EGAIN Corp - Quarter Report: 2003 March (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

For the quarterly period ended March 31, 2003

OR

For the transition period from ____________ to ____________

Commission File No. 0-30260

eGAIN COMMUNICATIONS CORPORATION

(Exact name of registrant as specified in its charter)

624 E. Evelyn Avenue, Sunnyvale, CA

(Address of principal executive offices)

94086

(Zip Code)

(408) 212-3400

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

YES  x        NO  ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act): Yes  ¨    No  x.

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

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eGAIN COMMUNICATIONS CORPORATION

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PART I.    FINANCIAL INFORMATION

Item 1.    Financial Statements

eGAIN COMMUNICATIONS CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

See accompanying notes

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eGAIN COMMUNICATIONS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

See accompanying notes

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eGAIN COMMUNICATIONS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

See accompanying notes

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eGAIN COMMUNICATIONS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1.    Basis of Presentation

The condensed consolidated financial statements have been prepared by eGain Communications Corp. (“eGain” or the “Company”) pursuant to the rules and regulations of the Securities and Exchange Commission and include the accounts of eGain and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated.

The accompanying financial statements have been prepared on the basis that the Company will continue as a going concern. The Company has incurred significant operating losses and negative cash flows since inception. The Company has not achieved profitability and may not be able to realize sufficient revenues to achieve or sustain profitability in the future. Since inception eGain experienced substantial expenditures as it grew operations and personnel. Although eGain has repeatedly taken actions to reduce its expense rates over the last two fiscal years, it expects to incur additional operating losses, at least through the fourth quarter of fiscal 2003 if not longer. eGain’s working capital requirements in the foreseeable future are subject to numerous risks and will depend on a variety of factors, in particular that revenue levels remain stable and that customers continue to pay on a timely basis. While eGain closed a $5 million credit facility (see Notes To Condensed Consolidated Financial Statements, Note 7: Related Party Notes Payable) in December 2002, the additional $3,000,000 in loan proceeds available under the Credit Facility is subject to eGain achieving certain performance milestones. eGain can make no assurances that it will achieve the performance milestones necessary to receive these additional loan proceeds. If eGain’s revenues fall significantly below expectations and such loan proceeds are not available, eGain may be unable to meet operating obligations and be required to initiate bankruptcy proceedings. These conditions raise doubt about eGain’s ability to continue as a going concern. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.

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. In the opinion of eGain, the unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of eGain’s financial position, results of operations and cash flows for the periods presented. These financial statements and notes should be read in conjunction with eGain’s audited consolidated financial statements and notes thereto for the year ended June 30, 2002, included in eGain’s Annual Report on Form 10-K. The condensed consolidated balance sheet at June 30, 2002 has been derived from audited financial statements as of that date but does not include all the information and footnotes required by generally accepted accounting principals for complete financial statements. The results of eGain’s operations for the interim periods presented are not necessarily indicative of results that may be expected for any other interim period or for the full fiscal year ending June 30, 2003.

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make certain estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

Certain reclassifications have been made to prior period amounts in order to conform to the current period’s presentation.

Note 2.    Software Revenue Recognition

eGain recognizes revenue in accordance with Statement of Position 97-2, Software Revenue Recognition (“SOP 97-2”), as amended. Under SOP 97-2, revenue from license fees is recognized when persuasive evidence of an agreement exists, delivery of the product has occurred, no significant eGain obligations remain, the fee is fixed or determinable, and collectibility is probable. License revenue in multiple element contracts is recognized using the residual method when there is vendor specific objective evidence of the fair value of all undelivered elements in an arrangement but vendor specific objective evidence of fair value does not exist for one or more of the delivered elements in an arrangement. Under the residual method, the total fair value of the undelivered elements, as indicated by vendor specific objective evidence, is deferred and the difference between the total arrangement fee and the amount deferred for the undelivered elements is recognized as revenue related to the delivered elements. If sufficient vendor-specific objective evidence does not exist for undelivered elements in an arrangement, all revenue from the arrangement is deferred until the earlier of the point at which (a) such sufficient vendor-specific objective evidence does exist or (b) all elements of the arrangement have been delivered.

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Revenue from hosting services is recognized ratably over the period of the agreement as services are provided. Hosting agreements are typically for a period of one year unless either party cancels the agreement.

Service revenue is primarily derived from consulting fees, maintenance agreements, and training. Service revenue from consulting and training billed on a time and materials basis is recognized as performed. Service revenue on fixed price service arrangements is recognized upon completion of specific contractual milestone events, or based on an estimated percentage of completion as work progresses. Maintenance agreements include the right to software updates on an if-and-when-available basis. Maintenance revenue is deferred and recognized on a straight-line basis as service revenue over the life of the related agreement, which is typically one year.

In all cases, eGain assesses whether the service element of the arrangement is essential to the functionality of the other elements of the arrangement. In this determination, eGain focuses on whether the services include significant alterations to the features and functionality of the software, whether the services involve the building of complex interfaces, the timing of payments and the existence of milestones. In making this determination, eGain considers the following: (1) the relative fair value of the services compared to the software, (2) the amount of time and effort subsequent to delivery of the software until the interfaces or other modifications are completed, (3) the degree of technical difficulty in building the interfaces or other modifications, and (4) any contractual cancellation, acceptance, or termination provisions for failure to complete the interfaces. In those instances where eGain determines that the service elements are essential to the other elements of the arrangement, eGain accounts for the entire arrangement in accordance with Accounting Research Bulletin (ARB) No. 45, “Long-Term Construction-Type Contracts,” using the relevant guidance from SOP 97-2 and SOP 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts.”

Revenue from sales to resellers are recognized either upon delivery to the reseller or on a sell-through basis, depending on the facts and circumstances of the transaction, such as eGain’s understanding of the reseller’s use of its software, the reseller’s financial status, and eGain’s past experience with the particular reseller. Accordingly, the decision whether to recognize revenue to resellers either upon delivery or on a sell-through basis requires significant management judgment. This judgment can materially impact the timing of revenue recognition.

Note 3.    Stock-Based Compensation

eGain accounts for its stock-based compensation arrangements with employees using the intrinsic-value method in accordance with Accounting Principles Board 25, Accounting for Stock Issued to Employees. Deferred stock-based compensation is recorded on the date of grant when the deemed fair value of the underlying common stock exceeds the exercise price for stock options or the purchase price for the shares of common stock.

Deferred compensation is amortized on a graded vesting method over the vesting period of the individual grants. In addition, eGain records compensation expense in connection with grants of stock options to non-employees pursuant to “Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation” (“SFAS 123”). These grants are periodically revalued as they vest in accordance with SFAS 123 and “EITF 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.”

As of March 31, 2003, the outstanding balance of deferred stock compensation was $57,000. eGain amortized $31,000 and $233,000 of deferred compensation in the quarters ended March 31, 2003 and March 31, 2002, respectively. The total of amortization of deferred stock based compensation was $136,000 for the nine months period ended March 31, 2003 and $793,000 for the same period in the prior year.

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eGain has adopted the disclosure requirements of Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation, Transition and Disclosure. Pro forma information regarding net income (loss) has been determined as if we had accounted for our employee stock options under the fair value method prescribed by SFAS 123 (in thousands, except per share data):

Note 4.    Goodwill and Other Intangible Assets

The following table provides a summary of the carrying amount of goodwill which includes amounts originally allocated to assembled workforce (in thousands):

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The following table summarizes the carrying amount of other intangible assets that continue to be amortized and excludes amounts originally allocated to assembled workforce (in thousands):

Effective July 1, 2002, eGain adopted SFAS No. 142, “Goodwill and Other Intangible Assets.” As required by SFAS No. 142, eGain no longer amortizes goodwill, but will review goodwill annually (or more frequently if impairment indicators arise) for impairment. Intangible assets with a net carrying value of $750,000, which do not qualify as separate intangible assets under SFAS No. 142, have been reclassed to goodwill. Upon initial application in connection with the transitional goodwill impairment evaluation under SFAS No. 142, the Company completed a goodwill review as of the date of adoption—July 1, 2002 and found no impairment of goodwill beyond amounts previously recorded prior to that date.

Upon adoption of Statement of Financial Accounting Standards Number 142, “Goodwill and Other Intangible Assets”, (“SFAS 142”), in its fiscal year beginning July 1, 2002, eGain is required to present specific disclosures under the transitional provisions of SFAS 142. The following table presents the loss for all periods presented, as adjusted, to exclude the amortization of goodwill (in thousands, except per share data; unaudited):

        Purchased intangible assets are carried at cost less accumulated amortization. Amortization is computed over the estimated useful lives of the respective assets, generally 3 to 4 years. Long-lived assets, including intangible assets, are reviewed whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. Recoverability of a long lived asset other than goodwill is measured by comparison of its carrying amount to the expected future undiscounted cash flows (without interest charges) that the asset is expected to generate. An impairment charge is recorded if the carrying amount of the asset exceeds the sum of the expected undiscounted cash flows. Any impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair value. Fair value is determined based on discounted cash flows or appraised values, depending upon the nature of the assets. Significant management judgment is required in the forecasting of future operating results which are used in the preparation of projected discounted cash flows and, should different conditions prevail or judgments be made, material write-downs of net intangible assets and/or goodwill could occur.

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Note 5.    Net Loss Per Common Share

Basic net loss per common share is computed using the weighted-average number of shares of common stock outstanding.

The following table sets forth the calculation of basic and diluted net loss per common share (in thousands, except per share data):

Options and warrants to purchase 8,129,374 and 10,061,000 shares of common stock were outstanding at March 31, 2003 and 2002, respectively. In addition, convertible preferred stock convertible into 18,553,000 and 17,362,000 shares of common stock were outstanding at March 31, 2003 and 2002, respectively. The above amounts were excluded from the computation of net loss per common share, as their effect is anti-dilutive.

Note 6.    Comprehensive Loss

eGain’s comprehensive loss is comprised of net loss and foreign currency translation adjustments. Comprehensive loss was $2.5 million and $18.7 million for the three months ended March 31, 2003 and 2002, respectively, and $9.8 million and $59.7 million for the nine months ended March 31, 2003 and 2002, respectively.

Note 7.    Segment Information

Operating segments are identified as components of an enterprise for which discrete financial information is available and regularly reviewed by eGain’s chief operating decision-maker to make decisions about resources to be allocated to the segment and assess its performance. eGain’s chief operating decision-maker, as defined under SFAS No. 131, is its executive management team. To date, eGain has viewed its operations and manages its business as principally one segment, the development, license, implementation and support of its customer interaction management software solutions. eGain’s chief operating decision-maker reviews financial information presented on a consolidated basis, accompanied by separate information about operating results by geographic region for purposes of making operating decisions and assessing financial performance.

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Information relating to eGain’s geographic areas is as follows (in thousands):

In addition, identifiable assets corresponding to eGain’s geographic areas are as follows (in thousands):

During the nine months ended March 31, 2003 and 2002, no single customer accounted for more than 10% of eGain’s total revenue.

Note 8.    Related Party Notes Payable

On December 24, 2002, eGain entered into a Note and Warrant Purchase Agreement (the “Purchase Agreement”) with Ashutosh Roy, the Company’s Chief Executive Officer, pursuant to which Mr. Roy will make loans to the Company evidenced by one or more subordinated secured promissory notes and will receive warrants to purchase shares of the Company’s common stock in connection with such loans (the “Credit Facility”). Each subordinated secured promissory note will have a term of five years and will bear interest at an effective annual rate of 12% due and payable upon the maturity of such note. The Company has the option to prepay each note at any time subject to the prepayment penalties set forth in such note. The warrants will allow Mr. Roy to purchase up to a number of shares equal to 25% of the aggregate amount loaned at an exercise price equal to 110% of the fair market value of the Company’s common stock (based on a five day trading average at the time of each loan). The warrants become exerciseable as to 50% of the warrant shares nine months after issuance of the warrant and as to 100% of the warrant shares on the first anniversary of the issuance of the warrant. An initial advance of $2,000,000 under the Credit Facility occurred on December 31, 2002. eGain recorded $1.83 million in related party notes payable and $173,000 of discount on the notes related to the value of the warrants issued in the transaction. Loans of up to an additional $3,000,000 may be made under the Credit Facility subject to the achievement by the Company of certain performance milestones set forth in the Purchase Agreement.

As of March 31, 2003, the outstanding balance of related party notes payable was $1.89 million including an accrued interest of $60,000 at an annual rate of 12%.

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Note 9.    Bank Borrowings

On September 20, 2002, eGain entered into an accounts receivable purchase agreement (the “AR Facility”) with Silicon Valley Bank (“SVB”), which replaced the existing revolving line of credit. The AR Facility provides for the sale of up to $5.0 million in certain qualified receivables, bears interest at a rate of prime plus 5.0% per annum and carries a 0.5% monthly administrative fee. As of March 31, 2003 there was approximately $500,000 outstanding under this agreement. As part of this agreement, the term loan and equipment loan were combined into one term loan facility in the amount of $1.1 million which was secured by establishing a restricted certificate of deposit for $1.1 million at March 31, 2003. This amount will be reduced as scheduled payments on the term loan are made. As of March 31, 2003 there was approximately $1,048,000 outstanding on the term loan.

On March 25, 2003, eGain entered into a modification agreement with SVB. The amendment extended the original term and termination of the AR Facility for an additional 90 days through June 30, 2003.

Total borrowings under the SVB Credit Facilities were $1,548,000 at March 31, 2003, which consisted of the following (in thousands):

Note 10.    Restructuring

During the quarter ended March 31, 2003, pursuant to a plan approved by the required level of management necessary to execute its components, eGain recorded a restructuring charge of $512,000 primarily due to the closure of the local office in Germany and the severance payments associated with planned worldwide headcount reductions. The charges consisted of $213,000 related to closure of the German office, $216,000 employee severance payments, $34,000 of fixed assets write-offs as well as $49,000 miscellaneous charges related to the excess facilities in North America.

During the quarter ended December 31, 2002, pursuant to a plan approved by the required level of management necessary to execute its components, eGain recorded a restructuring benefit of $1,285,000 which was primarily due to the termination of one of its facility leases. The savings from the facility lease termination was $1,660,000. This benefit was partially offset by current quarter charges of $215,000 related to severance payments associated with planned worldwide headcount reductions as well as $160,000 related to the closure of local offices in Australia and Singapore. The total payments of $648,000 for the quarter consisted of $135,000 employee severance, $187,000 related to closure of local offices in Europe, Australia, and Singapore in fiscal 2003, and $326,000 for excess facilities in North America accrued in fiscal 2002.

eGain entered into a settlement with Synergism Investors on December 11, 2002 to terminate an existing lease agreement for one of eGain’s excess facilities. Under this agreement, eGain agreed to pay $1,325,000 (the “Settlement Amount”) to Synergism. Of this obligation, $325,000 was secured through a certified deposit and paid in January, 2003. The remaining balance will be paid to Synergism in the event eGain makes a distribution of cash, stock, or other consideration (each, a “Preferred Payment”) to the holders of eGain’s 6.75% Series A Cumulative Convertible Preferred Stock (the “Series A Preferred”) with respect to the shares of Series A preferred held by them. Synergism will receive prior to any such Preferred Payment to holders of Series A Preferred a cash payment equal to the lesser of (i) an amount equal to $1,000,000 (the “Initial Payment Value”) plus an amount which would increase and accumulate at an annual rate equal to 6.75% of the Initial Payment Value; or (ii) the portion of the Preferred Payment made with respect to 10 shares of Series A Preferred, which shares have an aggregated stated value of $1,000,000.

Upon entering into this settlement agreement with Synergism Investors, eGain reduced its restructuring accrual by $53,000. A restructuring accrual in the amount of $1,000,000 remains as a liability in the event eGain makes Preferred Payments under the terms of the settlement agreement.

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During the three months ended September 30, 2002, pursuant to a plan approved by the required level of management necessary to execute its components, eGain recorded restructuring charges totaling $1,047,000. These charges were primarily related to severance payments associated with planned headcount reductions and the closure of local offices in Holland and France. Out of the total charges, there was $38,000 in professional fees incurred and paid that were associated with legal issues in the headcount reduction. During the three months ended September 30, 2002, eGain reduced its worldwide workforce by 94 employees across all departments pursuant to the adoption of eGain’s expense management strategy. The total payments in the quarter ended September 30, 2002 were $1,587,000, which consisted of $713,000 employee severance and $38,000 professional services incurred in fiscal 2003, $796,000 related to the consolidation of facilities in North America in fiscal 2002, and $40,000 in professional services accrued since fiscal 2001.

Details of the fiscal 2003 restructuring charges are as follows (in thousands):