaq National Market and severely limit the ability to sell any of our common stock.~~Our Industry

Our stock is currently traded on the Nasdaq National Market. Under Nasdaq's listing maintenance standards, if the closing bid price of our common stock is under $1.00 per share for 30 consecutive trading days, NASDAQ will notify us that it may be delisted from the NASDAQ National Market. If the closing bid price of our common stock does not thereafter regain compliance for a minimum of 10 consecutive trading days during the 90 days following notification by NASDAQ, NASDAQ may delist our common stock from trading on the NASDAQ National Market. We are convening a special meeting of our shareholders in early December 2001 to approve a one for ten reverse split of our common stock. There can be no assurance that our shareholders will approve this reverse split, and accordingly that our common stock will remain eligible for trading on the NASDAQ National Market. If our stock were delisted, your ability to sell any of our common stock at all would be severely, if not completely, limited. Since our common stock began trading publicly in September 1999, our common stock reached a high of $175.50 per share and traded as low as

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~~$0.36 per share through November 9, 2001. The last reported sales price of our shares on November 13, 2001 was $1.40 per share.~~

If the Internet and ~~web-based~~Web-based communications fail to grow and be accepted as media of communication, demand for our products and services will decline.

We sell our products and services primarily to organizations that receive large volumes of e-mail and ~~web-based~~Web-based communications. ~~Many of our customers have business models that are based on the continued growth of the Internet.~~ Consequently, our future revenues and profits, if any, substantially depend upon the continued acceptance and use of the Internet and e-mail, which are evolving as media of communication. Rapid growth in the use of the Internet and e-mail is a recent phenomenon and may not continue. As a result, a broad base of enterprises that use e-mail as a primary means of communication may not develop or be maintained. In addition, the market may not accept recently introduced products and services that process e-mail, including our products and services. Moreover, companies that have already invested significant resources in other methods of communications with customers, such as call centers, may be reluctant to adopt a new strategy that may limit or compete with their existing investments.

Consumers and businesses might reject the Internet as a viable commercial medium, or be slow to adopt it, for a number of reasons, including potentially inadequate network infrastructure, slow development of enabling technologies, concerns about the security of transactions and confidential information and insufficient commercial support. The Internet infrastructure may not be able to support the demands placed on it by increased Internet usage and bandwidth requirements. In addition, delays in the development or adoption of new standards and protocols required to handle increased levels of Internet activity, or increased governmental regulation, could cause the ~~Interest~~Internet to lose ~~our~~its viability as a commercial medium. If these or any other factors cause use of the Internet for business to decline or develop more slowly than expected, demand for our products and services will be reduced. Even if the required infrastructure, standards, protocols or complementary products, services or facilities are developed, we might incur substantial expenses adapting our products to changing or emerging technologies.

Future regulation of the Internet may slow our growth, resulting in decreased demand for our products and services and increased costs of doing business.

State, federal and foreign regulators could adopt laws and regulations that impose additional burdens on 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 our ~~Connect product,~~products, 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. Any new legislation or regulations, application of laws and regulations from jurisdictions whose laws do not currently apply to our business, or application of existing laws and regulations to the Internet and other online services could increase our costs and harm our growth.

~~Regulation of the collection and use of personal data could reduce demand for our Broadbase products.~~

Many of our Broadbase products connect to and analyze data from various applications, including Internet applications, that enable businesses to capture and use information about their customers. Government regulation that limits Broadbase's customers' use of this information could reduce the demand for Broadbase's products. A number of jurisdictions have adopted, or are considering adopting, laws that restrict the use of customer information from Internet applications. The European Union has required that its member states adopt legislation that imposes restrictions on the collection and use of personal data, and that limits the transfer of personally-identifiable data to countries that do not impose equivalent restrictions. In the United States, the Childrens Online Privacy Protection Act was enacted in October 1998. This legislation directs the Federal Trade Commission to regulate the collection of data from children

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on commercial websites. In addition, the Federal Trade Commission has begun investigations into the privacy practices of businesses that collect information on the Internet. These and other privacy-related initiatives could reduce demand for some of the Internet applications with which our Broadbase products operate, and could restrict the use of these products in some e-commerce applications. This could reduce demand for some Broadbase products.

The imposition of sales and other taxes on products sold by our customers over the Internet could have a negative effect on online commerce and the demand for our products and services.

The imposition of new sales or other taxes could limit the growth of Internet commerce generally and, as a result, the demand for our products and services. Recent federal legislation limits the imposition of state and local taxes on Internet-related ~~sales.~~sales until November 1, 2003. Congress may choose not to renew this legislation, ~~in 2001,~~ in which case state and local governments would be free to impose taxes on electronically purchased goods. We believe that most companies that sell products over the Internet do not currently collect sales or other taxes on shipments of their products into states or foreign countries where they are not physically present. However, one or more states or foreign countries may seek to impose sales or other tax collection obligations on ~~out-of-jurisdiction~~out- of-jurisdiction companies that engage in ~~e-commerce.~~e-commerce within their jurisdiction. A successful assertion by one or more states or foreign countries that companies that engage in e-commerce within their jurisdiction should collect sales or other taxes on the sale of their products over the Internet, even though not physically in the state or country, could indirectly reduce demand for our products.

Privacy concerns relating to the Internet are increasing, which could result in legislation that negatively affects our business, in reduced sales of our products, or both.

Businesses using our products capture information regarding their customers when those customers contact them on-line with customer service inquiries. Privacy concerns could cause visitors to resist providing the personal data necessary to allow our customers to use our software products most effectively. More importantly, even the perception of privacy concerns, whether or not valid, may indirectly inhibit market acceptance of our products. In addition, legislative or regulatory requirements may heighten these concerns if businesses must notify Web site users that the data captured after visiting certain Web sites may be used by marketing entities to unilaterally direct product promotion and advertising to that user. While we are not aware of any such legislation or regulatory requirements currently in effect in the United States, other countries and political entities, such as the European Union, have adopted such legislation or regulatory requirements and the United States may do so as well. If consumer privacy concerns are not adequately ~~addressed,~~resolved, our business could be harmed.Government regulation that limits our customers' use of this information could reduce the demand for our products. A number of jurisdictions have adopted , or are considering adopting, laws that restrict the use of customer information from Internet applications. The European Union has required that its member states adopt legislation that imposes restrictions on the collection and use of personal data, and that limits the transfer of personally-identifiable data tocountries that do not impose equivalent restrictions. In the United States, the Childrens' Online Privacy Protection Act was enacted in October 1998. This legislation directs the Federal Trade Commission to regulate the collection of data from children on commercial websites. In addition, the Federal Trade Commission has begun investigations into the privacy practices of businesses that collect information on the Internet. These and otherprivacy-related initiatives could reduce demand for some of the Internet applications with which our products operate, and could restrict the use of these products in some e-commerce applications. This could, in turn, reduce demand for these products.

Our security could be breached, which could damage our reputation and deter customers from using our services.

We must protect our computer systems and network from physical break-ins, security breaches and other disruptive problems caused by the Internet or other users. Computer break-ins could jeopardize the security of information stored in and transmitted through our computer systems and network, which could adversely affect our ability to retain or attract customers, damage our reputation and subject us to litigation. We have been in the past, and could be in the future, subject to denial of service, vandalism and other attacks on our systems by Internet hackers. Although we intend to continue to implement security technology and establish operational procedures to prevent break-ins, damage and failures, these security measures may fail. Our insurance coverage in certain circumstances may be insufficient to cover losses that may result from such events.

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Item 3: Quantitative and Qualitative Disclosures About Market Risk

Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio. The primary objective of our investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. At ~~September 30, 2001,~~March 31, 2002, our portfolio included money market funds, commercial paper, municipal bonds, government agency bonds, and corporate bonds. The diversity of the portfolio helps us to achieve our investment objective. At ~~September 30, 2001,~~March 31, 2002, the weighted average maturity of our portfolio was 9792 days.

We are exposed to market risk from fluctuations in foreign currency exchange rates. We manage exposure to variability in foreign currency exchange rates primarily through the use of natural hedges, as both liabilities and assets are denominated in the local currency. However, different durations in our funding obligations and assets may expose us to the risk of foreign exchange rate fluctuations. We have not entered into any derivative instrument transactions to manage this risk. Based on our overall foreign currency rate exposure at ~~September 30, 2001,~~March 31, 2002, we do not believe that a hypothetical 10% change in foreign currency rates would materially adversely affect our financial position.

We develop products in the United States and sell these products in North America, Europe, Asia, Australia and Latin America. Generally, our sales and expenses are incurred in local currency. At ~~September 30, 2001~~March 31, 2002 and December 31, ~~2000,~~2001, our primary net foreign currency market exposures were in Japanese ~~yen,~~Yen, Euros and British ~~pounds.~~Pounds. 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.

Foreign currency rate fluctuations can impact the U.S. ~~dollar~~Dollar translation of our foreign operations in our consolidated financial statements. To date, these fluctuations have not been material to our operating results.

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Part II: Other Information

Item 1. Legal Proceedings.

In April 2001, Office Depot, Inc. filed a complaint against KANA claiming that KANA has breached its license agreement with Office Depot. Office Depot is seeking relief in the form of a refund of license fees and maintenance fees paid to KANA, attorneys' fees and costs. The litigation is currently in its early stages. We intend to defend this claim vigorously and do not expect it to have a material impact on our results of operations.

The ~~Company's~~ underwriters for our initial public offering, Goldman Sachs & Co., Lehman Bros, Hambrecht & Quist LLC, Wit Capital Corp as well as the Company and certain current and former officers of the Company have been named as defendants in federal securities class action lawsuits filed in the United States District Court for the Southern District of New York. The cases allege violations of Section 11, 12(a)(2) and Section 15 of the Securities Act of 1933 and violations of Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934, on behalf of a class of plaintiffs who purchased ~~our~~the Company's stock between September 21, 1999 and December 6, 2000 in connection with ~~our~~the Company's initial public offering. Specifically, the complaints alleged that the underwriter defendants engaged in a scheme concerning sales of ~~our~~the Company 's securities in the initial public offering and in the aftermarket. ~~By Order of the Court, these~~These cases ~~have been~~are stayed pending ~~consolidation and coordination~~selection of ~~proceedings in the U.S. District Court~~lead counsel for the ~~Southern District of New York. A panel of lead plaintiffs' counsel~~plaintiff class. The Company believes it has been selected and the parties are negotiating a stipulation that would, among other things, stay the action against the Issuer and Individual defendants. Although we are in the early stages of analyzing the claims alleged against us and the individual defendants, we believe that we have good ~~and valid~~ defenses to these ~~claims. We intend~~claims and intends to defend the action vigorously.

On April ~~24, 2001, Office Depot, Inc. ("Office Depot")~~16, 2002, Davox Corporation filed ~~a complaint~~an action against KANA in the ~~Circuit~~Superior Court, ~~for the 15th District~~Middlesex, Commonwealth of ~~the State~~Massachusetts, in relation to an OEM Agreement between Davox and KANA under which Davox has paid a total of ~~Florida claiming that KANA has breached its license agreement with Office Depot. Office Depot~~approximately $1.6 million in fees, asserting breach of contract, breach of implied covenant of good faith and fair dealing, unjust enrichment, misrepresentation, and unfair trade practices. Davox seeks actual and punitive damages in an amount to be determined at trial, and award of attorneys' fees. This action is ~~seeking relief~~ in the ~~form of a refund of license fees and maintenance fees paid to KANA, attorneys' fees and costs. The litigation is currently in its~~ early stages and ~~we have~~has not ~~received material information or documentation.~~yet been served upon KANA. KANA is in the early stages of its review of these claims and intends to defend ~~itself from this claim vigorously~~the matter vigorously.

The ultimate outcome of any litigation is uncertain, and ~~does not expect it to materially~~either unfavorable or favorable outcomes could have a material negative impact on our results ~~from operations. KANA is not currently~~of operations, consolidated balance sheet and cash flows, due to defense costs, diversion of management resources and other factors.

Item 2. Changes in Securities and Use of Proceeds.

On February 13, 2002, we completed the sale of an aggregate of approximately 2.9 million shares of our common stock to 20 institutional investors for an aggregate of approximately $34.5 million. The offer and sale were completed in reliance on Section 4(2) and/or Regulation D promulgated under the Securities Act of 1933. The securities were sold to a ~~party~~limited number of purchasers, with no general solicitation or advertising. The purchasers were sophisticated investors with access to ~~any other material legal proceedings.~~all relevant information necessary to evaluate the investment and who represented to the issuer that the shares were being acquired for investment.

Item 3. Defaults Upon Senior Securities.

Not applicable.

Item 4. Submission of Matters to a Vote of Security Holders.

~~None.~~On February 1, 2002, we held a special stockholders' meeting to vote on a proposed issuance of up to $45 million of a Series A convertible preferred stock to two investment funds. The stockholder vote followed an announcement on January 14, 2002 of the decision by our Board of Directors to withdraw its recommendations that its stockholders vote in favor of the proposed preferred stock transaction. The shares voting for and against this action were 3,352,831and 7,075,685 respectively, with 34,872 shares abstaining.

Item 5. Other Information.

Not applicable.

Item 6. Exhibits and Reports on Form 8-K.

	(a)	Exhibits:
		10.01 Loan Modification Agreement with Silicon Valley Bank
		10.02 Separation Agreement between Brett White and KANA

	(b)	Reports on Form 8-K:

		1) On January 14, 2002, we filed a current report on Form 8-K, reporting that our Board of Directors had withdrawn its recommendation to the KANA stockholders that they vote in favor of the proposal to approve the issuance by us of up to $45 million of Series A convertible preferred stock in a private placement.
		~~None~~

392) On February 7, 2002, we filed a current report on Form 8-K, reporting that our stockholders voted against the proposed issuance by us of up to $45 million of Series A convertible preferred stock and that immediately following the stockholder vote, we elected to terminate the share purchase agreement. In addition, we reported that on February 6, 2002, we announced that we entered into definitive agreements to sell approximately 2.9 million shares of our common stock to several institutional investors in a private placement with gross proceeds of approximately $34.5 million. In addition, we reported that on January 22, 2002, we announced our results for the quarter ended December 31, 2001.
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3) On February 13, 2002, we filed a current report on Form 8-K, reporting that we had completed the sale of an aggregate of approximately 2.9 million shares of our common stock to institutional investors in a private placement with gross proceeds of approximately $34.5 million.

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~~ May 14, ~~2001~~2002	KANA Software, Inc.

	/s/ Chuck Bay
	Chuck Bay
	Chief Executive Officer, President and ~~Chairman of the Board~~
	Director (Principal Executive Officer)

	/s/ ~~Brett White~~
	~~Brett White~~
	~~Chief Financial Officer~~
	Joseph McCarthy Joseph McCarthy Vice President of Finance (Principal Financial and Accounting Officer)

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Delaware	77-0435679
~~(State~~ (State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification ~~No.)~~
~~Incorporation or Organization)~~	Number)

							September 30, 2001			December 31, 2000
ASSETS

Current assets:
		Cash and cash equivalents					$	21,438		$	76,202
		Short-term investments						30,489			297
		Accounts receivable, net						19,223			43,393
		Prepaid expenses and other current assets						10,670			14,866

					Total current assets			81,820			134,758

Restricted cash								11,018			—
Property and equipment, net								15,778			40,095
Goodwill and identifiable intangibles, net								80,464			800,000
Other assets								4,977			5,271

						Total assets	$	194,057		$	980,124


LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:

			Current portion of notes payable				$	1,463		$	1,456
			Accounts payable					16,078			17,980
			Accrued liabilities					32,256			35,846
			Accrued restructuring and merger costs					28,349			—
			Deferred revenue					24,106			25,242

				Total current liabilities				102,252			80,524
Accrued restructuring, less current portion								18,027			—
Notes payable, less current portion								300			148

			Total liabilities					120,579			80,672

Stockholders' equity:
	Common stock							182			94
	Additional paid-in capital							4,222,571			4,130,231
	Deferred stock-based compensation							(24,914	)		(21,639	)
	Notes receivable from stockholders							(798	)		(5,367	)
	Accumulated other comprehensive loss							(1,343	)		(377	)
	Accumulated deficit							(4,122,220	)		(3,203,490	)

		Total stockholders' equity						73,478			899,452

		Total liabilities and stockholders' equity					$	194,057		$	980,124

	Three Months Ended							Nine Months Ended
	September 30,							September 30,
		2001			2000			2001			2000

Revenues:
License	$	2,891		$	23,730		$	24,335		$	46,633
Service		14,507			15,312			37,705			26,097

Total revenues		17,398			39,042			62,040			72,730

Cost of revenues:
License		503			918			1,789			1,719
Service (excluding stock-based compensation of $311, $655, $1,019 and $2,345, respectively)		20,224			14,824			43,047			27,675

Total cost of revenues		20,727			15,742			44,836			29,394

Gross profit (loss)		(3,329	)		23,300			17,204			43,336

Operating expenses:
Sales and marketing (excluding stock-based compensation of $1,653, $2,250, $5,117 and $5,175, respectively)		19,205			25,749			59,528			58,297
Research and development (excluding stock-based compensation of $1,542, $658, $2,254 and $2,357, respectively)		10,236			12,993			29,458			29,291
General and administrative (excluding stock-based compensation of $671, $227, $2,149 and $826, respectively)		9,500			6,347			18,091			11,929
Restructuring costs		32,081			—			86,338			—
Merger and transition related costs		4,841			—			11,517			6,564
Amortization of deferred stock-based compensation		4,177			3,790			10,539			10,703
Amortization of goodwill and identifiable intangibles		13,551			312,865			114,133			559,908
Goodwill impairment		—			—			603,446			—
In process research and development		—			—			—			6,900

Total operating expenses		93,591			361,744			933,050			683,592

Operating loss		(96,920	)		(338,444	)		(915,846	)		(640,256	)
Other income, net		858			2,039			908			3,930

Loss from continuing operations		(96,062	)		(336,405	)		(914,938	)		(636,326	)
Discontinued operation:
Income (loss) from operations of discontinued operation		—			71			(125	)		603
Loss on disposal, including provision of $1.1 million for operating losses during phase-out period		—			—			(3,667	)		—

Net loss	$	(96,062	)	$	(336,334	)	$	(918,730	)	$	(635,723	)

Basic and diluted net loss per share:
Loss from continuing operations	$	(0.53	)	$	(3.81	)	$	(7.55	)	$	(7.58	)

Income (loss) from discontinued operation	$	—		$	—		$	(0.03	)	$	0.01

Net loss	$	(0.53	)		$ (3.81	)	$	(7.58	)	$	(7.57	)

Shares used in computing basic and diluted net loss per share		180,376			88,388			121,143			83,949

	Nine Months Ended September 30,
	2001			2000
Cash flows from operating activities:
Net loss	$	(918,730	)	$	(635,723	)
Adjustments to reconcile net loss to net cash used operating activities:
Depreciation		8,117			5,869
Other non-cash charges		755,764			577,511
Changes in operating assets and liabilities, net of effects from acquisitions:
Accounts receivable		38,149			(23,877	)
Prepaid and other current assets		9,043			(9,552	)
Other assets		(830	)		—
Accounts payable and accrued liabilities		1,397			4,701
Accrued restructuring and merger		20,053			—
Deferred revenue		(9,794	)		16,584
Other liabilities		(233	)		—

Net cash used in operating activities		(97,064	)		(64,487	)

Cash flows from investing activities:

Sales of short-term investments, net		24,752			32,128
Property and equipment purchases		(11,121	)		(23,782	)
Acquisitions, net of cash acquired		33,556			27,165
Restricted cash		(7,800	)		—

Net cash provided by investing activities		39,387			35,511

Cash flows from financing activities:
Payments on notes payable		(287	)		(3,093	)
Proceeds from issuance of common stock and warrants		1,486			124,794
Payments on stockholders' notes receivable		2,677			699

Net cash provided by financing activities		3,876			122,400
Effect of exchange rate changes on cash and cash equivalents		(963	)		766

Net increase (decrease) in cash and cash equivalents		(54,764	)		94,190
Cash and cash equivalents at beginning of period		76,202			18,695

Cash and cash equivalents at end of period	$	21,438		$	112,885

Supplemental disclosure of cash flow information and noncash activities:
Cash paid during the year for interest	$	117		$	225

Issuance of common stock and assumption of options
and warrants related to acquisitions	$	94,064		$	—

Issuance of warrants and common stock to non-employees	$	1,305		$	15,800

		Three Months Ended September 30,					Nine Months Ended September 30,
		2001		2000				2001				2000
Numerator:		(in thousands, except per share amounts)
Loss from continuing operations	$	(96,062	)	$	(336,405	)		$	(914,938	)	$	(636,326	)

Denominator:
Weighted-average shares of common stock outstanding		180,975			93,420				122,849			89,729
Less weighted-average shares subject to repurchase		599			5,032				1,706			5,780

Denominator for basic and diluted calculation		180,376			88,388				121,143			83,949

Basic and diluted net loss per share	$	(0.53	)	$	(3.81	)		$	(7.55	)	$	(7.58	)

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2001		2000		2001		2000
United States	$	14,930	$	33,526	$	52,806	$	63,195
International		2,468		5,516		9,234		9,535

	$	17,398	$	39,042	$	62,040	$	72,730

	Three Months Ended				Nine Months Ended
	September 30				September 30,
	2001		2000			2001			2000
Revenues	$	208	$	1,601		$	3,161		$	4,086

Income (loss) from operations of discontinued operation	$	—	$	71		$	(125	)	$	603
Loss on disposal		—		—			(3,667	)		—

Total income (loss) on discontinued operations	$	—	$	71		$	(3,792	)	$	603

Tangible assets acquired	$	125,144
Deferred compensation		15,485
Liabilities assumed		(37,111	)
Deferred credit – negative goodwill		(2,146	)

Net assets acquired	$	101,372

Fair market value of common stock	$	81,478
Fair market value of options and warrants assumed		12,586
Acquisition–related costs		7,308

Total	$	101,372

	(Unaudited Pro forma) Nine Months Ended September 30,
	2001			2000
	(In thousands, except per share amounts)
Net revenues	$	88,517		$	139,911
Net loss	$	(1,940,910	)	$	(1,130,724	)
Basic and diluted net loss per share	$	(10.85	)	$	(6.20	)

Shares used in basic and diluted net loss per share calculation		178,929			182,281

	Three Months Ended September 30,				Nine Months Ended September 30,
	2001		2000			2001		2000
Revenues:
License	17	%	61	%		39	%	64	%
Service	83		39			61		36

Total revenues	100		100			100		100

Cost of revenues:
License	3		2			3		2
Service	116		38			69		38
Total cost of revenues	119		40			72		40

Gross profit (loss)	(19)		60			28		60

Selected operating expenses:
Sales and marketing	110		66			96		80
Research and development	59		33			47		40
General and administrative	55	%	16	%		29	%	16	%

392) On February 7, 2002, we filed a current report on Form 8-K, reporting that our stockholders voted against the proposed issuance by us of up to $45 million of Series A convertible preferred stock and that immediately following the stockholder vote, we elected to terminate the share purchase agreement. In addition, we reported that on February 6, 2002, we announced that we entered into definitive agreements to sell approximately 2.9 million shares of our common stock to several institutional investors in a private placement with gross proceeds of approximately $34.5 million. In addition, we reported that on January 22, 2002, we announced our results for the quarter ended December 31, 2001.
~~[RETURN TO TABLE OF CONTENTS]~~		3) On February 13, 2002, we filed a current report on Form 8-K, reporting that we had completed the sale of an aggregate of approximately 2.9 million shares of our common stock to institutional investors in a private placement with gross proceeds of approximately $34.5 million.

Note 2. Investments

Note 3.2. Net Loss per Share

Note 4.3. Comprehensive Loss

Note 5.4. Stock-Based Compensation

Note 7.6. Restructuring costs

Note 8. Goodwill impairment

Note 9. Segment Information

Note 10. Notes Payable and Commitments

Note 12. Acquisition of Broadbase

Note 13. Recent Accounting Pronouncements

marketing.......... 10,305 41 26,534 113 Research and development..... 6,638 26 12,949 55 General and administrative... $ 3,220 13 % $ 6,068 26 %

Operating Expenses

Item 3: Quantitative and Qualitative Disclosures About Market Risk