10-Q 1 f66968e10-q.txt FORM 10-Q FOR QUARTERLY PERIOD ENDED SEPT.30, 2000 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10 - Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 Commission File Number 000-26881 E.PIPHANY, INC. --------------------------------------------------- (Exact Name as Registrant specified in its charter) DELAWARE 77-0443392 ------------------------------- --------------------------------------- (State or other jurisdiction of (I.R.S. Employer Identification Number) incorporation or organization) 1900 SOUTH NORFOLK STREET, SUITE 310 SAN MATEO, CALIFORNIA 94403 ---------------------------------------- (Address of principal executive offices) (650) 356-3800 ---------------------------------------------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ] The number of shares outstanding of the registrant's common stock, par value $.0001 per share, as of September 30, 2000, was 45,354,636. 2 E.PIPHANY, INC. QUARTERLY REPORT ON FORM 10-Q QUARTER ENDED SEPTEMBER 30, 2000 TABLE OF CONTENTS
PAGE NO. ---------------------------------------------------------------------------------- PART I FINANCIAL INFORMATION Item 1. Financial Statements Condensed Consolidated Balance Sheets -- 3 As of December 31, 1999 and September 30, 2000 Condensed Consolidated Statements of Operations -- 4 Three and nine months ended September 30, 1999 and 2000 Condensed Consolidated Statements of Cash Flows -- 5 Nine months ended September 30, 1999 and 2000 Notes to Condensed Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of 11 Financial Condition and Results of Operations Item 3. Quantitative and Qualitative Disclosures About Market Risk 30 -------------------------------------------------------------------------------- PART II OTHER INFORMATION Item 1. Legal Proceedings 31 Item 2. Changes in Securities and Use of Proceeds 31 Item 3. Defaults Upon Senior Securities 31 Item 4. Submission of Matters to a Vote of Securities Holders 31 Item 5. Other Information 31 Item 6. Exhibits and reports on Form 8-K 31 -------------------------------------------------------------------------------- SIGNATURES 32 --------------------------------------------------------------------------------
3 E.PIPHANY, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
DECEMBER 31, SEPTEMBER 30, 1999 2000 ----------- ------------ (UNAUDITED) ASSETS Current assets: Cash and cash equivalents .......................... $ 58,084 $ 313,257 Short-term investments ............................. 22,926 99,872 Accounts receivable, net ........................... 5,502 21,693 Prepaid expenses and other assets .................. 2,959 6,924 --------- ----------- Total current assets ............................ 89,471 441,746 Property and equipment, net .......................... 3,932 15,718 Goodwill and purchased intangibles ................... -- 2,810,864 Other assets ......................................... 183 848 --------- ----------- Total assets .................................... $ 93,586 $ 3,269,176 ========= =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current portion of capital lease obligations ....... $ 237 $ 693 Current portion of notes payable ................... 894 -- Trade accounts payable ............................. 650 2,737 Accrued merger costs ............................... -- 7,671 Accrued compensation ............................... 3,504 12,749 Accrued other ...................................... 2,192 15,831 Deferred revenue ................................... 3,643 18,304 --------- ----------- Total current liabilities ....................... 11,120 57,985 Capital lease obligations, net of current portion .... 399 765 Notes payable, net of current portion ................ 7,425 -- --------- ----------- Total liabilities ............................... 18,944 58,750 --------- ----------- Stockholders' equity: Common stock ....................................... 5 6 Additional paid-in capital ......................... 113,636 3,742,435 Warrants to purchase preferred stock ............... 143 -- Notes receivable ................................... (640) (2,758) Accumulated and other comprehensive income ......... (31) (240) Deferred compensation .............................. (2,602) (1,355) Accumulated deficit ................................ (35,869) (527,662) --------- ----------- Total stockholders' equity ...................... 74,642 3,210,426 --------- ----------- Total liabilities and stockholders' equity ...... $ 93,586 $ 3,269,176 ========= ===========
The accompanying notes are an integral part of the condensed consolidated financial statements. 3 4 E.PIPHANY, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------ ------------------------ 1999 2000 1999 2000 -------- --------- -------- --------- Revenues: Product license ....................................... $ 2,704 $ 21,382 $ 5,633 $ 43,943 Services .............................................. 2,640 17,758 4,835 34,131 -------- --------- -------- --------- Total revenues ..................................... 5,344 39,140 10,468 78,074 -------- --------- -------- --------- Cost of revenues: Product license ....................................... 58 342 83 766 Services .............................................. 2,957 17,307 5,445 32,703 -------- --------- -------- --------- Total cost of revenues ............................. 3,015 17,649 5,528 33,469 -------- --------- -------- --------- Gross profit ....................................... 2,329 21,491 4,940 44,605 -------- --------- -------- --------- Operating expenses: Research and development .............................. 1,857 8,533 4,722 17,699 Sales and marketing ................................... 5,225 19,872 11,576 46,989 General and administrative ............................ 1,262 6,207 2,546 12,503 In-process research and development charge ............ -- -- -- 47,000 Amortization of goodwill and purchased intangibles .... -- 269,904 -- 427,162 Stock-based compensation .............................. 742 332 2,314 1,993 -------- --------- -------- --------- Total operating expenses ........................... 9,086 304,848 21,158 553,346 -------- --------- -------- --------- Loss from operations ............................... (6,757) (283,357) (16,218) (508,741) Other income (expense), net ............................. (32) 6,088 83 16,948 -------- --------- -------- --------- Net loss ........................................... $ (6,789) $(277,269) $(16,135) $(491,793) ======== ========= ======== ========= Basic and diluted net loss per share .................... $ (0.91) $ (6.52) $ (2.90) $ (13.91) ======== ========= ======== ========= Shares used in computing basic and diluted net loss per share ...................................... 7,446 42,542 5,563 35,348 ======== ========= ======== ========= Pro forma basic and diluted net loss per share .......... $ (0.38) $ (6.52) $ (1.00) $ (13.91) ======== ========= ======== ========= Shares used in computing pro forma basic and diluted net loss per share .................................. 18,002 42,542 16,197 35,348 ======== ========= ======== =========
The accompanying notes are an integral part of the condensed consolidated financial statements. 4 5 E.PIPHANY, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
NINE MONTHS ENDED SEPTEMBER 30, ------------------------ 1999 2000 -------- --------- (UNAUDITED) Cash flows from operating activities: Net loss ............................................................ $(16,135) $(491,795) Adjustments to reconcile net loss to net cash used for operating activities: Depreciation and amortization .................................... 549 2,045 Allowance for doubtful accounts .................................. 50 1,450 Noncash compensation expense ..................................... 2,314 1,993 Noncash interest expense ......................................... 47 -- In-process research and development charge ....................... -- 47,000 Amortization of goodwill and purchased intangibles ............... -- 427,162 Changes in operating assets and liabilities, net of effect of acquisitions: Accounts receivable ............................................ (2,000) (13,677) Prepaid expenses and other assets .............................. (1,763) (3,030) Trade accounts payable ......................................... 572 1,220 Accrued liabilities ............................................ 3,414 1,033 Deferred revenue ............................................... 2,157 12,503 -------- --------- Net cash used in operating activities ....................... (10,795) (14,126) -------- --------- Cash flows from investing activities: Purchases of property and equipment ................................. (1,594) (8,583) Cash acquired in acquisitions ....................................... -- 24,282 Direct costs of purchase transactions ............................... -- (21,330) Purchases and sales of investments, net ............................. -- (76,918) -------- --------- Net cash (used in) investing activities ..................... (1,594) (82,549) -------- --------- Cash flows from financing activities: Borrowings on line of credit ........................................ 8,000 -- Repayments on line of credit ........................................ (135) (8,319) Principal payments on capital lease obligations ..................... (44) (405) Proceeds from secondary offering, net ............................... 69,866 356,108 Repayments on notes receivable ...................................... -- 246 Proceeds from sale of convertible preferred stock, net .............. 5,970 -- Proceeds from sale of common stock, net of repurchases .............. 4,838 4,455 -------- --------- Net cash provided by financing activities ................... 88,495 352,085 -------- --------- Effect of foreign exchange rates on cash and cash equivalents ......... -- (237) -------- --------- Net increase in cash and cash equivalents ............................. 76,106 255,173 Cash and cash equivalents at beginning of period ...................... 13,595 58,084 -------- --------- Cash and cash equivalents at end of period ............................ $ 89,701 $ 313,257 ======== =========
The accompanying notes are an integral part of the condensed consolidated financial statements. 5 6 E.PIPHANY, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION The condensed consolidated financial statements included herein have been prepared by E.piphany, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. However, E.piphany believes that the disclosures are adequate to make the information presented not misleading. These condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in E.piphany's Annual Report on Form 10-K for the fiscal year ended December 31, 1999. The unaudited condensed consolidated financial statements included herein reflect all adjustments (which include only normal, recurring adjustments) which are, in the opinion of management, necessary to state fairly the results for the three and nine months ended September 30, 2000. The results for the three and nine months ended September 30, 2000 are not necessarily indicative of the results expected for the full fiscal year. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The accompanying condensed consolidated financial statements include the accounts of E.piphany and its wholly owned subsidiaries. All intercompany accounts and transactions have been eliminated. FOREIGN CURRENCY TRANSLATION The functional currency of E.piphany's subsidiaries is the local currency. Accordingly, all assets and liabilities are translated into U.S. dollars at the current exchange rate as of the applicable balance sheet date. Revenues and expenses are translated at the average exchange rate prevailing during the period. Gains and losses resulting from the translation of the financial statements are reported as a separate component of stockholders' equity, which through September 30, 2000 have not been material. Foreign currency transaction gains and losses are included in other income (expense) and as of September 30, 2000 these transactions have not been material. 3. COMPREHENSIVE INCOME (LOSS) In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income," which E.piphany adopted beginning on January 1, 1998. SFAS No. 130 establishes standards for reporting and display of comprehensive income and its components in a full set of general purpose financial statements. The objective of SFAS No. 130 is to report a measure of all changes in equity of an enterprise that results from transactions and other economic events of the period other than transactions with stockholders ("comprehensive income"). Comprehensive income is the total of net income and all other non-owner changes in equity. For the three and nine months ended September 30, 1999, and the three and nine months ended September 30, 2000, E.piphany's comprehensive income (loss) did not differ materially from reported net loss. 4. COMPUTATION OF BASIC AND DILUTED NET LOSS PER SHARE AND PRO FORMA BASIC AND DILUTED NET LOSS PER SHARE Basic and diluted net loss per common share are presented in conformity with SFAS No. 128, "Earnings Per Share," for all periods presented. In accordance with SFAS No. 128, basic net loss per common share has been computed using the weighted average number of shares of common stock outstanding during the period, less shares subject to repurchase. Basic and diluted pro forma net loss per common share, as presented in the statements of 6 7 operations, has been computed as described above and also gives effect to the conversion of the convertible preferred stock (using the as if-converted to common stock method) from the original date of issuance. The following table presents the calculation of basic and pro forma basic net loss per share (in thousands, except per share amounts):
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------ ------------------------ 1999 2000 1999 2000 -------- --------- -------- --------- Net loss ....................................... $ (6,789) $(277,269) $(16,135) $(491,793) ======== ========= ======== ========= Basic and diluted: Weighted average shares of common stock outstanding .................................... 11,448 45,268 9,913 37,988 Less: Weighted average shares subject to repurchase ..................................... (4,002) (2,726) (4,350) (2,640) -------- --------- -------- --------- Weighted average shares used in computing basic and diluted net loss per common share .... 7,446 42,542 5,563 35,348 ======== ========= ======== ========= Basic and diluted net loss per common share .... $ (0.91) $ (6.52) $ (2.90) $ (13.91) ======== ========= ======== ========= Net loss ....................................... $ (6,789) $(277,269) $(16,135) $(491,793) ======== ========= ======== ========= Shares used above .............................. 7,446 42,542 5,563 35,348 Pro forma adjustment to reflect weighted effect of assumed conversion of convertible preferred stock .................... 10,556 -- 10,634 -- -------- --------- -------- --------- Shares used in computing pro forma basic and diluted net loss per common share .............. 18,002 42,542 16,197 35,348 ======== ========= ======== ========= Pro forma basic and diluted net loss per common share ................................... $ (0.38) $ (6.52) $ (1.00) $ (13.91) ======== ========= ======== =========
E.piphany has excluded all convertible preferred stock, warrants for convertible preferred stock, outstanding stock options, and shares subject to repurchase from the calculation of diluted net loss per common share because all such securities are antidilutive for all periods presented. The total number of shares excluded from the calculations of basic and diluted net loss per share were 17,968,795 and 7,295,102 for the three months ended September 30, 1999 and September 30, 2000, respectively. The total number of shares excluded from the calculations of basic and diluted net loss per share were 18,503,754 and 7,227,565 for the nine months ended September 30, 1999 and September 30, 2000, respectively. 5. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which requires companies to record derivative financial instruments on the balance sheet as assets or liabilities, measured at fair value. Gains or losses resulting from changes in the values of those derivatives would be accounted for depending on the use of the derivative and whether it qualifies for hedge accounting. The key criterion for hedge accounting is that the hedging relationship must be highly effective in achieving offsetting changes in fair value or cash flows. In June 1999, the FASB issued SFAS No. 137, "Accounting For Derivative Instruments and Hedging Activities -- Deferral of the Effective Date of FASB Statement No. 133," which amends SFAS No. 133 to be effective for all fiscal quarters of all fiscal years beginning after June 15, 2000 (or January 1, 2001 for E.piphany). This statement will not have a material impact on the financial condition or results of operations of E.piphany. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial Statements." SAB 101 provides guidance on applying generally accepted accounting principle to revenue recognition issues in financial statements. We will adopt SAB 101 as required in 7 8 the fourth quarter of 2000. We do not expect the adoption of SAB 101 to have a material impact on our consolidated results of operations and financial position. 6. ACQUISITIONS The Octane Acquisition On May 31, 2000, E.piphany acquired Octane Software, Inc. ("Octane") in a merger transaction. Octane is a next-generation provider of multi-channel customer interaction applications and infrastructure software for sales, service and support. Under the terms of the Octane Merger Agreement, stockholders of Octane received approximately 0.5097 shares of E.piphany common stock for each share of Octane common stock they owned at the time the merger was consummated. In addition, options and warrants to acquire Octane common stock were converted as a result of the merger into equivalent options and warrants for E.piphany common stock, based upon the exchange ratio. The total purchase price was approximately $2.7 billion, of which $25.0 million was allocated to in-process research and development and expensed upon closing of the acquisition as it had not reached technological feasibility and, in management's opinion, had no alternative future use. The total purchase price is subject to adjustments based upon finalization of management's integration plans, which may include elimination of duplicate facilities and fixed assets as well as employee severance. Purchased intangibles, representing purchase price in excess of identified tangible and intangible assets, of approximately $2.7 billion were recorded and are being amortized on a straight-line basis over a useful life of three years. Accumulated amortization was approximately $297.9 million at September 30, 2000. The value assigned to acquired in-process research and development was determined by identifying research projects in areas for which technological feasibility had not been established. The value was determined by estimating the costs to develop the acquired in-process technology into commercially viable products, estimating the resulting net cash flows from such projects, and discounting the net cash flows back to their present values. The discount rate includes a factor that takes into account the uncertainty surrounding the successful development of the acquired in-process technology. There can be no assurance that the value of the other purchased intangible assets may not become impaired prior to its amortization. In connection with the acquisition of Octane, net assets acquired were as follows (in thousands): Cash, receivables and other current assets ................... $ 24,828 Property, plant and equipment and other noncurrent assets .... 4,518 Note receivable from stockholder ............................. 1,179 Purchased intangibles, including in-process technology ....... 2,705,946 Current liabilities assumed .................................. (26,078) ----------- Net assets acquired ................................ $ 2,710,393 ===========
The eClass Acquisition On May 31, 2000, E.piphany acquired eClass Direct, Inc. ("eClass") in a merger transaction. eClass is an application service provider of permission-based e-mail marketing services. Under the terms of the eClass Merger Agreement, stockholders of eClass received approximately 0.1411 shares of E.piphany common stock for each share of eClass common stock. In addition, options to acquire eClass common stock were converted as a result of the merger into equivalent options for E.piphany common stock, based upon the exchange ratio. The total purchase price was approximately $50.3 million. The total purchase price is subject to adjustments based upon finalization of management's integration plans, which may include elimination of duplicate facilities and fixed assets as well as employee severance. Purchased intangibles, representing purchase price in excess of identified tangible and intangible assets, of approximately $48.6 million were recorded and are being amortized on a straight-line basis over a useful life of three years. Accumulated amortization was approximately $5.4 million at September 30, 2000. There can be no assurance that the value of the other purchased intangible assets may not become impaired prior to its amortization. 8 9 In connection with the acquisition, net assets acquired were as follows (in thousands): Cash, receivables and other current assets .... $ 1,571 Property, plant and equipment ................. 250 Purchased intangibles ......................... 48,620 Current liabilities assumed ................... (127) -------- Net assets acquired ................. $ 50,314 ========
The iLeverage Acquisition On May 1, 2000, E.piphany acquired iLeverage Corporation ("iLeverage") in a merger transaction. iLeverage develops marketing solutions for digital marketplaces. Under the terms of the iLeverage Merger Agreement, stockholders of iLeverage received approximately 0.007 and 0.008097 shares of E.piphany common stock for each share of iLeverage common stock and preferred stock, respectively. In addition, options to acquire iLeverage common stock were converted as a result of the merger into equivalent options for E.piphany common stock, based upon the exchange ratio. The total purchase price was approximately $29.0 million. The total purchase price is subject to adjustments based upon finalization of management's integration plans, which may include elimination of duplicate facilities and fixed assets as well as employee severance. Purchased intangibles, representing purchase price in excess of identified tangible and intangible assets, of approximately $29.1 million were recorded and are being amortized on a straight-line basis over a useful life of three years. Accumulated amortization was approximately $4.0 million at September 30, 2000. There can be no assurance that the value of the other purchased intangible assets may not become impaired prior to its amortization. In connection with the acquisition of iLeverage, net assets acquired were as follows (in thousands): Cash, receivables and other current assets .... $ 285 Purchased intangibles ......................... 29,143 Current liabilities assumed ................... (391) -------- Net assets acquired ................. $ 29,037 ========
The RightPoint Acquisition On January 4, 2000, E.piphany acquired RightPoint Software, Inc. ("RightPoint") in a merger transaction. RightPoint develops and markets real time marketing software solutions that enable companies to optimize and present marketing offers, promotions, and communications while a customer is interacting with a web site, call center agent or other point of customer interaction. Under the terms of the RightPoint Merger Agreement, shareholders of RightPoint received approximately 0.1185 shares of E.piphany common stock for each share of RightPoint common stock they owned at the time the merger was consummated. In addition, options and warrants to acquire RightPoint common stock were converted as a result of the merger into equivalent options and warrants for E.piphany common stock, based upon the exchange ratio. The total purchase price was approximately $496.8 million, of which $22.0 million was allocated to in-process research and development and expensed upon closing of the acquisition as it had not reached technological feasibility and, in management's opinion, had no alternative future use. The total purchase price is subject to adjustments based upon finalization of management's integration plans, which may include elimination of duplicate facilities and fixed assets as well as employee severance. Purchased intangibles, representing purchase price in excess of identified tangible and intangible assets, of approximately $479.3 million were recorded and are being amortized on a straight-line basis over a useful life of three years. Accumulated amortization was approximately $119.8 million at September 30, 2000. The value assigned to acquired in-process research and development was determined by identifying research projects in areas for which technological feasibility had not been established. The value was determined by 9 10 estimating the costs to develop the acquired in-process technology into commercially viable products, estimating the resulting net cash flows from such projects, and discounting the net cash flows back to their present values. The discount rate includes a factor that takes into account the uncertainty surrounding the successful development of the acquired in-process technology. There can be no assurance that the value of the other purchased intangible assets may not become impaired prior to its amortization. In connection with the acquisition of RightPoint, net assets acquired were as follows (in thousands): Cash, receivables and other current assets ................... $ 3,076 Property, plant and equipment and other noncurrent assets .... 817 Note receivable from stockholder ............................. 1,185 Purchased intangibles, including in-process technology ....... 501,318 Current liabilities assumed .................................. (9,633) --------- Net assets acquired ................................ $ 496,763 =========
The following table presents the unaudited pro forma results assuming that E.piphany had merged with Octane, eClass, iLeverage and RightPoint at the beginning of fiscal year 1999. Net income has been adjusted to exclude the write-offs of acquired in-process research and development of approximately $47.0 million and includes amortization of purchased intangibles of approximately $809.5 million for the nine months ended September 30, 1999 and 2000. Net income also includes $2.3 million and $2.0 million of stock based compensation for the nine months ended September 30, 1999 and 2000, respectively, and $14.0 million of acquisition related costs for the nine months ended September 30, 2000. This information may not necessarily be indicative of the future combined results of operations of Epiphany (in thousands, except per share amounts).
NINE MONTHS ENDED SEPTEMBER 30, ------------------------- 1999 2000 --------- --------- Revenues .................... $ 17,983 $ 85,962 Net loss .................... $(836,816) $(860,933) Basic net loss per share .... $ (26.41) $ (20.40)
7. SUBSEQUENT EVENT On October 19, 2000, the Company announced a 3-for-2 stock split for stockholders of record on October 30, 2000. The stock split will be effected through a stock dividend that is payable on November 13, 2000. The Company has not reflected the effects of this split in the accompanying financial statements. 10 11 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The statements contained in this Quarterly Report on Form 10-Q (the "Report") that are not historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act") and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), including statements regarding E.piphany's expectations, beliefs, intentions or strategies regarding the future. Forward-looking statements include, without limitation, statements regarding the extent and timing of future revenues and expenses and customer demand, statements regarding the deployment of E.piphany's products, and statements regarding reliance on third parties. All forward-looking statements included in this document are based on information available to E.piphany as of the date hereof, and E.piphany assumes no obligation to update any such forward-looking statement. It is important to note that E.piphany's actual results could differ materially from those in such forward-looking statements. Factors that might cause or contribute to such a discrepancy include, but are not limited to, those discussed under the heading "Risk Factors" and the risks discussed in our other Securities Exchange Commission ("SEC") filings. OVERVIEW E.piphany develops, markets and sells E.piphany E.5, an integrated suite of customer relationship management software solutions that provide capabilities for the analysis of customer data, the creation of inbound and outbound marketing campaigns, and the execution of sales and service customer interactions. Companies can implement E.piphany E.5 to collect and analyze data from their existing software systems, and from third party data providers, to better understand and proactively and personally interact with their customers across a variety of channels. Business users within these companies can use this information to design and execute marketing campaigns as well as personalize products, services and related interactions. E.piphany was founded in November 1996. From E.piphany's founding through the end of 1997, E.piphany primarily engaged in research activities, developing products and building business infrastructure. E.piphany began shipping its first software product and first generated revenues from software license fees, implementation and consulting fees, and maintenance fees in early 1998. During 1998, E.piphany introduced several other software products, and in August 2000, E.piphany began shipping its E.piphany E.5 System software solutions. Although E.piphany's revenues consistently increased from quarter to quarter during 1998 and 1999, E.piphany incurred significant costs to develop its technology and products, to continue the recruitment of research and development personnel, to build a direct sales force and a professional services organization, and to expand its general and administrative infrastructure. E.piphany's total headcount has increased from 69 employees at December 31, 1998 to 849 employees at September 30, 2000. ACQUISITIONS THE OCTANE ACQUISITION On May 31, 2000, E.piphany acquired Octane Software, Inc., a next-generation provider of multi-channel customer interaction applications and infrastructure software for sales, service and support, in a merger transaction. In connection with this transaction, E.piphany acquired all of the outstanding shares of capital stock of Octane in exchange for 11,568,951 shares of E.piphany's common stock. In addition, options and warrants of Octane were converted into options and warrants to purchase approximately 1,224,559 shares of E.piphany's common stock. E.piphany accounted for the acquisition under the purchase method of accounting and the results of Octane's operations subsequent to May 31, 2000 have been included in E.piphany's operating results for the three and nine months ended September 30, 2000. Please see Note 6 in the Notes to Condensed Consolidated Financial Statements for more detailed information. 11 12 THE eCLASS ACQUISITION On May 31, 2000, E.piphany acquired eClass Direct, Inc., an application service provider of permission-based e-mail marketing services in a merger transaction. In connection with this transaction, E.piphany acquired all of the outstanding shares of capital stock of eClass in exchange for 722,687 shares of E.piphany's common stock. In addition, options of eClass were converted into options to purchase approximately 46,383 shares of E.piphany's common stock. E.piphany accounted for the acquisition under the purchase method of accounting and the results of eClass' operations subsequent to May 31, 2000 have been included in E.piphany's operating results for the three and nine months ended September 30, 2000. Please see Note 6 in the Notes to Condensed Consolidated Financial Statements for more detailed information. THE iLEVERAGE ACQUISITION On May 1, 2000, E.piphany acquired iLeverage Corporation, a start-up company that develops marketing solutions for digital marketplaces. In connection with this transaction, E.piphany acquired all of the outstanding shares of capital stock of iLeverage in exchange for 118,097 shares of E.piphany's common stock. In addition, options of iLeverage were converted into options to purchase approximately 63,487 shares of E.piphany's common stock. E.piphany accounted for the acquisition under the purchase method of accounting and the results of iLeverage's operations subsequent to May 1, 2000 have been included in E.piphany's operating results for the three and nine months ended September 30, 2000. Please see Note 6 in the Notes to Condensed Consolidated Financial Statements for more detailed information. THE RIGHTPOINT ACQUISITION On January 4, 2000, E.piphany acquired RightPoint Software, Inc., a provider of real time marketing software solutions that enable companies to optimize and present marketing offers, promotions, and communications while a customer is interacting with a web site, call center agent or other point of customer interaction. In connection with this transaction, E.piphany acquired all of the outstanding shares of capital stock of RightPoint in exchange for 3,076,661 shares of E.piphany's common stock. In addition, options and warrants of RightPoint were converted into options and warrants to purchase approximately 530,000 shares of E.piphany's common stock. E.piphany accounted for the acquisition under the purchase method of accounting and the results of RightPoint's operations subsequent to January 4, 2000 have been included in E.piphany's operating results for the three and nine months ended September 30, 2000. Please see Note 6 in the Notes to Condensed Consolidated Financial Statements for more detailed information. SOURCE OF REVENUES AND REVENUE RECOGNITION POLICY E.piphany generates revenues principally from licensing its software products directly to customers and providing related professional services including implementation, consulting, support and training. Through September 30, 2000, substantially all of E.piphany's revenues have been derived from sales through E.piphany's direct sales force. During 2000, E.piphany expanded its international sales efforts which accounted for 10% of revenues for the three months ended September 30, 2000. E.piphany's license agreements generally provide that customers pay a software license fee for one or more software solutions for a specified number of users. The amount of the license fee varies based on which software solution is purchased, the number of software solutions purchased and the number of users licensed. Customers can subsequently pay additional license fees to allow additional users to use previously purchased software solutions or to purchase additional software solutions. Each software solution included in the E.piphany E.5 System contains the same core technology, allowing for easy integration of additional software solutions as they are purchased from E.piphany. Customers that purchase software solutions receive the software on compact disc or via Internet delivery. Customers generally require consulting and implementation services which include evaluating their business needs, identifying the data sources necessary to meet these needs and installing the software solution in a manner which fulfills their needs. Customers have generally purchased these services directly from E.piphany through E.piphany's internal professional services organization on either a fixed fee or a time and expense basis. E.piphany has historically supplemented the capacity of its internal professional services organization by subcontracting some 12 13 of these services to consulting organizations, especially to those organizations with which E.piphany has relationships such as KPMG and PricewaterhouseCoopers. However, E.piphany intends to increasingly encourage customers to purchase services directly from these consulting organizations. E.piphany believes that this would increase the number of consultants who can provide consulting and implementation services related to E.piphany's software products and that it would increase E.piphany's overall gross margins by increasing E.piphany's percentage of license revenue, which has substantially higher gross margins than services revenue, as a percentage of total revenue. E.piphany also believes that it will encourage these consulting organizations to generate sales leads within their customer base. Customers also generally purchase maintenance contracts which provide software upgrades and technical support over a stated term, generally twelve months. Revenue on software upgrades and technical support is recognized ratably over the term of the maintenance contract. E.piphany recognizes product license revenues in accordance with the provisions of American Institute of Certified Public Accounts (AICPA) Statement of Position (SOP) 97-2, "Software Revenue Recognition." Pursuant to the requirements of SOP 97-2, E.piphany recognizes product license revenues when all of the following conditions are met: - E.piphany has signed a noncancellable agreement with the customer, - E.piphany has delivered the software product to the customer, - the amount of fees to be paid by the customer is fixed or determinable, and - E.piphany believes that collection of these fees is probable. To date, when E.piphany manages the implementation process for its customers, the implementation services have been considered essential to the functionality of the software products. Accordingly, both the product license revenues and services revenues are recognized in accordance with the provisions of SOP 81-1, "Accounting for Performance of Construction Type and Certain Production Type Contracts." Prior to 1999, E.piphany recognized substantially all of its revenues using the completed contract method as estimates of costs and efforts necessary to complete the implementation were generally not reliable given E.piphany's lack of history with implementing its products. In 2000 and future years, E.piphany expects to recognize most of its revenues using the percentage of completion method, and therefore both product license and services revenues are recognized as work progresses. While E.piphany's software solutions can generally be implemented in less than sixteen weeks, implementation can take longer depending on the solution which has been licensed, the number of software solutions licensed, the complexity of the customer's information technology environment and the resources directed by customers to the implementation projects. To date, E.piphany has managed the implementation of E.piphany's solutions for the substantial majority of its customers. When E.piphany subcontracts services to consulting organizations, E.piphany is responsible for managing the implementation. To the extent that customers contract directly with consulting organizations to provide implementation services and E.piphany does not manage the implementation, license revenues are recognized when the relevant conditions of SOP 97-2 are met. Some of E.piphany's contracts provide for the delivery of unspecified future products over a period of time. Accordingly, payments received from E.piphany's customers upon the signing of these agreements are deferred and the revenues are recognized ratably over the contract period. Revenue allocated to training and other services is recognized as the services are performed. COST OF REVENUES AND OPERATING EXPENSES E.piphany's cost of license revenues primarily consists of license fees due to third parties for integrated technology. E.piphany's cost of services revenues include salaries and related expenses for E.piphany's implementation, consulting support and training organizations, costs of subcontracting to consulting organizations to provide consulting services to customers and an allocation of facilities, communications and depreciation expenses. E.piphany's operating expenses are classified into three general categories: sales and marketing, research and development, and general and administrative. E.piphany classifies all charges to these operating expense categories based on the nature of the expenditures. E.piphany allocates the costs for overhead and facilities to each of the 13 14 functional areas that use the overhead and facilities services based on their headcount. These allocated charges include facility rent for corporate offices, communication charges and depreciation expenses for office furniture and equipment. Software development costs incurred prior to the establishment of technological feasibility are included in research and development costs as incurred. Since license revenues from E.piphany's software solutions are not recognized until after technological feasibility has been established, software development costs are not generally expensed in the same period in which license revenues for the developed products are recognized. RESULTS OF OPERATIONS REVENUES Total revenues increased to $39.1 million for the three months ended September 30, 2000, from $5.3 million for the three months ended September 30, 1999. Total revenues increased to $78.1 million for the nine months ended September 30, 2000, from $10.5 million for the nine months ended September 30, 1999. Product license revenues increased to $21.4 million, or 55% of total revenue, for the three months ended September 30, 2000 from $2.7 million, or 51% of total revenue, for the three months ended September 30, 1999. Product license revenues increased to $43.9 million, or 56% of total revenue, for the nine months ended September 30, 2000 from $5.6 million, or 54% of total revenue, for the nine months ended September 30, 1999. The increase in dollar amount of product license revenues was due to both an increase in the number of licenses sold and the average size of the licenses, and resulted primarily from the growth of E.piphany's direct sales force and the introduction and shipment of new products. Services revenues increased to $17.8 million, or 45% of total revenues, for the three months ended September 30, 2000 from $2.6 million, or 49% of revenues, for the three months ended September 30, 1999. Services revenues increased to $34.1 million, or 44% of total revenues, for the nine months ended September 30, 2000 from $4.8 million, or 46% of revenues, for the nine months ended September 30, 1999. The increase in dollar amount of services revenues was primarily attributable to increased implementation and consulting services performed in connection with increased license sales and to maintenance contracts sold to E.piphany's new customers. The relative amount of services revenues as compared to license revenues has varied based on the volume of license fees for software solutions compared to the volume of product license fees for additional users, which generally do not require services. In addition, the amount of services E.piphany provides for a software solution can vary greatly depending on the solution which has been licensed, the complexity of the customers' information technology environment, the resources directed by customers to their implementation projects, the number of users licensed and the extent to which consulting organizations provide services directly to customers. Services revenues have substantially lower margins relative to product license revenues. This is especially true when E.piphany is required to subcontract with consulting organizations to supplement its internal professional services organization. It generally costs E.piphany more to subcontract with consulting organizations to provide these services than to provide these services itself. To offset the effect that providing services itself or through subcontractors has on E.piphany's gross margins, E.piphany intends to further encourage customers to contract directly with consulting organizations for implementation and consulting services. Encouraging direct contracts between E.piphany's customers and consulting organizations may also increase the overall amount of services available to customers and generate sales leads. E.piphany does not receive any services revenues when customers contract directly with consulting organizations for implementation and consulting services. To the extent that services revenues become a greater percentage of our total revenues and services margins do not increase, E.piphany's overall gross margins will decline. COST OF REVENUES Total cost of revenues increased to $17.6 million for the three months ended September 30, 2000 from $3.0 million for the three months ended September 30, 1999. Total cost of revenues increased to $32.7 million for the nine months ended September 30, 2000 from $5.5 million for the nine months ended September 30, 1999. Cost of product license revenues consists primarily of license fees paid to third parties under technology license 14 15 arrangements and have not been significant to date. Cost of services revenues consists primarily of the costs of consulting and customer service and support. Cost of services revenues increased to $17.3 million, or 97% of services revenues, for the three months ended September 30, 2000 from $3.0 million, or 112% of services revenues, for the three months ended September 30, 1999. Cost of services revenues increased to $32.7 million, or 96% of services revenues, for the nine months ended September 30, 2000 from $5.4 million, or 113% of services revenues, for the nine months ended September 30, 1999. The increase in cost of services revenues in absolute dollars resulted primarily from the hiring of additional employees and the subcontracting of consulting services to consulting organizations to support increased customer demand for consulting services. Cost of services revenues has almost exceeded service revenues during the three months and nine months ended September 30, 2000, and during the three months and nine months ended September 30, 1999 exceeded services revenues, due to the rapid growth of E.piphany's services organization and E.piphany's investment in experienced management in anticipation of future revenue growth. OPERATING EXPENSES Research and Development Research and development expenses consist primarily of personnel and related costs associated with E.piphany's product development efforts. Research and development expenses increased to $8.5 million for the three months ended September 30, 2000 from $1.9 million for the three months ended September 30, 1999. Research and development expenses increased to $17.7 million for the nine months ended September 30, 2000 from $4.7 million for the nine months ended September 30, 1999. The increase in absolute dollars was primarily due to an increase in the number of employees engaged in research and development from our internal growth and acquisitions. Research and development expenses as a percentage of total revenues decreased from 35% for the three months ended September 30, 1999 to 22% for the three months ended September 30, 2000. Research and development expenses as a percentage of total revenues decreased from 45% for the nine months ended September 30, 1999 to 23% for the nine months ended September 30, 2000. Research and development expenses as a percentage of total revenues decreased primarily due to growth in E.piphany's revenues. E.piphany believes that investments in product development are essential to its future success and expects that the absolute dollar amount of research and development expenses will increase in future periods. Sales and Marketing Sales and marketing expenses consist primarily of employee salaries, benefits and commissions, and the costs of trade shows, seminars, promotional materials and other sales and marketing programs. Sales and marketing expenses increased to $19.9 million for the three months ended September 30, 2000 from $5.2 million for the three months ended September 30, 1999. Sales and marketing expenses increased to $47.0 million for the nine months ended September 30, 2000 from $11.6 million for the nine months ended September 30, 1999. Sales and marketing expenses as a percentage of total revenues decreased from 98% for the three months ended September 30, 1999 to 51% for the three months ended September 30, 2000. Sales and marketing expenses as a percentage of total revenues decreased from 111% for the nine months ended September 30, 1999 to 60% for the nine months ended September 30, 2000. The increase in sales and marketing expenses in absolute dollars was primarily attributable to an increase in the number of sales and marketing employees from internal growth and acquisitions. Sales and marketing expenses as a percentage of total revenues decreased primarily due to growth in E.piphany's revenues. E.piphany expects that the absolute dollar amount of sales and marketing expenses will continue to increase due to the planned growth of its sales force, including the establishment of sales offices in additional domestic and international locations including Europe and Asia, and due to expected additional increases in advertising and marketing programs and other promotional activities. General and Administrative General and administrative expenses consist primarily of employee salaries and related expenses for executive, finance and administrative personnel. General and administrative expenses increased to $6.2 million for the three months ended September 30, 2000 from $1.3 million for the three months ended September 30, 1999. General and administrative expenses increased to $12.5 million for the nine months ended September 30, 2000 from $2.5 million 15 16 for the nine months ended September 30, 1999. The increase in general and administrative expenses in absolute dollars was primarily attributable to an increase in the number of executive, finance and administrative employees from our internal growth and acquisitions necessary to support our expanding operations. General and administrative expenses as a percentage of total revenues decreased from 24% for the three months ended September 30, 1999 to 16% for the three months ended September 30, 2000. General and administrative expenses as a percentage of total revenues decreased from 24% for the nine months ended September 30, 1999 to 16% for the nine months ended September 30, 2000. General and administrative expenses as a percentage of total revenues decreased primarily due to growth in E.piphany's revenues. E.piphany expects general and administrative expenses to increase in absolute dollars in future periods. Amortization of Goodwill and Purchased Intangibles Goodwill and purchased intangibles represent the purchase price of Octane, RightPoint, eClass and iLeverage in excess of identified tangible assets. During the first nine months of 2000, E.piphany recorded approximately $3.2 billion of goodwill and purchased intangibles, which are being amortized on a straight-line basis over three years. The total purchase price is subject to adjustments based upon finalization of management's integration plans, which may include elimination of duplicate facilities and fixed assets as well as employee severance. E.piphany recorded amortization expense of $269.9 million and $427.2 million for the three months and the nine months ended September 30, 2000, respectively. There can be no assurance that the value of the goodwill and purchased intangible assets may not become impaired prior to its amortization. In-Process Research and Development Charge In connection with the Octane acquisition we recorded a charge of $25.0 million in the quarter ended June 30, 2000. In connection with the RightPoint acquisition we recorded a charge of $22.0 million in the quarter ended March 31, 2000. Please see Note 6 in the Notes to Condensed Consolidated Financial Statements for more detailed information. 16 17 Stock-Based Compensation Stock-based compensation consists of amortization of deferred compensation in connection with stock option grants and sales of stock to employees at exercise or sales prices below the deemed fair market value of E.piphany's common stock and compensation related to equity instruments issued to non-employees for services rendered. E.piphany has recorded aggregate deferred compensation of $5.9 million related to stock-based compensation to employees. As of September 30, 2000, deferred compensation remaining to be amortized totaled $1.4 million. This amount is being amortized over the respective vesting periods of these equity instruments in a manner consistent with Financial Accounting Standards Board Interpretation No. 28. Total stock-based compensation was $332,000 and $1,993,000 for the three and nine months ended September 30, 2000, respectively. E.piphany expects amortization of approximately $296,000 in the fourth quarter of 2000 and $774,000, $306,000, and $25,000 for the years ended December 31, 2001, 2002, and the first six months of 2003, respectively. INTEREST INCOME, NET Interest income increased to $6.1 million for the three months ended September 30, 2000 from a $32,000 expense for the three months ended September 30, 1999. Interest income increased to $16.9 million for the nine months ended September 30, 2000 from $0.1 million for the nine months ended September 30, 1999. The increase in interest income, net of interest expense, for the three and nine months ended September 30, 2000 when compared to the same periods in the prior year was due to increased cash balances as a result of the completion of E.piphany's initial public offering in September 1999 and its follow-on public offering in January 2000. LIQUIDITY AND CAPITAL RESOURCES Net cash used in operating activities totaled $14.1 million and $10.8 million for the nine months ended September 30, 2000 and 1999, respectively. Cash used in operating activities for each period resulted from net losses in those periods. For the period ended September 30, 2000, cash used in operating activities also resulted from an increase in accounts receivable and prepaid expenses and other assets. These uses of cash were partially offset by an increase in deferred revenue. Net cash used in investing activities totaled $82.5 million for the nine months ended September 30, 2000 compared to $1.6 million used in investing activities for the nine months ended September 30, 1999. The increase resulted from the purchase of investments during the first nine months of 2000. Net cash provided by financing activities totaled $352.1 million and $88.5 million for the nine months ended September 30, 2000 and 1999, respectively. The increase was due primarily to the receipt of proceeds from E.piphany's secondary offering completed during the first quarter of 2000. At September 30, 2000, E.piphany had $313.3 million in cash and cash equivalents and $99.9 million in short-term investments. E.piphany had a $3.0 million term loan under a senior credit facility which was paid in full during January 2000. On January 20, 2000, E.piphany completed a follow-on public offering. E.piphany issued 1,993,864 shares of common stock in exchange for net proceeds of approximately $338.4 million, after deduction of the underwriters' discount and expenses. In connection with the follow-on offering on February 15, 2000, the underwriters' exercised an option to purchase from E.piphany an additional 104,342 shares of common stock, resulting in additional net proceeds of approximately $17.7 million, after the underwriters' discount and expenses. The aggregate number of shares of E.piphany common stock issued in the follow-on offering was 2,098,206, resulting in aggregate net proceeds of approximately $356.1 million, after the underwriters' discount and expenses. In addition, E.piphany had a subordinated debt facility with Comdisco, Inc. under which E.piphany was entitled to borrow up to $10.0 million over 42 months beginning June 1999 at a fixed interest rate of 10.0%. The outstanding balance as of December 31, 1999 of $5.0 million from this loan was paid in full during January 2000. E.piphany also has a $2.0 million equipment lease line with Comdisco. Under the equipment lease line, E.piphany is entitled to lease equipment with payment terms extending over 42 months. The ability to lease new equipment expired on May 31, 2000 and borrowings bear interest at 8.5% for the first six months of the lease, and 8.0% thereafter. 18 18 As of September 30, 2000, E.piphany's principal sources of liquidity included $313.3 million of cash and cash equivalents and $99.9 million in short-term investments. E.piphany anticipates a substantial increase in its capital expenditures consistent with anticipated growth in operations, infrastructure and personnel. E.piphany believes that its current cash and cash equivalents and short-term investments will be sufficient to meet its anticipated liquidity needs for working capital and capital expenditures for at least the next twelve months. If E.piphany requires additional capital resources to grow its business internally or to acquire complementary technologies and businesses at any time in the future, E.piphany may seek to sell additional equity or debt securities or secure an additional bank line of credit. The sale of additional equity or convertible debt securities could result in additional dilution to E.piphany's stockholders. E.piphany cannot assure you that any financing arrangements will be available in amounts or on terms acceptable to it in the future. RISK FACTORS An investment in our common stock is very risky. You should carefully consider the risks described below, together with all of the other information in this quarterly report, before making an investment decision. If any of the following risks actually occur, our business, financial condition or results of operations could be materially adversely affected, the trading price of our common stock could decline, and you may lose all or part of your investment. This quarterly report also contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including the risks faced by us described below and elsewhere in this quarterly report. E.PIPHANY HAS A HISTORY OF LOSSES, EXPECTS LOSSES IN THE FUTURE AND MAY NOT EVER BECOME PROFITABLE. We incurred net losses of $491.8 million for the nine months ended September 30, 2000, $22.4 million in the year ended December 31, 1999, $10.3 million in the year ended December 31, 1998 and $3.1 million in the year ended December 31, 1997. We had an accumulated deficit of $527.7 million as of September 30, 2000, and $35.9 million as of December 31, 1999. We expect to continue to incur losses before amortization charges for the foreseeable future. In addition, in connection with the acquisitions of Octane, RightPoint, eClass, and iLeverage, we will incur significant accounting charges for the amortization of intangible assets over the three years following these mergers. These losses will be substantial, and we may not ever become profitable. In addition, we expect to significantly increase our expenses in the near term, especially research and development and sales and marketing expenses. Therefore, our operating results will be harmed if our revenue does not keep pace with our expected increase in expenses or is not sufficient for us to achieve profitability. If we do achieve profitability in any period, it cannot be certain that we will sustain or increase profitability on a quarterly or annual basis. OUR LIMITED OPERATING HISTORY AND THE LIMITED OPERATING HISTORY OF THE COMPANIES WE ACQUIRED MAKES FINANCIAL FORECASTING AND EVALUATION OF OUR BUSINESS DIFFICULT. Our limited operating history and the limited operating history of the companies that we acquired makes it difficult to forecast E.piphany's future operating results. E.piphany was founded in November 1996 and began developing products in 1997. Our revenue and income potential is unproven. We received our first revenues from licensing our software and performing related services in early 1998. Since neither we nor the companies we acquired have a long history upon which to base forecasts of future operating results, any predictions about our future revenues and expenses may not be as accurate as they would be if E.piphany and the other companies we acquired had a longer business history. VARIATIONS IN QUARTERLY OPERATING RESULTS DUE TO SUCH FACTORS AS CHANGES IN DEMAND FOR OUR PRODUCTS AND CHANGES IN OUR MIX OF REVENUES MAY CAUSE OUR STOCK PRICE TO DECLINE. We expect our quarterly operating results to fluctuate. We therefore believe that quarter-to-quarter comparisons of our operating results may not be a good indication of our future performance, and you should not rely on them to predict our future performance or the future performance of our stock price. Our short-term expense levels are 19 19 relatively fixed and are based on our expectations of future revenues. As a result, a reduction in revenues in a quarter may harm our operating results for that quarter. Our quarterly revenues, expenses and operating results could vary significantly from quarter-to-quarter. If our operating results in future quarters fall below the expectations of market analysts and investors, the trading price of our common stock will fall. Factors that may cause our operating results to fluctuate on a quarterly basis are: - varying size, timing and contractual terms of orders for our products, - our ability to timely complete our service obligations related to product sales, - changes in the mix of revenue attributable to higher-margin product license revenue as opposed to substantially lower-margin service revenue, - customers' decisions to defer orders or implementations, particularly large orders or implementations, from one quarter to the next, - changes in demand for our software or for enterprise software and real time marketing solutions generally, - announcements or introductions of new products by our competitors, - software defects and other product quality problems, - our ability to integrate acquisitions, - any increase in our need to supplement our professional services organization by subcontracting to more expensive consulting organizations to help provide implementation, support and training services when our own capacity is constrained, and - our ability to hire, train and retain sufficient engineering, consulting, training and sales staff. THE LOSS OF KEY PERSONNEL, OR ANY INABILITY TO ATTRACT AND RETAIN ADDITIONAL PERSONNEL, COULD AFFECT OUR ABILITY TO SUCCESSFULLY GROW OUR BUSINESS. Our future success will depend in large part on our ability to hire and retain a sufficient number of qualified personnel, particularly in sales, marketing, research and development, service and support. If we are unable to do so, this inability could affect our ability to grow our business. Competition for qualified personnel in high technology is intense, particularly in the Silicon Valley region of Northern California where our principal offices are located. Our future success also depends upon the continued service of our executive officers and other key sales, engineering and technical staff. The loss of the services of our executive officers and other key personnel would harm our operations. None of our officers or key personnel are bound by an employment agreement and we do not maintain key person insurance on any of our employees. We would also be harmed if one or more of our officers or key employees decided to join a competitor or otherwise compete with us. The market price of our common stock has fluctuated substantially since our initial public offering in September 1999. Consequently, potential employees may perceive our equity incentives such as stock options as less attractive and current employees whose options are no longer priced below market value may choose not to remain employed by us. In that case, our ability to attract or retain employees will be adversely affected. IF CUSTOMERS DO NOT CONTRACT DIRECTLY WITH CONSULTING ORGANIZATIONS TO IMPLEMENT AND SUPPORT OUR PRODUCTS, OUR REVENUES, PROFITABILITY AND MARGINS MAY BE HARMED. Our principal focus is providing software solutions rather than services. As a result, we encourage our customers to purchase consulting, implementation, maintenance and training services directly from consulting organizations instead of purchasing these services from us. While we do not receive any fees directly from these consulting organizations when they contract directly with our customers, we believe that these consulting organizations increase market awareness and acceptance of our software solutions and allow us to focus on software development 20 20 and licensing. If consulting organizations are unwilling or unable to provide a sufficient level and quality of services directly to our customers or if customers are unwilling to contract directly with these consulting organizations, we may not realize these benefits and our revenues and profitability may be harmed. Further, to the extent that consulting organizations do not provide consulting, implementation, maintenance and training services directly to our customers, we need to provide these services to our customers. We provide these services to our customers either directly through our internal professional services organization or indirectly through subcontractors we hire to perform the services on our behalf. Because our margins on service revenues are less than our margins on license revenues, our overall margins decline when we provide these services to customers. This is particularly true if we hire subcontractors to perform these services because it costs us more to hire subcontractors to perform these services than to provide the services ourselves. IF OUR INTERNAL PROFESSIONAL SERVICES ORGANIZATION DOES NOT PROVIDE IMPLEMENTATION SERVICES EFFECTIVELY AND ACCORDING TO SCHEDULE, OUR REVENUES AND PROFITABILITY WOULD BE HARMED. Customers that license our products typically require consulting, implementation, maintenance and training services and obtain them from our internal professional services, customer support and training organizations, which employed a staff of 282 as of September 30, 2000, or from outside consulting organizations. When we provide these services, we generally recognize revenue from the licensing of our software products as the implementation services are performed. If our internal professional services organization does not effectively implement and support our products or if we are unable to expand our internal professional services organization as needed to meet our customers' needs, our ability to sell software, and accordingly our revenues, will be harmed. In addition, when we sell licenses together with professional services for implementation, we generally recognize the revenue from both the license and the services as we perform the implementation services. Therefore, delays in providing implementation services will delay our recognition of revenue. If we are unable to expand our internal professional services organization to keep pace with sales, we will be required to increase our use of subcontractors to help meet our implementation and service obligations, which will result in lower gross margins. In addition, we may be unable to negotiate agreements with subcontractors to provide a sufficient level and quality of services. If we fail to retain sufficient subcontractors, our ability to sell software for which these services are required will be harmed and our revenues will suffer. OUR SERVICE REVENUES HAVE A SUBSTANTIALLY LOWER MARGIN THAN OUR PRODUCT REVENUES, AND AN INCREASE IN SERVICE REVENUES RELATIVE TO LICENSE REVENUES COULD HARM OUR GROSS MARGINS. Our service revenues, which includes fees for consulting, implementation, maintenance and training, were 44% of our revenues for the nine months ended September 30, 2000, 47% of our revenues for the year ended December 31, 1999 and 34% of our revenues for the year ended December 31, 1998. Our service revenues have substantially lower gross margins than license revenues. Our cost of service revenues for the nine months ended September 30, 2000 and the year ended December 31,1999 was 96% and 102%, respectively, of our service revenues. An increase in the percentage of total revenues represented by services revenues could adversely affect our overall gross margins. Service revenues as a percentage of total revenues and cost of service revenues as a percentage of total revenues have varied significantly from quarter to quarter due to our relatively early stage of development. The relative amount of service revenues as compared to license revenues has varied based on the volume of software solution orders compared to the volume of additional user orders. In addition, the amount and profitability of services can depend in large part on: - the software solution which has been licensed, - the complexity of the customers' information technology environment, - the resources directed by customers to their implementation projects, 21 21 - the number of users licensed, and - the extent to which outside consulting organizations provide services directly to customers. NEW PRODUCT INTRODUCTIONS AND PRICING STRATEGIES BY OUR COMPETITORS COULD ADVERSELY AFFECT OUR ABILITY TO SELL OUR PRODUCTS AND COULD RESULT IN PRESSURE TO PRICE OUR PRODUCTS IN A MANNER THAT REDUCES OUR MARGINS. Competitive pressures could prevent us from growing, reduce our market share or require us to reduce prices on our products and services, any of which could harm our business. We compete principally with vendors of: - enterprise application software, such as Oracle, PeopleSoft, SAP and Siebel Systems, - data management and data analysis software tools, such as Broadbase, Business Objects, Informatica, and Microstrategy, - marketing campaign management software tools, such as Exchange Applications, Prime Response, and Recognition Systems, - software that recommends products to customers in real-time such as Net Perceptions, and - electronic customer relationship management software, such as Kana Communications, eGain, and Primus Knowledge Solutions. Many of these companies have significantly greater financial, technical, marketing, service and other resources than we do. Many of these companies also have a larger installed base of users, have been in business longer or have greater name recognition than we do. In addition, some large companies may attempt to build capabilities into their products that are similar to the capabilities of our products. Some of our competitors' products may be more effective than our products at performing particular functions or be more customized for particular needs. Even if these functions are more limited than those provided by our products, our competitors' software products could discourage potential customers from purchasing our products. For example, our competitors' software products may incorporate other capabilities, such as recording accounting transactions, customer orders or inventory management data. A software product that performs these functions, as well as some of the functions of our software solutions, may be appealing to some customers because it would reduce the number of different types of software necessary to effectively run their business. Further, our competitors may be able to respond more quickly than we can to changes in customer requirements. In addition, our products must integrate with software solutions provided by a number of our existing or potential competitors. These competitors could alter their products so that our products no longer integrate well with them, or they could deny or delay access by us to advance software releases that allow us to timely adapt our products to integrate with their products. Our competitors have made and may also continue to make strategic acquisitions or establish cooperative relationships among themselves or with other software vendors. This may increase the ability of their products to address the need for software solutions such as ours, which provide both the ability to collect data from multiple sources and analyze that data to profile customer characteristics and preferences. Our competitors may also establish or strengthen cooperative relationships with our current or future distributors or other parties with whom we have relationships, thereby limiting our ability to sell through these channels, reducing promotion of our products and limiting the number of consultants available to implement our software. OUR REVENUES MIGHT BE HARMED BY RESISTANCE TO ADOPTION OF E.PIPHANY'S SOFTWARE BY INFORMATION TECHNOLOGY DEPARTMENTS. Some businesses may have already made a substantial investment in other third party or internally developed software designed to integrate data from disparate sources and analyze this data or manage marketing campaigns. 22 22 These companies may be reluctant to abandon these investments in favor of our software. In addition, information technology departments of potential customers may resist purchasing our software solutions for a variety of other reasons, particularly the potential displacement of their historical role in creating and running software and concerns that packaged software products are not sufficiently customizable for their enterprises. If the market for our products does not grow for any of these reasons, our revenues will be harmed. IF THE MARKET IN WHICH WE SELL OUR PRODUCTS AND SERVICES DOES NOT GROW AS WE ANTICIPATE, OUR REVENUES WILL BE REDUCED. If the market for software that enables companies to establish, manage, maintain and continually improve customer relationships by collecting and analyzing data to design and manage marketing campaigns and customize products and services and providing timely, consistent, multichannel customer interaction does not grow as quickly or become as large as we anticipate, our revenues will be reduced. Our market is still emerging, and our success depends on its growth. Our potential customers may: - not understand or see the benefits of using these products, - not achieve favorable results using these products, - experience technical difficulty in implementing or using these products, or - use alternative methods to solve the same business problems. In addition, because our products can be used in connection with Internet commerce and we are currently developing additional Internet commerce solutions, if the Internet commerce market does not grow as quickly as we anticipate, we may experience sales which are lower than our expectations. IF WE FAIL TO DEVELOP NEW PRODUCTS OR IMPROVE OUR EXISTING PRODUCTS TO MEET OR ADAPT TO THE CHANGING NEEDS AND STANDARDS OF OUR INDUSTRY, SALES OF OUR PRODUCTS MAY DECLINE. Our future success depends on our ability to address the rapidly changing needs of our customers and potential customers. We must maintain and improve our E.piphany E.5 System and develop new products that include new technological developments, keep pace with products of our competitors and satisfy the changing requirements of our customers. If we do not, we may not achieve market acceptance and we may be unable to attract new customers. E.piphany may also lose existing customers, to whom we seek to sell additional software solutions and professional services. To achieve increased market acceptance of our products, we must, among other things, continue to: - improve and introduce new software solutions for reporting and analysis, distributed database marketing and e-commerce, - improve the effectiveness of our software, particularly in implementations involving very large databases and large numbers of simultaneous users, - enhance our software's ease of administration, - improve our software's ability to extract data from existing software systems, and - adapt to rapidly changing computer operating system and database standards and Internet technology. We may not be successful in developing and marketing these or other new or improved products. If we are not successful, we may lose sales to competitors. In addition, we have entered into customer contracts, which contain specific performance goals relating to new product releases or enhancements, and if we are not able to meet these goals, we may be required to, among other things, return fees, pay damages and offer discounts. 23 23 IF OUR PRODUCTS DO NOT STAY COMPATIBLE WITH CURRENTLY POPULAR SOFTWARE PROGRAMS, WE MAY LOSE SALES AND REVENUES. The E.piphany E.5 System must work with commercially available software programs that are currently popular. If these software programs do not remain popular, or we do not update our software to be compatible with newer versions of these programs, we may lose customers. In order to operate the E.piphany E.5 System, the system must be installed on both a computer server running the Microsoft Windows NT or Windows 2000 computer operating systems and a computer server running database software from Microsoft or Oracle. E.piphany is currently modifying its respective software to also operate on UNIX operating systems and IBM DB2 databases. If we fail to successfully complete these modifications in a timely manner, we may lose sales and revenues. In addition, users access the E.piphany E.5 System through standard Internet browsers such as Microsoft Internet Explorer. If we fail to obtain access to developer versions of these software products, we may be unable to build and enhance our products on schedule. After installation, the E.piphany E.5 System collects and analyzes data to profile customers' characteristics and preferences. This data may be stored in a variety of our customers' existing software systems, including leading systems from Oracle, PeopleSoft, Siebel Systems, SAP and Vantive, running on a variety of computer operating systems. If we fail to enhance our software to collect data from new versions of these products, we may lose potential customers. If we lose customers, our revenues and profitability may be harmed. IF DATABASE ACCESS BECOMES STANDARDIZED, DEMAND FOR OUR PRODUCTS WILL BE REDUCED. Our products are useful for integrating data from a variety of disparate data sources. Adoption of uniform, industry-wide standards across various database and analytic software programs could minimize the importance of the data integration capabilities of our products. This, in turn, could adversely affect the competitiveness and market acceptance of our products. Also, a single competitor in the market for database and analytic software programs or Internet relationship management may become dominant, even if there is no formal industry-wide standard. If large numbers of our customers adopt a single standard, this would similarly reduce demand for our product. If E.piphany loses customers because of the adoption of standards, we may have lower revenues and profitability. OUR PRODUCTS HAVE LONG SALES CYCLES WHICH MAKES IT DIFFICULT TO PLAN EXPENSES AND FORECAST RESULTS. It takes us between three and six months to complete the majority of our sales and it can take us up to one year or longer. It is therefore difficult to predict the quarter in which a particular sale will occur and to plan expenditures accordingly. The period between initial contact with a potential customer and their purchase of products and services is relatively long due to several factors, including: - the complex nature of our products, - our need to educate potential customers about the uses and benefits of our products, - the purchase of our products requires a significant investment of resources by a customer, - our customers have budget cycles which affect the timing of purchases, - many of our customers require competitive evaluation and internal approval before purchasing our products, - potential customers may delay purchases due to announcements or planned introductions of new products by E.piphany or its competitors, and - many of our customers are large organizations, which may require a long time to make decisions. 24 24 The delay or failure to complete sales in a particular quarter could reduce our revenues in that quarter, as well as subsequent quarters over which revenues for the sale would likely be recognized. If our sales cycle unexpectedly lengthens in general or for one or more large orders, it would adversely affect the timing of our revenues. If we were to experience a delay of several weeks on a large order, it could harm our ability to meet our forecasts for a given quarter. IF WE FAIL TO ESTABLISH, MAINTAIN OR EXPAND OUR RELATIONSHIPS WITH THIRD PARTIES, OUR ABILITY TO GROW REVENUES COULD BE HARMED. In order to grow our business, we must generate, retain and strengthen relationships with third parties. To date, we have established relationships with several companies, including consulting organizations and system integrators that implement our software, including Deloitte & Touche, KPMG and PricewaterhouseCoopers; resellers, including Acxiom, Harte-Hanks and Pivotal; and application service providers that provide access to our software to their customers over the Internet, including Corio and Interrelate. If the third parties with whom we have relationships do not provide sufficient, high-quality service or integrate and support our software correctly, our revenues may be harmed. In addition, the third parties with whom we have relationships may offer products of other companies, including products that compete with our products. We typically enter into contracts with third parties that generally set out the nature of our relationships. However, our contracts do not require these third parties to devote resources to promoting, selling and supporting our products. Therefore we have little control over these third parties. We cannot assure you that we can generate and maintain relationships that offset the significant time and effort that are necessary to develop these relationships. 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 both our direct and indirect sales channels. If we fail to do so, this failure could harm our ability to increase revenues. We currently receive substantially all of our revenues from direct sales, but we intend to increase sales through indirect sales channels in the future. We also need to expand our direct sales force by hiring additional salespersons and sales management. We intend to derive revenues from indirect sales channels by selling our software through value added resellers. These resellers offer our software products to their customers together with consulting and implementation services or integrate our software solutions with other software. We also intend to increasingly offer our software through application service providers, who install our software on their own computer servers and charge their customers for access to that software. We need to expand our indirect sales channels by entering into additional relationships with these third parties. We expect as part of our strategy to increase international sales principally through the use of indirect sales channels. We will be even more dependent on indirect sales channels in the future due to our international strategy. We also plan to use international direct sales personnel and therefore must hire additional sales personnel outside the United States. Our ability to develop and maintain these channels will significantly affect our ability to penetrate international markets. WE HAVE GROWN VERY QUICKLY AND IF WE FAIL TO MANAGE OUR GROWTH, OUR ABILITY TO GENERATE NEW REVENUES AND ACHIEVE PROFITABILITY WOULD BE HARMED. We have grown significantly since our inception and will need to grow quickly in the future. Any failure to manage this growth could impede our ability to increase revenues and achieve profitability. We have increased our number of employees from 21 at December 31, 1997 to 849 as of September 30, 2000. Our future expansion could be expensive and strain our management and other resources. In order to manage growth effectively, we must: - hire, train and integrate new personnel, 25 25 - integrate people and technologies from acquired companies, - continue to augment our financial and accounting systems, - manage our sales operations, which are in several locations, - expand our facilities, and - if we do not manage our growth effectively, our business could suffer. IF WE ACQUIRE ADDITIONAL COMPANIES OR TECHNOLOGIES IN THE FUTURE, THEY COULD PROVE DIFFICULT TO INTEGRATE, DISRUPT OUR BUSINESS, DILUTE STOCKHOLDER VALUE OR ADVERSELY AFFECT OUR OPERATING RESULTS. In addition to the acquisitions that we have already completed, we may acquire or make investments in other complementary companies, services and technologies in the future. If we fail to properly evaluate and execute acquisitions and investments, they may seriously harm our business and prospects. To successfully complete an acquisition, we must: - properly evaluate the business, personnel and technology of the company to be acquired, - accurately forecast the financial impact of the transaction, including accounting charges and transaction expenses, - integrate and retain personnel, - combine potentially different corporate cultures, - effectively integrate products and research and development, sales, marketing and support operations, and - maintain focused on our day-to-day operations. Further, the financial consequences of our acquisitions and investments may include potentially dilutive issuances of equity securities, one-time write-offs, amortization expenses related to goodwill and other intangible assets and the incidence of contingent liabilities. IF OTHERS CLAIM THAT WE ARE INFRINGING THEIR INTELLECTUAL PROPERTY, WE COULD INCUR SIGNIFICANT EXPENSES OR BE PREVENTED FROM SELLING OUR PRODUCTS. We cannot assure you that others will not claim that we are infringing their intellectual property rights or that we do not in fact infringe those intellectual property rights. We have not conducted a search for existing intellectual property registrations and we may be unaware of intellectual property rights of others that may cover some of our technology. We have been contacted by a company which has asked us to evaluate the need for a license of several patents that the company holds directed to data extraction technology. This company has filed litigation alleging infringement of its patents against several of our competitors. We cannot assure you that the holder of the patents will not file litigation against us or that we would prevail in the case of such litigation. In addition, the patent holder has informed us that it has applications pending in numerous foreign countries. 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, is issued. Any litigation regarding intellectual property rights could be costly and time-consuming and divert the attention of our management and key personnel from our business operations. The complexity of the technology involved and the uncertainty of intellectual property litigation increase these risks. Claims of intellectual property infringement might also require us to enter into costly royalty or license agreements. 26 26 However, we may not be able to obtain royalty or license agreements on terms acceptable to us, or at all. We also may be subject to significant damages or an injunction against use of our products. A successful claim of patent or other intellectual property infringement against us would have an immediate material adverse effect on our business and financial condition. IF WE ARE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, THIS INABILITY COULD WEAKEN OUR COMPETITIVE POSITION, REDUCE OUR REVENUES AND INCREASE OUR COSTS. Our success depends in large part on our proprietary technology. We rely on a combination of patent, copyright, trademark and trade secrets, confidentiality procedures and licensing arrangements to establish and protect our proprietary rights. We may be required to spend significant resources to monitor and police our intellectual property rights. If we fail to successfully enforce our intellectual property rights, our competitive position may be harmed. Our pending patent and trademark registration applications may not be allowed or competitors may successfully challenge the validity or scope of these registrations. In addition, our patents may not provide a significant competitive advantage. Other software providers could copy or otherwise obtain and use our products or technology without authorization. They also could develop similar technology independently which may infringe our proprietary rights. We may not be able to detect infringement and may lose a competitive position in the market before we do so. In addition, competitors may design around our technology or develop competing technologies. The laws of some foreign countries do not protect proprietary rights to the same extent as do the laws of the United States. In addition, one of the ways in which we charge for our software is based on the number of users at a particular site that will be permitted to use the software. Organizations that have a site license for a fixed number of users for our products could allow unauthorized use of our software by unlicensed users. Unauthorized use is difficult to detect and, to the extent that our software is used without authorization, we may lose potential license fees. PRIVACY AND SECURITY CONCERNS, PARTICULARLY RELATED TO THE USE OF OUR SOFTWARE ON THE INTERNET, MAY LIMIT THE EFFECTIVENESS OF AND REDUCE THE DEMAND FOR OUR PRODUCTS. The effectiveness of our software products relies on the storage and use of customer data collected from various sources, including information collected on web sites, as well as other data derived from customer registrations, billings, purchase transactions and surveys. Our collection and use of such data for customer profiling may raise privacy and security concerns. Our customers generally have implemented security measures to protect customer data from disclosure or interception by third parties. However, the security measures may not be effective against all potential security threats. If a well-publicized breach of customer data security were to occur, our software products may be perceived as less desirable, impacting our future sales and profitability. In addition, due to privacy concerns, some Internet commentators, consumer advocates, and governmental or legislative bodies have suggested legislation to limit the use of customer profiling technologies. The European Union and some European countries have already adopted some restrictions on the use of customer profiling data. In addition, Internet users can, if they choose, configure their web browsers to limit the collection of user data for customer profiling. Should many Internet users choose to limit the use of customer profiling technologies, or if major countries or regions adopt legislation or other restrictions on the use of customer profiling data, E.piphany's software would be less useful to customers, and E.piphany's sales and profits could decrease. OUR PRODUCTS ARE NEW, AND IF THEY CONTAIN DEFECTS, OR OUR SERVICES ARE NOT PERCEIVED AS HIGH QUALITY, WE COULD LOSE POTENTIAL CUSTOMERS OR BE SUBJECT TO DAMAGES. We began shipping our first products in early 1998. These products are complex and may contain currently unknown errors, defects or failures, particularly since they are new and recently released. In the past we have discovered software errors in some of our products after introduction. We may not be able to detect and correct errors before releasing our products commercially. If our commercial products contain errors, we may be required to: 27 27 - expend significant resources to locate and correct the error, - delay introduction of new products or commercial shipment of products, or - experience reduced sales and harm to our reputation from dissatisfied customers. Our customers also may encounter system configuration problems which require us to spend additional consulting or support resources to resolve these problems. In addition, our customers generally store their data across computer networks, which are often connected to the Internet. Our software operates across our customers' computer networks and can, at the customer's option, be accessed through an Internet connection. Our software contains technology designed to prevent theft or loss of data. Nevertheless, customers may encounter security issues with their existing databases installed across networks, particularly the Internet, or with our software. A security breach involving our software, or a widely publicized security breach involving the Internet generally, could harm our sales. A security breach involving our software could also expose us to claims for damages. Because our software products are used for important decision-making processes and enable our customers to interact with their customers, product defects may also give rise to product liability claims. Although our license agreements with customers typically contain provisions designed to limit our exposure, some courts may not enforce all or part of these limitations. Although we have not experienced any product liability claims to date, we may encounter these claims in the future. Product liability claims, whether or not successful, could: - divert the attention of our management and key personnel from our business, - be expensive to defend, and - result in large damage awards. Our product liability insurance may not be adequate to cover all of the expenses resulting from a claim. In addition, if our customers do not find our services to be of high quality, they may elect to use other training, consulting and product integration firms rather than contract for our services. If customers are dissatisfied with our services, we may lose revenues. WE INTEND TO EXPAND OUR INTERNATIONAL SALES EFFORTS BUT WE DO NOT HAVE SUBSTANTIAL EXPERIENCE IN INTERNATIONAL MARKETS. We intend to expand our international sales efforts in the future. We have limited experience in marketing, selling and supporting our products and services abroad. If we are unable to grow our international operations successfully and in a timely manner, our business and operating results could be seriously harmed. In addition, doing business internationally involves greater expense and many additional risks, particularly: - unexpected changes in regulatory requirements, taxes, trade laws and tariffs, - differing intellectual property rights, - differing labor regulations, - unexpected changes in regulatory requirements, - changes in a specific country's or region's political or economic conditions, - greater difficulty in establishing, staffing and managing foreign operations, and - fluctuating exchange rates. We plan to expand our international operations in the near future, and this will require a significant amount of attention from our management and substantial financial resources. We have begun efforts at international expansion in Europe and, as of September 30, 2000, had 51 sales and marketing professionals located in the United Kingdom, 28 28 Australia, Germany, Canada, Japan, The Netherlands and France. We are also exploring other regions for future expansion. SEASONAL TRENDS IN SALES OF BUSINESS SOFTWARE MAY AFFECT OUR QUARTERLY REVENUES. The market for business software has experienced seasonal fluctuations in demand. The first and third quarters of the year have been typically characterized by lower levels of revenue growth. We believe that these fluctuations are caused in part by customer buying patterns, which are influenced by year-end budgetary pressures and by sales force commission structures. As our revenues grow, we may experience seasonal fluctuations in our revenues. PROVISIONS IN OUR CHARTER DOCUMENTS AND DELAWARE LAW MAY DELAY OR PREVENT AN ACQUISITION OF E.PIPHANY. Our certificate of incorporation and bylaws contain provisions which could make it harder for a third party to acquire us without the consent of our board of directors. For example, if a potential acquiror were to make a hostile bid for us, the acquiror would not be able to call a special meeting of stockholders to remove our board of directors or act by written consent without a meeting. In addition, our board of directors have staggered terms, which makes it difficult to remove them all at once. The acquiror would also be required to provide advance notice of its proposal to remove directors at an annual meeting. The acquiror also will not be able to cumulate votes at a meeting, which will require the acquiror to hold more shares to gain representation on our board of directors than if cumulative voting were permitted. Our board of directors also has the ability to issue preferred stock which would significantly dilute the ownership of a hostile acquiror. In addition, Section 203 of the Delaware General Corporation Law limits business combination transactions with 15% stockholders that have not been approved by the board of directors. These provisions and other similar provisions make it more difficult for a third party to acquire us without negotiation. These provisions may apply even if the offer may be considered beneficial by some stockholders. Our board of directors could choose not to negotiate with an acquiror that it did not feel was in the strategic interests of our company. If the acquiror was discouraged from offering to acquire us, or prevented from successfully completing a hostile acquisition by the antitakeover measures, you could lose the opportunity to sell your shares at a favorable price. 29 29 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK MARKET RISK The following discusses our exposure to market risk related to changes in interest rates, equity prices and foreign currency exchange rates. This discussion contains forward-looking statements that are subject to risks and uncertainties. Actual results could vary materially as a result of a number of factors including those set forth in the risk factors section of this Quarterly Report on Form 10-Q. Foreign Currency Exchange Rate Risk To date, substantially all of our recognized revenues have been denominated in U.S. dollars and primarily from customers in the United States, and our exposure to foreign currency exchange rate changes has been immaterial. We expect, however, that future product license and services revenues may also be derived from international markets and may be denominated in the currency of the applicable market. As a result, our operating results may become subject to significant fluctuations based upon changes in the exchange rates of certain currencies in relation to the U.S. dollar. Furthermore, to the extent that we engage in international sales denominated in U.S. dollars, an increase in the value of the U.S. dollar relative to foreign currencies could make our products less competitive in international markets. Although we will continue to monitor our exposure to currency fluctuations, and when appropriate, may use financial hedging techniques to minimize the effect of these fluctuations, we cannot assure you that exchange rate fluctuations will not adversely affect our financial results in the future. Interest Rate Risk As of September 30, 2000, we had cash and cash equivalents of $313.3 million which consisted of cash and highly liquid short-term investments. Declines of interest rates over time would reduce our interest income from our short-term investments. Based upon our balance of cash and cash equivalents, a decrease in interest rates of 0.5% would cause a corresponding decrease in our annual interest income by approximately $1.6 million. As of September 30, 2000, we did not have any short-term or long-term debt outstanding. 30 30 E.PIPHANY, INC. FORM 10-Q, SEPTEMBER 30, 2000 PART II: OTHER INFORMATION Item 1. Legal Proceedings As of the date hereof, there is no material litigation pending against E.piphany. From time to time, E.piphany may be a party to litigation and claims incident to the ordinary course of our business. Although the results of litigation and claims cannot be predicted with certainty, we believe that the final outcome of such matters will not have a material adverse effect on the results of operations, financial condition or prospects of E.piphany. Item 2. Changes in Securities and Use of Proceeds (a) None. (b) None. (c) None. (d) None. Item 3. Defaults Upon Senior Securities None. Item 4. Submission of Matters to a Vote of Security Holders None. Item 5. Other Information None. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 27.1 Financial Data Schedule. (b) Reports on Form 8-K None. 31 31 E.PIPHANY, INC. FORM 10-Q, SEPTEMBER 30, 2000 SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. E.piphany, Inc. DATE: November 14, 2000 SIGNATURE: /s/ Roger S. Siboni ----------------- ----------------------------- Roger S. Siboni President, Chief Executive Officer and Director DATE: November 14, 2000 SIGNATURE: /s/ Kevin J. Yeaman ----------------- ----------------------------- Kevin J. Yeaman Chief Financial Officer 32 32 EXHIBIT INDEX Exhibit # Description --------- ----------- 27.1 Financial Data Schedule