10-Q 1 f72477e10-q.txt FORM 10-Q QUARTERLY PERIOD ENDED MARCH 31, 2001 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 MARCH 31, 2001 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 $0.0001 per share, as of April 30, 2001, was 70,572,128. 2 E.PIPHANY, INC. QUARTERLY REPORT ON FORM 10-Q QUARTER ENDED MARCH 31, 2001 TABLE OF CONTENTS
PAGE NO. PART I FINANCIAL INFORMATION Item 1. Financial Statements Condensed Consolidated Balance Sheets - ...................... 3 As of December 31, 2000 and March 31, 2001 Condensed Consolidated Statements of Operations - ............ 4 Three months ended March 31, 2000 and 2001 Condensed Consolidated Statements of Cash Flows - ............ 5 Three months ended March 31, 2000 and 2001 Notes to Condensed Consolidated Financial Statements ......... 6 Item 2. Management's Discussion and Analysis of ...................... 9 Financial Condition and Results of Operations Item 3. Quantitative and Qualitative Disclosures About Market Risk ... 26 PART II OTHER INFORMATION Item 1. Legal Proceedings ............................................ 27 Item 2. Changes in Securities and Use of Proceeds .................... 27 Item 3. Defaults Upon Senior Securities .............................. 27 Item 4. Submission of Matters to a Vote of Securities Holders ........ 27 Item 5. Other Information ............................................ 27 Item 6. Exhibits and reports on Form 8-K ............................. 27 SIGNATURES ........................................................... 28
3 PART I: FINANCIAL INFORMATION ITEM 1: FINANCIAL STATEMENTS E.PIPHANY, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
DECEMBER 31, MARCH 31, 2000 2001 ----------- ----------- (UNAUDITED) ASSETS Current assets: Cash and cash equivalents .......................... $ 319,634 $ 272,140 Short-term investments ............................. 77,339 95,836 Accounts receivable, net ........................... 27,592 27,652 Prepaid expenses and other assets .................. 5,152 6,406 ----------- ----------- Total current assets ............................ 429,717 402,034 Property and equipment, net .......................... 21,789 25,599 Goodwill and purchased intangibles ................... 2,541,245 2,281,133 Other assets ......................................... 2,323 2,248 ----------- ----------- Total assets .................................... $ 2,995,074 $ 2,711,014 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current portion of capital lease obligations ....... $ 658 $ 620 Trade accounts payable ............................. 2,191 2,963 Accrued compensation ............................... 12,715 16,049 Accrued other ...................................... 17,289 13,452 Deferred revenue ................................... 23,412 20,639 ----------- ----------- Total current liabilities ....................... 56,265 53,723 Capital lease obligations, net of current portion .... 618 481 ----------- ----------- Total liabilities ............................... 56,883 54,204 Stockholders' equity: Common stock ....................................... 6 6 Additional paid-in capital ......................... 3,746,759 3,759,187 Notes receivable ................................... (2,668) (1,645) Accumulated other comprehensive loss ............... (550) (261) Deferred compensation .............................. (1,009) (735) Accumulated deficit ................................ (804,347) (1,099,742) ----------- ----------- Total stockholders' equity ...................... 2,938,191 2,656,810 ----------- ----------- Total liabilities and stockholders' equity ...... $ 2,995,074 $ 2,711,014 =========== ===========
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 MARCH 31, 2000 2001 --------- --------- Revenues: Product license ............................................... $ 8,268 $ 22,432 Services ...................................................... 6,147 15,645 --------- --------- Total revenues ............................................. 14,415 38,077 --------- --------- Cost of revenues: Product license ............................................... 109 744 Services ...................................................... 6,020 21,507 --------- --------- Total cost of revenues ..................................... 6,129 22,251 --------- --------- Gross profit ............................................... 8,286 15,826 --------- --------- Operating expenses: Research and development ...................................... 3,758 11,419 Sales and marketing ........................................... 11,212 23,978 General and administrative .................................... 2,257 8,639 In-process research and development charge .................... 22,000 -- Amortization of goodwill and purchased intangibles ............ 39,943 270,436 Stock-based compensation ...................................... 477 290 --------- --------- Total operating expenses ................................... 79,647 314,762 --------- --------- Loss from operations ....................................... (71,361) (298,936) Other income (expense), net ..................................... 4,393 3,541 --------- --------- Net loss ................................................... $ (66,968) $(295,395) ========= ========= Basic and diluted net loss per share ............................ $ (1.57) $ (4.48) ========= ========= Shares used in computing basic and diluted net loss per ......... 42,678 65,943 ========= =========
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) (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2000 2001 --------- --------- Cash flows from operating activities: Net loss ...................................................... $ (66,968) $(295,395) Adjustments to reconcile net loss to net cash used for operating activities: Depreciation and amortization .............................. 467 852 Allowance for doubtful accounts ............................ 250 2,000 Noncash compensation expense ............................... 477 290 In-process research and development charge ................. 22,000 -- Amortization of goodwill and purchased intangibles ......... 39,943 270,436 Changes in operating assets and liabilities, net of effect of acquisitions: Accounts receivable ...................................... (2,652) (2,061) Prepaid expenses and other assets ........................ (416) (1,179) Trade accounts payable ................................... (5,002) 772 Accrued liabilities ...................................... 8,373 205 Deferred revenue ......................................... (680) (2,773) --------- --------- Net cash used in operating activities ................. (4,208) (26,853) --------- --------- Cash flows from investing activities: Purchases of property and equipment ........................... (2,414) (4,662) Cash acquired in acquisitions ................................. 1,613 -- Direct costs of purchase transactions ......................... -- (75) Purchases and sales of investments, net ....................... (491) (18,434) --------- --------- Net cash used in investing activities ................. (1,292) (23,171) --------- --------- Cash flows from financing activities: Repayments on line of credit .................................. (8,319) -- Principal payments on capital lease obligations ............... (68) (175) Proceeds from secondary offering, net ......................... 356,361 -- Repayments on notes receivable ................................ 185 1,023 Proceeds from sale of common stock, net of repurchases ........ 525 1,456 --------- --------- Net cash provided by financing activities ............. 348,684 2,304 --------- --------- Effect of foreign exchange rates on cash and cash equivalents ... -- 226 --------- --------- Net increase (decrease) in cash and cash equivalents ............ 343,184 (47,494) Cash and cash equivalents at beginning of period ................ 58,084 319,634 --------- --------- Cash and cash equivalents at end of period ...................... $ 401,268 $ 272,140 ========= =========
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, 2000. 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 months ended March 31, 2001. The results for the three months ended March 31, 2001 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 our foreign subsidiaries is the local currency. The Company translates the assets and liabilities of international non-U.S. functional currency subsidiaries into dollars at the current rates of exchange in effect during each period. Revenues and expenses are translated using rates that approximate those in effect during the period. Gains and losses from translation adjustments are included in stockholders' equity in the consolidated balance sheet caption "Accumulated other comprehensive loss." Currency transaction gains or losses, derived on monetary assets and liabilities stated in a currency other than the functional currency, are recognized in current operations and have not been significant to the Company's operating results in any period. The effect of foreign currency rate changes on cash and cash equivalents has not been significant in any period. IMPAIRMENT OF LONG-LIVED ASSETS AND IDENTIFIABLE INTANGIBLE ASSETS The Company evaluates long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair market value. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board issued Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("FAS 133"), which provides a comprehensive and consistent standard for the recognition and measurement of derivatives and hedging activities. As amended, this statement is effective for fiscal years beginning after June 15, 2000. E.piphany applied the new rules prospectively to transactions beginning in the first quarter of 2001. The adoption did not have a material effect on its financial position or results of operations. 6 7 In March 2000, the FASB issued Financial Standards Board Interpretation ("FIN") No. 44, "Accounting for Certain Transactions Involving Stock Compensation an Interpretation of APB Opinion No. 25." FIN No. 44 addresses the application of APB No. 25 to clarify, among other issues (a) the definition of "employee" for purposes of applying APB No. 25, (b) the criteria for determining whether a plan qualifies as a noncompensatory plan, (c) the accounting consequence of various modifications to the terms of a previously fixed stock option or award, and (d) the accounting for an exchange of stock compensation awards in a business combination. FIN No. 44 is effective July 1, 2000, but certain conclusions cover specific events that occurred after either December 15, 1998 or January 12, 2000, but before the effective date of July 1, 2000, the effects of applying the interpretation have been recognized on a prospective basis from July 1, 2000. E.piphany adopted FIN No. 44 in July 2000. The adoption did not have a material effect on its financial position or results of operations. 3. STOCKHOLDERS' EQUITY STOCK-BASED COMPENSATION In connection with the grant of certain stock options to employees during the years ended December 31, 1998 and 1999, the Company recorded deferred compensation of approximately $5.8 million, representing the difference between the deemed value of the common stock for accounting purposes and the option exercise price or stock sale price at the date of the option grant or stock sale. Such amount is presented as a reduction of stockholders' equity and amortized over the vesting period of the applicable options in a manner consistent with FASB Interpretation No. 28. Total stock-based compensation expensed was approximately $0.5 million and $0.3 million during the three months ended March 31, 2000 and 2001, respectively. Compensation expense is decreased in the period of forfeiture for any accrued but unvested compensation arising from the early termination of an option holder's services. 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 months ended March 31, 2000, and the three months ended March 31, 2001, E.piphany's comprehensive income (loss) did not differ materially from reported net loss. 4. COMPUTATION OF 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. The following table presents the calculation of basic net loss per share (in thousands, except per share amounts):
THREE MONTHS ENDED MARCH 31, 2000 2001 --------- --------- Net loss ....................................................... $ (66,968) $(295,395) ========= ========= Basic and diluted: Weighted average shares of common stock outstanding .......... 47,594 68,594 Less: Weighted average shares subject to repurchase ............ (4,916) (2,651) --------- --------- Weighted average shares used in computing basic and diluted net loss per common share .................................... 42,678 65,943 ========= ========= Basic and diluted net loss per common share .................. $ (1.57) $ (4.48) ========= ========= Net loss ..................................................... $ (66,968) $(295,395) ========= =========
7 8 E.piphany has excluded all 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 11,084,000 and 3,824,000 for the three months ended March 31, 2000 and 2001, respectively. 5. COMMITMENTS LETTERS OF CREDIT In February 2001, the Company entered into four secured letters of credit totaling $3,915,000 with a bank. These letters of credit, which expire in February 2002, collateralize the Company's obligation to third parties for lease payments. In November 2000, the Company entered into a $3,303,000 secured letter of credit with a bank. This letter of credit, which expires in November 2001, collateralizes the Company's obligation to a third party for lease payments. In October 2000, the Company entered into an $835,000 secured letter of credit with a bank. This letter of credit, which expires in October 2001, collateralizes the Company's obligation to a third party for lease payments. In July 2000, the Company entered into two secured letters of credit totaling $1,191,000 with a bank. These letters of credit, which expire in July 2001, collateralize the Company's obligation to a third party for lease payments. The letters of credit are secured by cash, cash equivalents and short-term investments. 6. SEGMENT INFORMATION During 1998, E.piphany adopted SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information." SFAS No. 131 requires a new basis of determining reportable business segments (i.e., the management approach). This approach requires that business segment information used by management to assess performance and manage company resources be the source for segment information disclosure. On this basis, E.piphany is organized and operates as one business segment, the design, development, and marketing of software solutions. The Company markets its products in the United States and in foreign countries through its sales personnel and its subsidiaries. Information regarding geographic areas is as follows (in thousands):
THREE MONTHS ENDED MARCH 31, ---------------------------- 2000 2001 ------- ------- Revenues: North America ...... $14,287 $29,039 International ...... 128 9,038 ------- ------- Total ...... $14,415 $38,077 ======= =======
7. ACQUISITIONS On January 29, 2001, E.piphany acquired the intellectual property assets of Radnet, Inc. Under the terms of the asset purchase agreement, E.piphany issued 238,032 shares of common stock in exchange for the assets. This transaction will add to E.piphany's strategic intellectual property and complement its current product development plan. The total purchase price was approximately $10.3 million, and is being amortized on a straight-line basis over a useful life of three years. Accumulated amortization was approximately $0.6 million at March 31, 2001. 8. SUBSEQUENT EVENT On April 12, 2001, E.piphany acquired Moss Software, Inc. through a merger of a wholly-owned subsidiary of E.piphany with and into Moss Software, Inc. Moss Software, Inc. is a provider of customer relationship management products that resolve its customer sales automation challenges and better manage their sales cycles. Under the terms of the Reorganization Agreement, E.piphany issued 1,547,050 shares of common stock in return for all of the outstanding shares of common stock and options to purchase shares of common stock of Moss Software, Inc. 8 9 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 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 the E.piphany E.5 System, an integrated suite of customer relationship management (CRM) software solutions. These CRM solutions 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 the E.piphany E.5 System to gain insight into their customers' characteristics and preferences, and then take action on that insight to better and more profitably serve those customers. To gain insight into their customers, companies use our analytic CRM solutions, which collect customer data from existing software systems or other E.piphany solutions, as well as third party data providers. To take action on this insight, companies use our operational CRM solutions to more efficiently interact with their customers across a variety of communication and distribution channels. 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. Despite our revenue growth, E.piphany has incurred significant costs to develop its technology and products, for 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 279 employees at December 31, 1999 to 978 employees at March 31, 2001. RECENT EVENTS ACQUISITIONS On January 29, 2001, E.piphany acquired the intellectual property assets of Radnet, Inc. Under the terms of the asset purchase agreement, E.piphany issued 238,032 shares of common stock in exchange for the assets. This transaction will add to E.piphany's strategic intellectual property and complement its current product development plan. The total purchase price was approximately $10.3 million, and is being amortized on a straight-line basis over a useful life of three years. Accumulated amortization was approximately $0.6 million at March 31, 2001. On April 12, 2001, E.piphany acquired Moss Software, Inc. through a merger of a wholly-owned subsidiary of E.piphany with and into Moss Software, Inc. Moss Software, Inc. is a provider of customer relationship management products that resolve its customer sales automation challenges and better manage their sales cycles. Under the terms of the Reorganization Agreement, E.piphany issued 1,547,050 shares of common stock in return for all of the outstanding shares of common stock and options to purchase shares of common stock of Moss Software, Inc. 9 10 STOCK OPTION EXCHANGE PROGRAM On April 2, 2001, E.piphany announced a voluntary stock option exchange program for our employees. Under the program, our employees are being given the opportunity to elect to cancel outstanding stock options held by them in exchange for an equal number of new options to be granted at a future date. These elections needed to be made by May 1, 2001 and must include all options granted during the prior six months. A total of 614 employees elected to participate in the exchange program. Those 614 employees tendered a total of 5,849,237 options to purchase our common stock in return for promises to grant new options on the grant date of November 5, 2001. The exercise price of the new options will be equal to the fair market value of the Company's common stock on the date of grant. The exchange program is not available to our executives, outside directors, consultants, former employees or any of our employees who are residents of the Netherlands, Switzerland, Spain or Brazil or are employed by our subsidiaries located in those countries. 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 March 31, 2001, substantially all of E.piphany's revenues have been derived from sales through E.piphany's direct sales force. E.piphany's license agreements generally provide that customers pay a software license fee to use one or more software solutions in perpetuity (a perpetual license) 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 can purchase 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 or they can purchase these services directly from third party consulting organizations, such as KPMG and PricewaterhouseCoopers. E.piphany has also historically supplemented the capacity of its internal professional services organization by subcontracting some of these services to these third party consulting organizations. We intend to increasingly encourage customers to purchase services directly from these consulting organizations. We believe that this would increase the number of consultants who can provide consulting and implementation services related to our software products and that it would increase our overall gross margins by increasing our percentage of license revenue, which has substantially higher gross margins than services revenue, as a percentage of total revenue. We also believe that it will encourage these consulting organizations to generate sales leads within their customer base. Fees from licenses are recognized as revenue upon contract execution, provided all shipment obligations have been met, fees are fixed or determinable, collection is probable, and vendor specific objective evidence exists to allocate the total fee between all delivered and undelivered elements of the arrangement. If vendor specific objective evidence does not exist to allocate the total fee to all delivered and undelivered elements of the arrangement, revenue is deferred until the earlier of a) such evidence does exist for the undelivered elements, or b) all elements are delivered. Fees from license agreements which include the right to receive unspecified future products are recognized over the term of the arrangement or, if not specified, the estimated economic life of the product. When licenses are sold together with consulting and implementation services, license fees are recognized upon shipment, provided that (1) the above criteria have been met, (2) payment of the license fees is not dependent upon the performance of the consulting services, and (3) the services do not include significant alterations to the features and functionality of the software. To date, services have been essential to the functionality of the software products for substantially all license agreements entered into which included implementation services. For these arrangements and other arrangements which don't meet the above criteria, both the product license revenues and services revenues are recognized in accordance with the provisions of Statement of Position ("SOP") 81-1, "Accounting for Performance of Construction Type and Certain Production Type Contracts." When reliable estimates are available 10 11 for the costs and efforts necessary to complete the implementation services, we account for the arrangements under the percentage of completion contract method pursuant to SOP 81-1. When such estimates are not available, the completed contract method is utilized. We provide for sales returns based on historical rates of return which, to date, have not been material. Maintenance agreements generally call for us to provide technical support and software updates to customers. Revenue on technical support and software update rights is recognized ratably over the term of the maintenance agreement and is included in services revenue in the accompanying consolidated statements of operations. We provide consulting, implementation and training services to our customers. Revenue from such services, when not sold in conjunction with product licenses, is generally recognized as the services are performed. COST OF REVENUES AND OPERATING EXPENSES Our cost of license revenues primarily consist of license fees due to third parties for integrated technology. Our cost of services revenues include salaries and related expenses for our 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. Our operating expenses are classified into three general categories: sales and marketing, research and development, and general and administrative. We classify all charges to these operating expense categories based on the nature of the expenditures. We allocate the costs for overhead and facilities to each of the 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 our 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 $38.1 million for the three months ended March 31, 2001, from $14.4 million for the three months ended March 31, 2000. The rapid growth in revenues reflected our relatively early stage of development, and we do not expect revenues to increase at the same rate in the future. The increase was also due to expansion of our business outside the United States. Product license revenues increased to $22.4 million, or 59% of total revenue, for the three months ended March 31, 2001 from $8.3 million, or 57% of total revenue, for the three months ended March 31, 2000. The increase in dollar amount of product license revenues was due, in part, to an increase in the average size of the license fees per transaction, which resulted primarily from the growth of E.piphany's direct sales force and the introduction and shipment of new products. Services revenues increased to $15.6 million, or 41% of total revenues, for the three months ended March 31, 2001 from $6.1 million, or 43% of revenues, for the three months ended March 31, 2000. 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 extent to which consulting organizations provide services directly to customers, the solution which has been licensed, the complexity of the customers' information technology environment, the resources directed by customers to their implementation projects and the number of users licensed. Services revenues have substantially lower margins relative to product license revenues. This is especially true when we are required to subcontract with consulting organizations to supplement our internal professional services organization. It generally costs us more to subcontract with third party consulting 11 12 organizations to provide these services than to provide these services ourselves. To offset the effect that providing services ourselves or through subcontractors has on our gross margins, we intend to further encourage customers to contract directly with third party consulting organizations for implementation and consulting services. Encouraging direct contracts between our customers and consulting organizations may also increase the overall professional services resources available to customers and generate sales leads. We do not receive any services revenues when customers contract directly with third party 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, our overall gross margins will decline. COST OF REVENUES Total cost of revenues increased to $22.3 million for the three months ended March 31, 2001 from $6.1 million for the three months ended March 31, 2000. Cost of product license revenues consists primarily of license fees paid to third parties under technology license 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 $21.5 million, or 137% of services revenues, for the three months ended March 31, 2001 from $6.0 million, or 98% of services revenues, for the three months ended March 31, 2000. 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 third party consulting organizations to support increased customer demand for consulting services. The increase was also due to the decision to have customers contract directly with consulting organizations even though the company had unutilized internal resources. This decision was made in conjunction with our overall strategy to strengthen our alliances with our system integrators, and increase the number and quality of our relationships with system integrators that recommend and implement our software on customers' computer systems. Cost of services revenues has exceeded services revenues due to the rapid growth of our services organization and our investment in experienced management in anticipation of future revenue growth. Cost of services revenues may continue to exceed services revenues in future periods as we continue to transition our services capacity to have a greater reliance on system integrators or if services revenues decrease in future periods. OPERATING EXPENSES Research and Development Research and development expenses consist primarily of personnel and related costs associated with our product development efforts. Research and development expenses increased to $11.4 million for the three months ended March 31, 2001 from $3.8 million for three months ended March 31, 2000. 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, and fees paid to outside contractors for the internationalization of our products. Research and development expenses as a percentage of total revenues increased to 30% for the three months ended March 31, 2001 from 26% for the three months ended March 31, 2000. We believe that investments in product development are essential to our future success and expect that the absolute dollar amount of research and development expenses may 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 $24.0 million for the three months ended March 31, 2001 from $11.2 million for the three months ended March 31, 2000. Sales and marketing expenses as a percentage of total revenues decreased to 63% for the three months ended March 31, 2001 from 78% for the three months ended March 31, 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 resulting from internal growth and acquisitions, and the establishment of sales offices in additional domestic and international locations including Europe and Asia. We expect that the absolute dollar amount of sales and marketing expenses may decrease in future periods due to a decrease in advertising, marketing, and promotional activities. 12 13 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 $8.6 million for the three months ended March 31, 2001 from $2.3 million for the three months ended March 31, 2000. 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 increased to 23% for the three months ended March 31, 2001 from 16% for the three months ended March 31, 2000. We expect general and administrative expenses to decrease in absolute dollars in future periods due to the Company's focus on reducing general and administrative expenses. In-Process Research and Development Charge In connection with the acquisition of RightPoint Software, Inc., we recorded a charge of $22.0 million in the quarter ended March 31, 2000. There was no in-process research and development charge incurred during the three months ended March 31, 2001. Amortization of Goodwill and Other Intangible Assets Our acquisitions of RightPoint Software Inc., iLeverage Corporation, eClass Direct, Inc., Octane Software, Inc. and the intellectual property assets of Radnet, Inc. were accounted for under the purchase method of accounting. Accordingly, we recorded goodwill and other intangible assets representing the excess of the purchase price paid over the fair value of net assets acquired. The aggregate amortization of goodwill and these other intangible assets increased to $270.4 million for the three months ended March 31, 2001 from $39.9 million for the three months ended March 31, 2000. The increase was due to the timing of our acquisitions as we had only completed the RightPoint acquisition as of March 31, 2000, however, amortization for all five of our acquisitions was included in the three months ended March 31, 2001. We anticipate that future amortization of goodwill and other intangibles associated with our acquisitions will continue to be amortized on a straight-line basis over their expected useful lives of three years, and will amount to approximately $0.8 billion for the remaining nine months of 2001, $1.1 billion in 2002, and $1.1 billion in 2003. It is likely we may continue to expand our business through acquisitions and internal development. Any additional acquisitions could result in additional merger and acquisition related costs. From time to time we reevaluate the cost of our goodwill and other intangible assets. If we determine that the cost, net of accumulated amortization, exceeds the net realizable value of the assets, an acceleration of the amortization of these assets may be necessary. 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 $5.8 million related to stock-based compensation to employees. As of March 31, 2001, deferred compensation remaining to be amortized totaled $844,000. 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 $290,000 and $477,000 for the three months ended March 31, 2001 and 2000, respectively. E.piphany expects amortization of approximately $407,000, $303,000, and $25,000 for the remaining nine months of 2001, the year ended December 31, 2002, and the first six months of 2003, respectively. OTHER INCOME (EXPENSE), NET Interest income, net of interest expense, decreased to $3.5 million for the three months ended March 31, 2001 from $4.4 million for the three months ended March 31, 2000. The decrease in interest income, net of interest expense, was due to a $1.8 million recognized loss during the three months ended March 31, 2001. We held $7.5 13 14 million in commercial paper in a California public utility as of March 31, 2001. The investment had a maturity date of February 15, 2001 and was not paid by the public utility. As of March 31, 2001, we determined that the investment was permanently impaired based on our evaluation and recognized a loss on the investment. Subsequent to the date of the write-down, our investment advisor agreed to repurchase our commercial paper at par value in the total sum of $7.5 million. As a result, we will recognize a $1,875,000 gain on this investment for the three months ended June 30, 2001. LIQUIDITY AND CAPITAL RESOURCES Net cash used in operating activities totaled $26.9 million and $4.2 million for the three months ended March 31, 2001 and 2000, respectively. Cash used in operating activities for each period resulted from net losses in those periods. Cash used in operating activities for the three months ended March 31, 2001 also resulted from an increase in accounts receivable and a decrease in deferred revenue. These uses of cash were partially offset by an increase in accrued liabilities. Net cash used in investing activities totaled $23.2 million for the three months ended March 31, 2001 compared to $1.3 million used in investing activities for the three months ended March 31, 2000. The increase primarily resulted from the purchase of investments during the three months ended March 31, 2001. Net cash provided by financing activities totaled $2.3 million and $348.7 million for the three months ended March 31, 2001 and 2000, respectively. The decrease was due primarily to the receipt of proceeds from E.piphany's secondary offering completed during the first quarter of 2000. As of March 31, 2001, E.piphany's principal sources of liquidity included $272.1 million of cash and cash equivalents and $95.8 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 $295.4 million for the three months ended March 31, 2001, $768.5 million for the year ended December 31, 2000, $22.4 million for the year ended December 31, 1999 and $10.3 million for the year ended December 31, 1998. We had an accumulated deficit of $1.1 billion as of March 31, 2001, and $804.3 million as of December 31, 2000. We expect to continue to incur losses before amortization charges for the foreseeable future. In addition, in connection with the acquisitions of Octane Software, RightPoint Software, eClass Direct, iLeverage and Moss Software, we are incurring 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 14 15 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. OUR REVENUES MAY BE HARMED IF GENERAL ECONOMIC CONDITIONS CONTINUE TO WORSEN. Our revenues are dependent on the health of the economy and the growth of our customers and potential future customers. If the economy remains stagnant, our customers may continue to delay or reduce their spending on CRM software. When economic conditions weaken, sales cycles for sales of software products tend to lengthen and companies' information technology budgets tend to be reduced. If that happens, our revenues could suffer and our stock price may decline. Further, if the economic conditions in the United States worsen or if a wider or global economic slowdown occurs, we may experience a material adverse impact on our business, operating results, and financial condition. 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 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: o varying size, timing and contractual terms of orders for our products, o our ability to timely complete our service obligations related to product sales, o changes in the mix of revenue attributable to higher-margin product license revenue as opposed to substantially lower-margin service revenue, o customers' decisions to defer orders or implementations, particularly large orders or implementations, from one quarter to the next, o changes in demand for our software or for enterprise software and real time marketing solutions generally, o announcements or introductions of new products by our competitors, o software defects and other product quality problems, o our ability to integrate acquisitions, 15 16 o 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 o 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 and licensing. If consulting organizations are unwilling or unable to provide a sufficient level and quality of service 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. 16 17 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, 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. 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 41% of our revenues for the three months ended March 31, 2001, 42% of our revenues for the year ended December 31, 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 three months ended March 31, 2001 and the years ended December 31, 2000, 1999 and 1998 was 137%, 101%, 102% and 120%, 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: o the software solution which has been licensed, o the complexity of the customer's information technology environment, o the resources directed by customers to their implementation projects, o the number of users licensed, and o 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: o data management and data analysis software tools such as Broadbase, Microstrategy and Oracle, o enterprise application software such as PeopleSoft, SAP and Siebel Systems, o marketing campaign management software tools such as Exchange Applications, Prime Response and Recognition Systems, 17 18 o software that recommends products to customers in real time based on simple analytics such as Net Perceptions, and o web-based contact center software tools such as Kana Software. 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. 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: o not understand or see the benefits of using these products, o not achieve favorable results using these products, o experience technical difficulty in implementing or using these products, or 18 19 o 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: o improve and introduce new software solutions for reporting and analysis, distributed database marketing and e-commerce, o improve the effectiveness of our software, particularly in implementations involving very large databases and large numbers of simultaneous users, o enhance our software's ease of administration, o design software for vertical markets, o make available international versions of our software, o improve our software's ability to extract data from existing software systems, and o 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. 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. We are currently in various stages of porting our software to operate on additional operating systems and databases, including UNIX, IBM DB2 and other third party application servers such as BEA System's Web Logic product. 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 any of these software products, we may be unable to build and enhance our products on schedule. 19 20 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 systems from Oracle, PeopleSoft, Siebel Systems, and SAP, 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. 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: o the complex nature of our products, o our need to educate potential customers about the uses and benefits of our products, o the purchase of our products requires a significant investment of resources by a customer, o our customers have budget cycles which affect the timing of purchases, o uncertainty regarding future economic conditions, o many of our customers require competitive evaluation and internal approval before purchasing our products, o potential customers may delay purchases due to announcements or planned introductions of new products by us or our competitors, and o many of our customers are large organizations, which may require a long time to make decisions. 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, Hewlett-Packard and Harte-Hanks; and application service providers that provide access to our software to their customers over the Internet, including 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 20 21 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 expect as part of our strategy to increase international sales through the use of direct and 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 expand our international direct sales force 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 978 as of March 31, 2001. Our future expansion could be expensive and strain our management and other resources. In order to manage growth effectively, we must: o hire, train and integrate new personnel, o integrate people and technologies from acquired companies, o continue to augment our financial and accounting systems, o manage our sales operations, which are in several locations, and o expand our facilities. 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: o properly evaluate the business, personnel and technology of the company to be acquired, o accurately forecast the financial impact of the transaction, including accounting charges and transaction expenses, o integrate and retain personnel, o combine potentially different corporate cultures, o effectively integrate products and research and development, sales, marketing and support operations, and o maintain focus on our day-to-day operations. 21 22 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. Further, 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. 22 23 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, our software would be less useful to customers, and our 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. Our 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: o expend significant resources to locate and correct the error, o delay introduction of new products or commercial shipment of products, or o 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: o divert the attention of our management and key personnel from our business, o be expensive to defend, and o 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, 23 24 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: o unexpected changes in regulatory requirements, taxes, trade laws and tariffs, o differing intellectual property rights, o differing labor regulations, o unexpected changes in regulatory requirements, o changes in a specific country's or region's political or economic conditions, o greater difficulty in establishing, staffing and managing foreign operations, and o fluctuating exchange rates. We have expanded our international operations, which has required a significant amount of attention from our management and substantial financial resources. We have begun efforts at international expansion in Europe and Asia and, as of March 31, 2001, had 166 employees located in Australia, Canada, France, Germany, Japan, Switzerland, The Netherlands and the United Kingdom. We are also exploring other regions for future expansion. 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 we lose customers because of the adoption of standards, we may have lower revenues and profitability. 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 acquirer were to make a hostile bid for us, the acquirer 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 acquirer would also be required to provide advance notice of its proposal to remove directors at an annual meeting. The acquirer also will not be able to cumulate votes at a meeting, which will 24 25 require the acquirer 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 acquirer. 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 acquirer that it did not feel was in the strategic interests of our company. If the acquirer 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. 25 26 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK MARKET RISK The following discusses our exposure to market risk related to changes in foreign currency exchange rates and interest 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. Foreign Currency Exchange Rate Risk The majority of our operations are based in the United States and, accordingly, the majority of our transactions are denominated in U.S. Dollars. However, we do have foreign-based operations where transactions are denominated in foreign currencies and are subject to market risk with respect to fluctuations in the relative value of currencies. Currently, we have operations throughout Asia, Asia Pacific, Canada, Europe, Middle East and Latin America and conduct transactions in the local currency of each location. To date, the impact of fluctuations in the relative value of other currencies has not been material. Interest Rate Risk As of March 31, 2001, we had short-term investments of $95.8 million which consisted of fixed income securities. Declines of interest rates over time would reduce our interest income from our short-term investments. Based upon our balance of short-term investments, a decrease in interest rates of 0.5% would cause a corresponding decrease in our annual interest income by approximately $479,000. As of March 31, 2001, we did not have any short-term or long-term debt outstanding. The following summarizes the Company's short-term investments and the weighted average yields, as of March 31, 2001 (in thousands, except interest rates);
Expected maturity date ---------------------------------------------------------------------- 2001 2002 2003 2004 2005 Thereafter Total ------- ------ ------ ------ ------ ---------- ------- Certificates of deposit $ 1,191 $ -- $ -- $ -- $ -- $ -- $ 1,191 Weighted ave. yield 3.55% -- -- -- -- -- 3.55% Commercial paper $35,061 -- -- -- -- -- $35,061 Weighted ave. yield 5.71% -- -- -- -- -- 5.71% Corporate bonds $25,627 -- -- -- -- -- $25,627 Weighted ave. yield 6.07% -- -- -- -- -- 6.07% Government notes/bonds $26,503 $7,454 -- -- -- -- $33,957 Weighted ave. yield 4.89% 5.39% -- -- -- -- 5.00% ------- ------ ------ ------ ------ ------ ------- Total investment securities $88,382 $7,454 $ -- $ -- $ -- $ -- $95,836 ======= ====== ====== ====== ====== ====== =======
From time to time we reevaluate our accounting for all of our investments and we may recognize a loss in our income statement if we determine that the investment is permanently impaired. We held $7.5 million in commercial paper in a California public utility as of March 31, 2001. The investment had a maturity date of February 15, 2001 and was not paid by the public utility. As of March 31, 2001, we determined that the investment was permanently impaired based on our evaluation and therefore we recognized a loss of $1,875,000 during the three months ended March 31, 2001. Subsequent to the date of the write-down, our investment advisor agreed to repurchase our commercial paper at par value in the total sum of $7.5 million. As a result, we will recognize a $1,875,000 gain on this investment for the three months ended June 30, 2001. 26 27 E.PIPHANY, INC. FORM 10-Q, MARCH 31, 2001 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 See exhibit index attached hereto. (b) Reports on Form 8-K None. 27 28 E.PIPHANY, INC. FORM 10-Q, MARCH 31, 2001 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: May 15, 2001 SIGNATURE: /s/ Roger S. Siboni ------------------------ ------------------------------ Roger S. Siboni President, Chief Executive Officer and Chairman of the Board DATE: May 15, 2001 SIGNATURE: /s/ Kevin J. Yeaman ------------------------- ------------------------------ Kevin J. Yeaman Chief Financial Officer
28 29 EXHIBIT INDEX
NUMBER EXHIBIT TITLE 2.1+ Agreement and Plan of Reorganization by and among the Registrant, Yosemite Acquisition Corporation and RightPoint Software, Inc. 2.2++ Agreement and Plan of Merger and Reorganization dated March 14, 2000 by and among the Registrant, Octane Software, Inc. and Orchid Acquisition Corporation. 2.3++ Form of Octane Software, Inc. shareholder Voting Agreement relating to the proposed acquisition of Octane Software, Inc. 2.4++ Form of Registrant's stockholder Voting Agreement relating to the proposed acquisition of Octane Software, Inc. 3.1* Restated Certificate of Incorporation of the Registrant. 3.2* Restated Bylaws of the Registrant. 10.1* Form of Indemnification Agreement between the Registrant and each of its directors and officers. 10.2* 1999 Stock Plan and form of agreements thereunder. 10.3* 1999 Employee Stock Purchase Plan and form of agreements thereunder. 10.4* 1997 Stock Plan and form of agreements thereunder. 10.5* Fourth Amended and Restated Investors' Rights Agreement dated June 16, 1999. 10.6* Loan and Security Agreement entered into as of January 9, 1998 with Silicon Valley Bank. 10.7* Loan Modification Agreement between the Registrant and Silicon Valley Bank dated December 1, 1998. 10.8* Master Lease Agreement dated June 2, 1999 by and between Comdisco, Inc. and the Registrant. 10.9* Subordinated Loan and Security Agreement dated as of June 2, 1999 by and between the Registrant and Comdisco, Inc. 10.10* Sublease Portion of Third Floor of 1900 Norfolk Street, San Mateo, California dated April 23, 1999 by and between Inktomi Corporation and the Registrant. 10.11* Form of Amended and Restated Common Stock Purchase Agreement dated March 18, 1997 between the Registrant and four stockholders. 10.12* Restricted Stock Purchase Agreement, Promissory Note, Stock Pledge Agreement and Joint Escrow Instructions dated July 1, 1998 between Roger S. Siboni and the Registrant. 10.13* Promissory Note dated August 15, 1998 between Roger S. Siboni and the Registrant. 10.14** RightPoint Software, Inc. (formerly Datamind Corporation) 1996 Stock Option Plan. 10.15*** 2000 Nonstatutory Stock Option Plan and form of agreements thereunder.
------------ * Incorporated by reference to the Registrant's Registration Statement on Form S-1 (Registration No. 333-82799) declared effective by the Securities and Exchange Commission on September 21, 1999. ** Incorporated by reference to the Registrant's Registration Statement on Form S-1 (Registration No. 333-94033) declared effective by the Securities and Exchange Commission on January 20, 2000. *** Incorporated by reference to the Registrant's Registration Statement on Form S-8 (Registration No. 333-48460) declared effective by the Securities and Exchange Commission. + Incorporated by reference to Registrant's Registration Statement on Form S-4 (File No. 333-92013), declared effective on December 3, 1999. ++ Incorporated by reference to Registrant's Current Report on Form 8-K dated March 14, 2000 filed with the Commission on March 28, 2000.