**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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**FORM 10-Q**

 
| **ý** |   | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934**      |
|------------|--------|--------------------------------------------------------------------------------------------------------|
|       |   |                                                                                                   |
|       |   | **FOR THE QUARTERLY  PERIOD ENDED JUNE 30, 2004**                                                 |
|       |   |                                                                                                   |
| **o**      |   | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES AND EXCHANGE ACT OF 1934** |

 

**Commissionfile number 000-50507**

 

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**KINTERA,INC.**

(Exact name of Registrant asspecified in its charter)

 
| **Delaware**                                                    |   | **74-2947183**                        |
|-----------------------------------------------------------------|--------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |   | (I.R.S. Employer Identification  No.) |
|                                                            |   |                                  |
| **9605 Scranton Road, Suite 240  San Diego, California**        |   | **92121**                             |
| (Address of principal executive  offices)                       |   | (Zip Code)                            |

 

Registrant’s telephone number,including area code:**  (858)795-3000**

 

Securities registered pursuant toSection 12(b) of the Act:

**None**

 

Securities registered pursuant toSection 12(g) of the Act:

**CommonStock**

(Title of Class)

 

Indicate by check mark whether the registrant: (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days. Yes ý**Noo

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Exchange Act Rule 12b-2) Yes oNo ý

 

As of August 4, 2004 there were 27,782,753 shares of theregistrant’s common stock outstanding.

 

 

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**KINTERA,INC.**

 

**FORM10-Q**

**FORTHE QUARTERLY PERIOD ENDED JUNE 30, 2004**

**INDEX**

 
| **PART I. FINANCIAL INFORMATION** | **3**                                                                                                                                                               |
|-----------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                              |                                                                                                                                                                |   |
| Item 1.                           | Financial Statements                                                                                                                                                | 3 |
|                              |                                                                                                                                                                |   |
|                              | Consolidated Balance Sheets at  June 30, 2004 (unaudited) and December 31, 2003                                                                           | 3 |
|                              |                                                                                                                                                                |   |
|                              | Consolidated Statements of Operations for  the Three Months Ended June 30, 2004 and 2003 and for the Six Months  Ended June 30, 2004 and 2003 (unaudited) | 4 |
|                              |                                                                                                                                                                |   |
|                              | Consolidated Statements of Cash Flows for  the Six Months Ended June 30, 2004 and 2003 (unaudited)                                                             | 5 |
|                              |                                                                                                                                                                |   |
|                              | Notes to Consolidated Financial Statements  (unaudited)                                                                                                             | 6 |
|                              |                                                                                                                                                                |   |
| Item 2.                           | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                                                                         | 13 |
|                              |                                                                                                                                                                |   |
| Item 3.                           | Quantitative and Qualitative Disclosures  About Market Risk                                                                                                         | 25 |
|                              |                                                                                                                                                                |   |
| Item 4.                           | Controls and Procedures                                                                                                                                             | 25 |
|                              |                                                                                                                                                                |   |
| **PART II. OTHER INFORMATION**    | **26**                                                                                                                                                              |
|                              |                                                                                                                                                                |   |
| Item 1.                           | Legal Proceedings                                                                                                                                                   | 26 |
|                              |                                                                                                                                                                |   |
| Item 2.                           | Changes in Securities and Use of Proceeds                                                                                                                           | 26 |
|                              |                                                                                                                                                                |   |
| Item 6.                           | Exhibits and Reports on Form 8-K                                                                                                                                    | 27 |

 

2

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**PART I. FINANCIAL INFORMATION**

 

Item 1. Financial Statements

 

**Kintera, Inc.**

**Condensed Consolidated Balance Sheet**

**(in thousands, except share data)**

 
|                                                                                                                                                                                                  |   | **June 30,  2004** |   | **December 31,  2003** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|--------|-----------------------------|--------|
|                                                                                                                                                                                                  |   | **(unaudited)**         |   |                        |   |
| **Assets**                                                                                                                                                                                            |   |                    |   |                        |   |
| Current assets:                                                                                                                                                                                       |   |                    |   |                        |   |
| Cash and cash equivalents                                                                                                                                                                             |   | $                       | 8,966  |                        | $      | 38,480 |   |
| Marketable securities                                                                                                                                                                                 |   | 20,590                  |   | 192                         |   |
| Accounts receivable, net of allowance for  doubtful accounts of $366 and $196 at June 30, 2004 and December 31,  2003, respectively                                                         |   | 3,335                   |   | 1,933                       |   |
| Accounts receivable from related party                                                                                                                                                                |   | —                  |   | 475                         |   |
| Prepaid expenses and other current assets                                                                                                                                                             |   | 876                     |   | 736                         |   |
| Note receivable from employee                                                                                                                                                                         |   | 16                      |   | 19                          |   |
| Total current assets                                                                                                                                                                                  |   | 33,783                  |   | 41,835                      |   |
| Property and equipment, net                                                                                                                                                                           |   | 2,009                   |   | 1,458                       |   |
| Software development costs, net                                                                                                                                                                       |   | 559                     |   | —                      |   |
| Other assets                                                                                                                                                                                          |   | 901                     |   | 769                         |   |
| Intangible assets, net                                                                                                                                                                                |   | 8,373                   |   | 3,695                       |   |
| Total assets                                                                                                                                                                                          |   | $                       | 45,625 |                        | $      | 47,757 |   |
|                                                                                                                                                                                                  |   |                    |   |                        |   |
| **Liabilities and stockholders’ equity**                                                                                                                                                         |   |                    |   |                        |   |
| Current liabilities:                                                                                                                                                                                  |   |                    |   |                        |   |
| Accounts payable and accrued expenses                                                                                                                                                                 |   | $                       | 1,328  |                        | $      | 1,693 |   |
| Accrued salaries and employee benefits                                                                                                                                                                |   | 716                     |   | 703                         |   |
| Donations payable to customers                                                                                                                                                                        |   | 982                     |   | 799                         |   |
| Line of credit                                                                                                                                                                                        |   | 6                       |   | 361                         |   |
| Deferred revenue                                                                                                                                                                                      |   | 2,785                   |   | 1,931                       |   |
| Notes payable                                                                                                                                                                                         |   | 207                     |   | —                      |   |
| Note payable to founder                                                                                                                                                                               |   | 62                      |   | 45                          |   |
| Total current liabilities                                                                                                                                                                             |   | 6,086                   |   | 5,532                       |   |
| Deferred rent                                                                                                                                                                                         |   | 119                     |   | 72                          |   |
| Other                                                                                                                                                                                                 |   | 21                      |   | —                      |   |
| Commitments and contingencies                                                                                                                                                                         |   | —                  |   | —                      |   |
|                                                                                                                                                                                                  |   |                    |   |                        |   |
| Stockholders’ equity:                                                                                                                                                                            |   |                    |   |                        |   |
|                                                                                                                                                                                                  |   |                    |   |                        |   |
| Preferred stock, $.001 par value,  20,000,000 shares authorized at June 30, 2004 and December 31,  2003, no shares issued and outstanding at June 30, 2004 and  December 31, 2003 |   | —                  |   | —                      |   |
| Common stock, $.001 par value, 60,000,000  shares authorized; 25,075,116 and 23,748,564 shares issued and outstanding at  June 30, 2004 and December 31, 2003, respectively                 |   | 25                      |   | 24                          |   |
| Additional paid-in capital                                                                                                                                                                            |   | 95,042                  |   | 86,820                      |   |
| Deferred compensation                                                                                                                                                                                 |   | (12,722                 | )      | (10,863                     | )      |
| Accumulated other comprehensive loss                                                                                                                                                                  |   | (208                    | )      | —                      |   |
| Accumulated deficit                                                                                                                                                                                   |   | (42,738                 | )      | (33,828                     | )      |
| Total stockholders’ equity                                                                                                                                                                       |   | 39,399                  |   | 42,153                      |   |
| Total liabilities and stockholders’ equity                                                                                                                                                       |   | $                       | 45,625 |                        | $      | 47,757 |   |

 

See accompanying notes to unauditedconsolidated financial statements.

 

3

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**KINTERA, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(in thousands, except per share data)**

**(unaudited)**

 
|                                              |   | **Three  months ended  June 30,** |       | **Six months  ended  June 30,** |       |
|---------------------------------------------------|--------|----------------------------------------|------------|--------------------------------------|------------|
|                                              |   | **2004**                               |       | **2003**                             |       | **2004** |   | **2003** |   |
|                                              |   |                                   |       |                                 |       |   |   |   |   |
| Net  revenue                                      |   | $                                      | 5,893      |                                 | $          | 1,752 |   | $ | 8,964 |   | $ | 2,945 |   |
| Cost of  revenue                                  |   | 1,205                                  |       | 341                                  |       | 1,774 |   | 587 |   |
| Gross  profit                                     |   | 4,688                                  |       | 1,411                                |       | 7,190 |   | 2,358 |   |
|                                              |   |                                   |       |                                 |       |   |   |   |   |
| Sales and  marketing                              |   | 3,835                                  |       | 1,896                                |       | 6,819 |   | 3,684 |   |
| Product  development and support                  |   | 2,070                                  |       | 786                                  |       | 3,659 |   | 1,553 |   |
| General  and administrative                       |   | 1,855                                  |       | 460                                  |       | 3,466 |   | 903 |   |
| Stock-based  compensation                         |   | 1,155                                  |       | 508                                  |       | 2,283 |   | 882 |   |
| Total  operating expenses                         |   | 8,915                                  |       | 3,650                                |       | 16,227 |   | 7,022 |   |
|                                              |   |                                   |       |                                 |       |   |   |   |   |
| Operating  loss                                   |   | (4,227                                 | )          | (2,239                               | )          | (9,037 | ) | (4,664 | ) |
|                                              |   |                                   |       |                                 |       |   |   |   |   |
| Interest  income (expense) and other, net         |   | 71                                     |       | 3                                    |       | 128 |   | 10 |   |
|                                              |   |                                   |       |                                 |       |   |   |   |   |
| Net loss                                          |   | $                                      | (4,156     | )                                    | $          | (2,236 | ) | $ | (8,909 | ) | $ | (4,654 | ) |
|                                              |   |                                   |       |                                 |       |   |   |   |   |
| Basic and  diluted net loss per share             |   | $                                      | (0.17      | )                                    | $          | (0.24 | ) | $ | (0.38 | ) | $ | (0.52 | ) |
|                                              |   |                                   |       |                                 |       |   |   |   |   |
| Weighted  average shares - basic and diluted      |   | 23,880                                 |       | 9,373                                |       | 23,176 |   | 8,952 |   |
|                                              |   |                                   |       |                                 |       |   |   |   |   |
|                                              |   |                                   |       |                                 |       |   |   |   |   |
|                                              |   | **Three  months ended**                | ** ** | **Six months  ended**                | ** ** |
|                                              |   | **June 30,  2004**                |       | **June 30,  2003**              |       | **June 30,  2004** |   | **June 30,  2003** |   |
| Stock-based compensation includes the  following: |   |                                   |       |                                 |       |   |   |   |   |
|                                              |   |                                   |       |                                 |       |   |   |   |   |
| Sales and marketing                               |   | $                                      | 794        |                                 | $          | 299 |   | $ | 1,447 |   | $ | 507 |   |
| Product development and support                   |   | 147                                    |       | 181                                  |       | 393 |   | 341 |   |
| General and administrative                        |   | 214                                    |       | 28                                   |       | 443 |   | 34 |   |
|                                              |   |                                   |       |                                 |       |   |   |   |   |
|                                              |   | $                                      | 1,155      |                                 | $          | 508 |   | $ | 2,283 |   | $ | 882 |   |

 

See accompanying notes to unauditedconsolidated financial statements.

 

4

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**KINTERA,INC.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(in thousands)**

**(unaudited)**

 
|                                                                         |   | **Six months  ended June 30,** |   |
|------------------------------------------------------------------------------|--------|-------------------------------------|--------|
|                                                                         |   | **2004**                            |   | **2003** |   |
| **Operating activities:**                                                    |   |                                |   |   |   |
| Net loss                                                                     |   | $                                   | (8,909 | ) | $ | (4,654 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities: |   |                                |   |   |   |
| Bad debt expense                                                             |   | 79                                  |   | 72 |   |
| Depreciation                                                                 |   | 465                                 |   | 284 |   |
| Amortization of software development costs                                   |   | 33                                  |   | — |   |
| Amortization of intangible assets                                            |   | 478                                 |   | 230 |   |
| Forgiveness of employee note                                                 |   | 2                                   |   | 18 |   |
| Interest expense associated with issuance  of warrant                        |   | 55                                  |   | — |   |
| Stock-based compensation expense                                             |   | 127                                 |   | 21 |   |
| Amortization of deferred compensation                                        |   | 2,186                               |   | 859 |   |
| Changes in operating assets and  liabilities, net of acquisitions:           |   |                                |   |   |   |
| Accounts receivable                                                          |   | 1,731                               |   | (821 | ) |
| Prepaid expenses and other current assets                                    |   | (139                                | )      | (22 | ) |
| Accounts payable and accrued expenses                                        |   | (1,864                              | )      | 304 |   |
| Accrued salaries and employee benefits                                       |   | (508                                | )      | (26 | ) |
| Donations payable to customers                                               |   | 183                                 |   | — |   |
| Customer deposits                                                            |   | (958                                | )      | — |   |
| Deferred revenue                                                             |   | 592                                 |   | 773 |   |
| Notes payable                                                                |   | (160                                | )      | — |   |
| Deferred rent                                                                |   | 46                                  |   | (10 | ) |
| Sponsorships payable                                                         |   | —                              |   | (51 | ) |
| Net cash used in operating activities                                        |   | (6,561                              | )      | (3,023 | ) |
|                                                                         |   |                                |   |   |   |
| **Investing activities:**                                                    |   |                                |   |   |   |
| Purchases of marketable securities                                           |   | (24,270                             | )      | — |   |
| Sales and maturities of marketable  securities                               |   | 3,664                               |   | 2,046 |   |
| Acquisition costs, net of cash acquired                                      |   | (989                                | )      | (87 | ) |
| Purchases of property and equipment                                          |   | (706                                | )      | (142 | ) |
| Additions to software development costs                                      |   | (592                                | )      | — |   |
| Other assets                                                                 |   | (67                                 | )      | (234 | ) |
| Net cash provided by (used in) investing  activities                         |   | (22,960                             | )      | 1,583 |   |
|                                                                         |   |                                |   |   |   |
| **Financing activities:**                                                    |   |                                |   |   |   |
| Payment of line of credit obligation                                         |   | (391                                | )      | (8 | ) |
| Costs associated with the issuance of  common stock                          |   | (134                                | )      | — |   |
| Proceeds from exercise of common stock  options and ESPP                     |   | 532                                 |   | 6 |   |
| Repurchase of common stock                                                   |   | —                              |   | (5 | ) |
| Net proceeds from sale of preferred stock                                    |   | —                              |   | 2,821 |   |
| Net cash provided by financing activities                                    |   | 7                                   |   | 2,814 |   |
| Net increase (decrease) in cash and cash  equivalents                        |   | (29,514                             | )      | 1,374 |   |
| Cash and cash equivalents at beginning of  period                            |   | 38,480                              |   | 1,235 |   |
| Cash and cash equivalents at end of period                                   |   | $                                   | 8,966  |   | $ | 2,609 |   |
|                                                                         |   |                                |   |   |   |
| **Supplemental disclosure of cash flow  information:**                       |   |                                |   |   |   |
| Cash paid for interest                                                       |   | $                                   | 14     |   | $ | — |   |
|                                                                         |   |                                |   |   |   |
| **Supplemental disclosure of non-cash  investing and financing activities:** |   |                                |   |   |   |
| Issuance of common stock and options for  acquisitions                       |   | $                                   | 8,537  |   | $ | 519 |   |

 

See accompanying notes to unauditedconsolidated financial statements.

 

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**Kintera,Inc.Notes to Unaudited ConsolidatedFinancial Statements(dollars in thousands, except share data)**

 

**1. Organization and Summary of SignificantAccounting Policies**

 

***Descriptionof Business***

 

Kintera, Inc. (the “Company”) was incorporated in the state ofDelaware on February 8, 2000. The Company is a provider of software thatenables nonprofit organizations to use the Internet to increase donations,reduce fundraising costs and build awareness and affinity for an organization’scause by bringing their employees, volunteers and donors together in online,interactive communities.

 

***Basisof Presentation***

 

The accompanying unaudited condensed consolidated financial statementsof the Company have been prepared in accordance with accounting principlesgenerally accepted in the United States of America and with the instructions toForm 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and footnotesrequired by accounting principles generally accepted in the United States ofAmerica for complete financial statements. In the opinion of management, the unaudited condensed consolidatedfinancial statements reflect all adjustments considered necessary for a fairpresentation, consisting only of normal and recurring adjustments.  All significant intercompany transactionshave been eliminated in consolidation. Operating results for the three and six months ended June 30, 2004are not necessarily indicative of the results that may be expected for thefiscal year ending December 31, 2004. For further information, refer to the consolidated financial statementsand footnotes thereto for the year ended December 31, 2003.

 

In November 2003, the Company’s Board of Directors andstockholders approved a two-for-one reverse stock split of the outstandingshares of common and preferred stock. All share and per share informationincluded in these consolidated financial statements have been adjusted toreflect the impact of the reverse stock split.

 

***Useof Estimates***

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States requires management to makeestimates and assumptions that affect the amounts reported in the financialstatements and accompanying notes. Actual results could differ from thoseestimates.

 

***Principlesof Consolidation***

 

The consolidated financial statements include the accounts of theCompany and all wholly-owned subsidiaries. All significant intercompanyaccounts and transactions have been eliminated.

 

***Concentrationof Credit Risk and Significant Customers***

 

The Company had one customer that comprised 13% of net revenues for thesix months ended June 30, 2003.

 

***RevenueRecognition***

 

Kintera Sphere is an enterprise-grade software system that integrates asuite of features including content management, contact management,communication, commerce, community and reporting. The Company receives revenuesrelated to Kintera Sphere for upfront fees, monthly maintenance fees andtransaction fees tied to the donations and purchases that the Companyprocesses. The Company recognizes revenues when all of the following criteriaare met: (1) persuasive evidence of an arrangement exists (upon contractsigning or receipt of an authorized purchase order from the customer);(2) delivery has occurred (upon performance of services in accordance withcontract specifications); (3) customer payment is deemed fixed ordeterminable and free of contingencies or significant uncertainties (credit termsextending beyond twelve months or significantly longer than is customary aredeemed not to be fixed and determinable); and (4) collection is reasonablyassured (there are no indicators of non-payment based upon history with thecustomer and/or upon completion of credit procedures, if completed). As ofJune 30, 2004 and for each period presented, the Company did not have anyarrangements with credit terms extending beyond twelve months. Billings made orpayments received in advance of providing services are deferred until theperiod these services are provided.

 

To date, the Company’s arrangements that contain multiple elements havebeen contracts that include upfront payments for activation of Kintera Sphere,monthly fees for the maintenance and use of Kintera Sphere and transaction feestied to the donations

 

6

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and purchases that the Company processes. Revenue associated with theupfront payments is deferred and recognized on a straight-line basis over theentire term of the contract which in general range from twelve to thirty-sixmonths. Revenue related to monthly maintenance and transaction fees fordonations made through the website are recognized as services are provided.Credit card fees directly associated with processing customer donations andbilled to customers are excluded from revenues in accordance with EmergingIssues Task Force (“EITF”) consensus on Issue 99-19. *Reporting Revenue Gross as a Principal verses Net as an Agent*.

 

For arrangements with multiple elements, the Company allocates revenuesto each element of the transaction based upon its fair value. Fair value forall elements of an arrangement is determined when the delivered items havevalue to the customer on a stand-alone basis, evidence of the fair value of theundelivered items exists based on the price of regular sales on a stand-alonebasis, and delivery or performance of the undelivered items is consideredprobable and substantially in the control of the Company. Items are consideredto have stand alone value if the Company has sold that item separately on aregular basis in the past. When the fair value of a delivered element has notbeen established or the Company is unable to establish stand-alone value, as isthe case for the upfront payments for activation, maintenance, and use ofKintera Sphere, the revenues for the elements are recognized on a straight-linebasis over the entire term of the contract.

 

The unearned portion of paid subscriptions is deferred until thepublications are mailed to subscribers. Upon each mailing, a proportionateshare of the gross subscription price is included in revenues. Advertisingrevenues are recognized when the advertisements are distributed.

 

The Company’s acquisition, Prospect Information Network, LLC (“PIN”),recognizes revenues primarily from three sources: (1) software licensing; (2)post consumer support services of the software licenses; and (3) consultingservices and related data processing fees. Revenue is recognized in accordancewith American Institute of Certified Public Accountants (“AICPA”) Statement ofPosition (“SOP”) 97-2, *Software RevenueRecognition*.  Software license fee revenue is recognized whenpersuasive evidence of an arrangement exists, delivery of the product hasoccurred at the customer’s location, the fee is fixed or determinable andcollection is probable. PIN uses the residual method to recognize revenue whenan arrangement includes one or more elements to be delivered at a future dateand vendor-specific objective evidence (“VSOE”) of the fair value of allundelivered elements exists. VSOE of fair value is based on the normal pricingpractices for those products and services when sold separately by PIN andcustomer renewal rates for post-contract customer support services. Under theresidual method, the fair value of the undelivered elements is deferred and theremaining portion of the arrangement fee is recognized as revenue. If evidenceof the fair value of one or more undelivered elements does not exist, therevenue is deferred and recognized when delivery of those elements occurs orwhen fair value can be established.

 

When software licenses are sold together with consulting services,license fees are recognized upon delivery provided that the above criteria aremet, payment of the license fees is not dependent upon the performance of theservices, and the services do not provide significant customization ormodification of the software products and are not essential to thefunctionality of the software that was delivered. For arrangements withservices that are essential to the functionality of the software, the licenseand related service revenues are recognized upon completion of the delivery ofthe license and the services with the residual method utilized for the remainingelements in the contract.

 

If at the outset of an arrangement PIN determines that the arrangementfee is not fixed or determinable, revenue is deferred until the arrangement feebecomes due. If at the outset of an arrangement PIN determines that collectibilityis not probable, revenue is deferred until the earlier of when collectibilitybecomes probable or the receipt of payment. Revenues from post-contractcustomer support services, such as software maintenance, are recognized on astraight-line basis over the term of the support period. The majority ofsoftware maintenance agreements provide technical support as well asunspecified software product upgrades and releases when and if made availableduring the term of the support period.

 

Revenues recognized for consulting services associated with datamanagement and training are recognized as these services are performed,provided persuasive evidence of an arrangement exists, fees are fixed ordeterminable, and collection is reasonably assured.

 

The Company’s acquisition, Carol/Trevelyan Strategy Group (“CTSG”),recognizes revenues primarily from five sources: (1) software licensing; (2)website development and customization; (3) hosting services; (4) messagingservices (email/fax); and (5) consulting services. Revenue is recognized inaccordance with AICPA SOP 97-2, *SoftwareRevenue Recognition*.  Software license fee revenue isrecognized when persuasive evidence of an arrangement exists, delivery of theproduct has occurred, fees from the arrangement are fixed or determinable, andcollection is probable. CTSG uses the residual method to recognize revenue whenan arrangement includes one or more elements to be delivered at a future dateand VSOE of the fair value of all undelivered elements exists. VSOE of fairvalue is based on the normal pricing practices for those products and serviceswhen sold separately by CTSG and customer renewal rates for post-contractcustomer support services. Under the residual method, the fair value of theundelivered

 

7

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elements is deferred and the remaining portion of the arrangement feeis recognized as revenue. If evidence of the fair value of one or moreundelivered elements does not exist, the revenue is deferred and recognizedwhen delivery of those elements occurs or when fair value can be established.

 

For arrangements that include both the software license and acombination of website development and customization, hosting, messaging, orconsulting, CTSG allocates revenue to each element based upon its fair value asdetermined by VSOE.   If the revenues relate to initial services to a newcustomer, the license, website development/customization, hosting, andmessaging are deferred until the website has been delivered.  Upfront ormonthly fees for licensing and hosting are recognized ratably over the term ofthe arrangement, ranging typically from one month to one year.  Messagingrevenue is recognized after email/fax services have been provided. Revenueresulting from additional website development/customization services providedsubsequent to website delivery is recognized as services are performed based ontime incurred.  Consulting revenue is also recognized as the services areperformed.  Deferred revenue comprisesbillings in excess of recognized revenue and payments received in advance ofrevenue recognition.

 

***SoftwareDevelopment Costs***

 

TheCompany accounts for Internal Use Software Development costs in accordance withStatement of Position (“SOP”) 98-1, *Accountingfor the Costs of Computer Software Developed or Obtained for Internal Use*.In accordance with SOP 98-1, costs to develop internal use computer softwareduring the application development stage are capitalized. Internal usecapitalized software costs are amortized on a straight-line basis over theestimated useful lives of the related software applications of up to threeyears and are included in depreciation and amortization.  For the threeand six months ended June 30, 2004 and June 30, 2003 the Companycapitalized $339, $339, $0, and $0 related to internal use Software DevelopmentCosts, respectively.

 

The Company accounts forthe development cost of software that is marketed to customers in accordancewith Statement of Financial Accounting Standards No. 86, *Accounting for Costs of Computer Software to be Sold,Leased, or Otherwise Marketed* (“SFAS 86”). SFAS 86 requires productdevelopment costs to be charged to expense as incurred until technologicalfeasibility is attained. Technological feasibility is attained when softwarehas completed a detail program design for its intended use. Capitalizedsoftware costs are amortized on a straight-line basis over the estimated usefullives of the related software applications of up to three years and areincluded in depreciation and amortization.  The Company periodicallyreviews the software that has been capitalized for impairment.  For thethree and six months ended June 30, 2004 and June 30, 2003 theCompany capitalized $252, $252, $0, and $0 related to Costs of ComputerSoftware to be Sold, Leased or otherwise Marketed respectively.

 

***Stock-BasedCompensation***

 

As permitted by SFAS No. 123, *Accountingfor Stock-Based Compensation*, the Company has elected to followAccounting Principles Board Opinion No. 25, *Accounting for Stock Issued to Employees* (“APB 25”), andrelated interpretations in accounting for its employee stock options. Under APB25, when the exercise price of the Company’s employee stock options is equal toor greater than the fair value of the underlying stock on the date of grant, nocompensation expense is recognized. Certain of the Company’s stock options havebeen granted with exercise prices below the fair value of the Company’s commonstock. For these stock options, the Company has recorded deferred stock-basedcompensation for the difference between their exercise prices and such fairvalues which is being amortized to expense on a straight-line method over thestock option’s vesting period.

 

Compensation for equity instruments issued to non-employees has beendetermined in accordance with SFAS No. 123, Financial Accounting StandardsBoard (“FASB”) Interpretation No. 44, *Accountingfor Certain Transactions involving Stock Compensation*, and the EITFconsensus on Issue 96-18, *Accounting forEquity Instruments That Are Issued to Other Than Employees for Acquiring or inConjunction with Selling Goods or Services*, as the fair value of theconsideration received or the fair value of the equity instruments issued,whichever is more reliably measured.

 

Pro forma information regarding net loss is required by SFASNo. 123 and SFAS No. 148, *Accountingfor Stock-Based Compensation—Transition and Disclosure*, and has beendetermined as if the Company had accounted for its employee stock options underthe fair value method.

 

Future pro forma results of operations under SFAS No. 123 may bematerially different from actual amounts reported. For purposes of pro formadisclosures, the estimated fair value of the options is amortized to expenseover the vesting period. The Company has used the minimum value method todetermine the fair value of options granted prior to its initial publicoffering. This method does not consider the expected volatility of theunderlying stock, and is only available to non-public entities. Accordingly,the Company has used an estimated volatility factor of 80% throughDecember 31, 2003.

 

8

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The following table illustrates the effect on net losses if the Companyhad applied the fair value recognition provisions of SFAS No. 123 tostock-based compensation:

 

 
|                                                                                                         |   | **Three  months ended June 30,** |   | **Six months  ended June 30,** |   |
|--------------------------------------------------------------------------------------------------------------|--------|---------------------------------------|--------|-------------------------------------|--------|
|                                                                                                         |   | **2004**                              |   | **2003**                            |   | **2004** |   | **2003** |   |
|                                                                                                         |   | **(unaudited)**                       |   | **(unaudited)**                     |   |
| Net loss—as reported                                                                                    |   | $                                     | (4,156 | )                                   | $      | (2,236 | ) | $ | (8,909 | ) | $ | (4,654 | ) |
| Add: Stock-based employee compensation  expense included in reported net loss                                |   | 1,169                                 |   | 508                                 |   | 2,313 |   | 882 |   |
| Less: Total stock-based employee  compensation expense determined under the fair value method for all awards |   | (1,455                                | )      | (735                                | )      | (2,841 | ) | (1,434 | ) |
| Pro forma net loss                                                                                           |   | $                                     | (4,442 | )                                   | $      | (2,463 | ) | $ | (9,437 | ) | $ | (5,206 | ) |
|                                                                                                         |   |                                  |   |                                |   |   |   |   |   |
| Net loss per share:                                                                                          |   |                                  |   |                                |   |   |   |   |   |
| Basic and diluted—as reported                                                                           |   | $                                     | (0.17  | )                                   | $      | (0.24 | ) | $ | (0.38 | ) | $ | (0.52 | ) |
|                                                                                                         |   |                                  |   |                                |   |   |   |   |   |
| Basic and diluted—pro forma                                                                             |   | $                                     | (0.19  | )                                   | $      | (0.26 | ) | $ | (0.41 | ) | $ | (0.58 | ) |

 

***ComprehensiveIncome (Loss)***

 

Comprehensive loss is the total of net loss and all other non-ownerchanges in stockholders’ equity. The Company’s other comprehensive income(loss) consists of unrealized gains or losses on available-for-saleinvestments. The components of comprehensive income (loss) are as follows:

 
|                                             |   | **Three  months ended June 30,** |   | **Six months  ended June 30,** |   |
|--------------------------------------------------|--------|---------------------------------------|--------|-------------------------------------|--------|
|                                             |   | **2004**                              |   | **2003**                            |   | **2004** |   | **2003** |   |
|                                             |   | **(unaudited)**                       |   | **(unaudited)**                     |   |
| Net loss                                         |   | $                                     | (4,156 | )                                   | $      | (2,236 | ) | $ | (8,909 | ) | $ | (4,654 | ) |
| Other comprehensive income (loss)                |   |                                  |   |                                |   |   |   |   |   |
| Change in unrealized gain (loss) on  investments |   | 182                                   |   | 0                                   |   | 208 |   | 1 |   |
| Total comprehensive income (loss)                |   | $                                     | (3,974 | )                                   | $      | (2,236 | ) | $ | (8,701 | ) | $ | (4,653 | ) |

 

***NetLoss Per Share***

 

In accordance with SFAS No. 128, *EarningsPer Share*, basic net loss per common share is computed by dividingthe net loss for the period by the weighted average number of common sharesoutstanding during the period. Potentially dilutive securities are notconsidered in the calculation of net loss per common share as their inclusionswould be anti-dilutive.

 

In accordance with SAB No. 98, common shares issued for nominalconsideration, if any, would be included in the per share calculations as ifthey were outstanding for all periods presented. No common shares have been issuedfor nominal consideration.

 

9

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A reconciliation of the numerator and denominator used in thecalculation of basic and diluted net loss per share is as follows:

 
|                                                 |   | **Three  months ended June 30,** |   | **Six months  ended June 30,** |   |
|------------------------------------------------------|--------|---------------------------------------|--------|-------------------------------------|--------|
|                                                 |   | **2004**                              |   | **2003**                            |   | **2004** |   | **2003** |   |
|                                                 |   | **(unaudited)**                       |   | **(unaudited)**                     |   |
| Numerator                                            |   |                                  |   |                                |   |   |   |   |   |
| Net loss                                             |   | $                                     | (4,156 | )                                   | $      | (2,236 | ) | $ | (8,909 | ) | $ | (4,654 | ) |
| Denominator                                          |   |                                  |   |                                |   |   |   |   |   |
| Basic and diluted:                                   |   |                                  |   |                                |   |   |   |   |   |
| Weighted average common shares outstanding           |   | 24,893,157                            |   | 12,818,632                          |   | 24,389,966 |   | 12,786,490 |   |
| Less: Weighted average shares subject to  repurchase |   | (1,012,800                            | )      | (3,445,871                          | )      | (1,213,845 | ) | (3,834,064 | ) |
|                                                 |   |                                  |   |                                |   |   |   |   |   |
| Denominator on basic calculation                     |   | 23,880,357                            |   | 9,372,761                           |   | 23,176,121 |   | 8,952,426 |   |
|                                                 |   |                                  |   |                                |   |   |   |   |   |
| Basic and diluted net loss per share                 |   | $                                     | (0.17  | )                                   | $      | (0.24 | ) | $ | (0.38 | ) | $ | (0.52 | ) |

 

The following table summarizes potential common shares that are notincluded in the denominator used in the diluted net loss per share calculationbecause to do so would be antidilutive:

 
|                               |   | **June 30,** |   |
|------------------------------------|--------|-------------------|--------|
| **Common Stock Equivalents**       |   | **2004**          |   | **2003** |   |
|                               |   | **(unaudited)**   |   |
| Common stock subject to repurchase |   | 507,526           |   | 3,273,960 |   |
| Options to purchase common stock   |   | 3,062,571         |   | 1,880,618 |   |
| Warrants to purchase common stock  |   | 20,000            |   | — |   |
| Convertible preferred stock        |   | —            |   | 4,518,331 |   |
|                               |   | 3,590,097         |   | 9,672,909 |   |

 

***SegmentInformation***

 

The Company adopted the provisions of SFAS No. 131, *Disclosures about Segments of an Enterprise andRelated Information*. SFAS 131 requires public companies toreport financial and descriptive information about their reportable operatingsegments. The Company identifies its operating segments based on how managementinternally evaluates separate financial information, business activities andmanagement responsibility. The Company believes it operates in a singlebusiness segment and adoption of this standard did not have a material impacton the Company’s financial statements.

 

***Contingent Consideration***

 

Inconnection with certain of the Company’s acquisitions, if certain futureinternal performance goals are achieved, the aggregate consideration for therespective acquisition can be increased. Such additional consideration, ifearned, will be paid in the form of additional shares of the Company’s commonstock, which were issued and held in escrow for that purpose. Any additionalconsideration paid will be allocated between goodwill, stock-based compensationexpense and deferred compensation. The measurement, recognition and allocationof contingent consideration are accounted for using the principles outlinedbelow.

 

***Measurement andRecognition***

 

Inaccordance with SFAS No. 141, *BusinessCombinations*(“SFAS 141”) which superceded APB No. 16, *Business Combinations*(“APB 16”) asof July 1, 2001, contingent consideration is recorded when a contingencyis satisfied and additional consideration is issued or becomes issuable. TheCompany records the additional consideration issued or issuable in connectionwith the relevant acquisition when a specified internal performance goal is metor becomes probable. For additional consideration paid in stock, the Companycalculates the amount of additional consideration using the closing price ofits common stock on the date the performance goal is satisfied.

 

10

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## ***AmountAllocated to Goodwill***

 

Inaccordance with EITF No. 95-8, *Accountingfor Contingent Consideration Paid to the Shareholders of an Acquired Enterprisein a Purchase Business Combination*(“EITF 95-8”) and FIN 44,the portion of additional consideration issuable to holders of unrestrictedcommon stock and fully vested options as of the acquisition date is recorded asadditional purchase price, as the consideration is unrelated to continuingemployment with the Company. Such portion is allocated to goodwill.

 

***Amount Allocated toStock-Based Compensation Expense***

 

Inaccordance with EITF 95-8, the intrinsic value associated with additionalconsideration related to stock or options that vest between the acquisitiondate and the date at which the contingency is satisfied is recorded as animmediate charge to stock-based compensation expense because the considerationis related to continuing employment with the Company.

 

**2. Acquisitions**

 

### ***Prospect Information Network, LLC***

 

In February 2004, the Company completed the acquisition of PIN, aprovider of software, services and data for data screening services fornonprofit organizations. PIN’s services enable fundraisers to more efficientlyidentify, profile, monitor and rank the wealth of prospects in theirdatabase.  As consideration for all ofthe membership interests of PIN, the Company issued approximately 219,000shares of restricted common stock.  Up to336,000 additional shares of common stock are being held in escrow and will bereleased to the members of PIN if the revenue generated from PIN’s businessduring the year following the closing of the transaction meets certaintargets.  In addition, some of theshares issued to the PIN members are being held in escrow to secure the obligationsof PIN and its members under the purchase agreement.

 

#### ***Carol/TrevelyanStrategy Group***

 

In March 2004, the Company completed the acquisition of CTSG, aprovider of online advocacy solutions. CTSG’s services enable customers to meld offline and online strategiesand tools to build membership, affinity and impact for nonprofit organizations,political campaigns and unions.  TheCompany issued approximately 331,000 shares of restricted common stock and $250in cash to acquire CTSG.  Up to 93,000additional shares of common stock are being held in escrow and will be releasedif the revenue generated from CTSG’s business during the year following theclosing of the transaction meets certain targets.  In addition, some of the shares issued are being held in escrowto secure the obligations of CTSG and its stockholders.

 

#### ***BNW, Inc.***

 

In June 2004, the Company completed the acquisition of BNW, Inc.(“BNW”), a provider of recreational/athletic facilities management software.  BNW’s services were designed specifically for colleges, universities andcommunity centers like the YMCA.  The Company issued approximately 22,000shares of restricted common stock and $281 in cash to acquire BNW.  Up to105,000 additional shares of common stock are being held in escrow and will bereleased if the revenue generated from BNW’s business during the year followingthe closing of the transaction meets certain targets.  In addition, someof the shares issued are being held in escrow to secure the obligations of BNWand its stockholders.

 

The aggregate purchase price for PIN of $3,275 plus acquisition costsof $296, the aggregate purchase price for CTSG of $5,274, plus acquisitioncosts of $315 and the aggregate purchase price for BNW of $520, plus estimatedacquisition costs of $100, were preliminarily allocated as follows:

 
|                        |   | **PIN**         |   | **CTSG** |   | **BNW** |   |
|-----------------------------|--------|-----------------|--------|----------|--------|---------|--------|
|                        |   | **(unaudited)** |   |
| Current assets              |   | $               | 1,052  |     | $      | 1,475   |   | $ | 199 |   |
| Fixed assets                |   | 51              |   | 186      |   | 72      |   |
| Intangible assets           |   | 2,372           |   | 327      |   | 417     |   |
| Goodwill                    |   | 1,480           |   | 479      |   | 100     |   |
| Other assets                |   | 74              |   | 45       |   | —  |   |
| Total assets acquired       |   | 5,029           |   | 2,512    |   | 788     |   |
| Current liabilities assumed |   | (2,658          | )      | (691     | )      | (332    | )      |
| Deferred compensation       |   | 1,200           |   | 3,768    |   | 164     |   |
| Net assets acquired         |   | $               | 3,571  |     | $      | 5,589   |   | $ | 620 |   |

 

11

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The acquired intangible assets represent the customer bases of PIN,CTSG and BNW and were assigned an estimated useful life of five years foramortization purposes. The Company is performing a purchase price allocationstudies that are expected to be completed by the end of 2004. Differencesbetween the initial purchase price allocation and the final purchase priceallocation will primarily be related to the distribution between intangibleassets and goodwill of the excess purchase price over net tangible assetsacquired.

 

***UnauditedPro Forma Information***

 

The unaudited pro forma information for the six months endedJune 30, 2004 and the year ended December 31, 2003 assumes theacquisitions were consummated on January 1, 2003.

 

 
|                                 |   | **Six months  ended June,  2004** |   | **Year ended  December 31, 2003** |   |
|--------------------------------------|--------|-----------------------------------|--------|----------------------------------------|--------|
|                                 |   | **(unaudited)**                   |   |
|                                 |   |                              |   |                                   |   |
| Net revenues                         |   | $                                 | 10,941 |                                   | $      | 20,403 |   |
| Net loss                             |   | $                                 | (9,724 | )                                      | $      | (10,260 | ) |
| Net loss per share-basic and diluted |   | $                                 | (0.42  | )                                      | $      | (0.99 | ) |

 

These results give effect to the pro forma adjustments for theamortization of acquired intangible assets and the amortization of deferredcompensation. In addition, the common stock used as consideration for theacquisitions is presented as being outstanding during the entire period.

 

**3. Legal Proceedings**

 

In priorperiodic reports the Company disclosed that on February 11, 2002, theCompany filed a complaint against Convio, Inc., in the United States DistrictCourt for the Southern District of California and that Convio subsequentlyserved the Company with an answer and counterclaim.  On April 15, 2004, the Company entered into aconfidential settlement agreement with Convio. The settlement will not have a material effect on the Company’sbusiness, operating results or financial condition.

 

In addition to the foregoingmatters, from time to time, the Company may become involved in various lawsuitsand legal proceedings which arise in the ordinary course of business. However,litigation is subject to inherent uncertainties, and an adverse result in theseor other matters may arise from time to time that may harm business. TheCompany is not currently aware of any such legal proceedings or claims that theCompany believes will have, individually or in the aggregate, a materialadverse affect on the Company’s business, financial condition or operatingresults.

 

**4. Recent Events**

 

OnJuly 12, 2004, the Company sold 2,500,000 shares of its common stock in aprivate placement at a price of $8.00 per share for net proceeds ofapproximately $18.8 million.

 

On August 12, 2004, the company announced it signed a letter ofintent to acquire Kamtech Information Systems, a provider of wealth screeningservices.

 

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**Item 2. Management’s Discussion and Analysisof Financial Condition and Results of Operations**

 

*This report contains forward-lookingstatements. These statements relate to future events or our future financialperformance. In some cases, you can identify forward-looking statements byterminology such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,”“believe,” “estimate,” “predict,” “potential” or “continue,” the negative ofsuch terms or other comparable terminology. These statements are onlypredictions. Actual events or results may differ materially.*

 

*Although we believe that the expectationsreflected in the forward-looking statements are reasonable, we cannot guaranteefuture results, levels of activity, performance or achievements. Moreover,neither we, nor any other person, assume responsibility for the accuracy andcompleteness of the forward-looking statements. We are under no obligation toupdate any of the forward-looking statements after the filing of this QuarterlyReport on Form 10-Q to conform such statements to actual results or to changesin our expectations.*

 

*The following discussion should be read inconjunction with our consolidated financial statements and the related notesand other financial information appearing elsewhere in this Form 10-Q. Readersare also urged to carefully review and consider the various disclosures made byus which attempt to advise interested parties of the factors which affect ourbusiness, including without limitation the disclosures made under the caption“Management’s Discussion and Analysis of Financial Condition and Results of Operations,”under the caption “Risk Factors,” and the audited consolidated financialstatements and related notes included in our Annual Report filed on Form 10-Kfor the year ended December 31, 2003 and other reports and filings madewith the Securities and Exchange Commission.*

 

**Overview**

 

We are an innovative provider of software that enables nonprofitorganizations to use the Internet to increase donations, reduce fundraisingcosts and build awareness and affinity for an organization’s cause by bringingtheir employees, volunteers and donors together in online, interactivecommunities. Our flagship product, Kintera Sphere, is managed as a singlesystem and offered as a service accessed with a web browser. We wereincorporated in the State of Delaware in February 2000 and launched ourservice in the first quarter of 2001. Nonprofit organizations pay Kinteraservice fees for access to Kintera Sphere and transaction-based fees tied tothe donations and purchases.

 

Since inception, we have significantly increased our revenues through acombination of factors, including obtaining new customers, expanding existingcustomer relationships, acquiring complementary businesses, expanding thefeatures of Kintera Sphere and increasing the number and amount of donations weprocess that result in transaction-based fees. Although our revenues haveincreased substantially in recent periods, we have experienced significant netlosses and negative cash flows from operations in each fiscal period sinceinception, and as of June 30, 2004, we had an accumulated deficit of$42.7 million.

 

We have derived the substantial majority of our historical revenuesfrom fees paid by nonprofit organizations related to their use of KinteraSphere. The fees we receive for Kintera Sphere include upfront and monthlyservice fees that nonprofit organizations pay for access to Kintera Sphere aswell as transaction-based fees tied to donations and purchases we process. Wealso derive advertising and subscription revenue from the placement ofadvertisements in and the sale of subscriptions to our Masterplanner print andonline calendar publications in New York, Los Angeles, and San Diego. Weanticipate that revenues related to Masterplanner will account for asubstantially smaller portion of our revenues in future periods.

 

We derive a significant amount of our revenues from upfront servicefees for Sphere, which are deferred and recognized as revenue over the entireterm of our contracts. Conversely, we recognize the operating expensesassociated with generation of revenues from upfront service fees as they areincurred. Our operating expenses continue to increase as we expand our sellingand marketing efforts and administrative infrastructure to support increasedsales that we will recognize as revenue in subsequent periods. We anticipatethat our operating expenses will continue to grow in the near term. As aresult, because of the deferral of recognition of a portion of our revenues,our revenues and operating results will not increase at the same rate as ouroperating expenses incurred to support revenue recognized in future periods.

 

We currently market Kintera Sphere through a direct sales force thatincludes personnel located in our corporate headquarters and throughout theUnited States. To date, we have signed contracts with over 500 nonprofitorganizations, some of which have hundreds of individual chapters or divisions.Our customers include health organizations, educational institutions, religiousinstitutions, professional associations, political organizations, civicorganizations and other charities, at both a local and national level. Weexpect that a small group of nonprofit organizations in each fiscal periodgenerally will account for a large portion of our revenues. The significance ofa particular customer or group of customers in a given period will depend onthe nature and size of their fundraising events in that period as well as thescope of their use of Kintera Sphere. To continue our revenue growth, we mustboth obtain new customers and expand our existing customer relationshipsthrough usage of Kintera Sphere for new campaigns.

 

13

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In February 2004, we completed the acquisition of ProspectInformation Network, LLC (PIN), a provider of software, services and data fordata screening services for nonprofit organizations. PIN’s services enablefundraisers to more efficiently identify, profile, monitor and rank the wealthof prospects in their database. As consideration for all of the membershipinterests of PIN, we issued approximately 219,000 shares of common stock. Up to336,000 additional shares of common stock are being held in escrow to themembers of PIN if the revenue generated from PIN’s business during the yearfollowing the closing of the transaction meets certain targets. In addition,some of the shares issued to the PIN members are being held in escrow to securethe obligations of PIN and its members under the purchase agreement.

 

In March 2004, we completed the acquisition of Carol/TrevelyanStrategy Group (CTSG), a provider of online advocacy solutions. CTSG’s servicesenable customers to meld offline and online strategies and tools to buildmembership, affinity and impact for nonprofit organizations, politicalcampaigns and unions. We issued approximately 331,000 shares of common stockand paid $250,000 to acquire CTSG. Up to 93,000 additional shares of commonstock are being held in escrow if the revenue generated from CTSG’s businessduring the year following the closing of the transaction meets certain targets.In addition, some of the shares issued are being held in escrow to secure theobligations of CTSG and its stockholders.

 

In June 2004, we completed the acquisition of BNW, Inc. (“BNW”), aprovider of recreational/athletic facilities management software.   BNW’sservices were designed specifically for colleges, universities and communitycenters like the YMCA.  We issued approximately 22,000 shares ofrestricted common stock and $281,000 in cash to acquire BNW.  Up to 105,000additional shares of common stock are being held in escrow if the revenuegenerated from BNW’s business during the year following the closing of thetransaction meets certain targets.  Some of the shares issued are beingheld in escrow to secure the obligations of BNW and its stockholders.

 

**Cost of Revenues and Operating Expenses**

 

Cost of revenues consists primarily of salaries, benefits and relatedexpenses of operations and database support personnel, depreciation allocationsand communications charges associated with the delivery of our software as aservice. Our operating expenses are classified into four categories: sales andmarketing, product development and support, general and administrative andstock-based compensation. We allocate the costs of overhead and facilities toeach of the functional areas that use the overhead and facilities servicesbased on their headcount. These allocated charges include facilities rent forcorporate offices, communication charges and depreciation expenses for officefurniture and equipment.

 

Sales and marketing expenses consist primarily of salaries,commissions, benefits and related expenses of personnel engaged in selling,marketing and customer support functions as well as public relations,advertising and promotional costs. As we expand our sales and marketing force,we expect sales and marketing expenses to increase due to new personnelexpenses in future periods.

 

Product development and support expenses consist primarily of salariesand benefits and related expenses for engineers, developers and qualityassurance personnel as well as facilities and depreciation allocation.  We expect to continue to devote substantialresources to product development and support such that these expenses willincrease in absolute dollars.

 

General and administrative expenses consist primarily of salaries,benefits and related expenses for our executive, accounting, and administrativepersonnel, third party professional service fees and allocated facilities anddepreciation expenses. We expect general and administrative expenses toincrease in the future, reflecting growth in our operations, increased expensesassociated with being a public company and other factors.

 

We had 289 employees as of June 30, 2004 and intend to hire a significantnumber of employees in the future. This expansion will likely place significantdemands on our management and operational resources. To manage rapid growth andincreased customer demand for our service, we must continue to invest in andimplement additional operational systems, procedures and controls.

 

**Application of Critical Accounting Policies**

 

Our discussion and analysis of our financial condition and results ofoperations are based upon our financial statements, which have been prepared inaccordance with accounting principles generally accepted in the United States.The preparation of these financial statements requires us to make estimates andjudgments that affect the reported amounts of assets, liabilities, revenues andexpenses, and related disclosure of contingent assets and liabilities. On anon-going basis, we evaluate these estimates, including those related to theallowance for doubtful accounts, intangible assets, income taxes, commitmentsand accrued liabilities. We base our estimates on historical experience and onvarious other assumptions that are believed to be reasonable under thecircumstances, the results of which form the basis for making judgments aboutthe carrying values of assets and liabilities that are not readily apparent 

 

14

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from other sources. Actual results may differ from these estimatesunder different assumptions or conditions.

 

We consider the following accounting policies to be both those mostimportant to the portrayal of our financial condition and those that requirethe most subjective judgment:

 

•                       revenuerecognition;

 

•                       accountingfor goodwill and other intangible assets;

 

•                       accountingfor software development costs;

 

•                       accountingfor stock-based compensation; and

 

•                       accountingfor income taxes.

 

You should refer to our Annual Report on Form 10-K for the year endedDecember 31, 2003 filed on March 30, 2004 for a discussionof our policies on revenue recognition, accounting for goodwill and otherintangible assets, accounting for stock-based compensation and accounting forincome taxes.  See note 1 to ourcondensed consolidated financial statements included in this Quarterly Reporton Form 10-Q for an updated discussion of our revenue recognition and softwaredevelopment cost policies.

 

**Results of Operations**

 

***Comparison ofResults for the Three Months Ended June 30, 2004 to the Three Months EndedJune 30, 2003 and for the Six Months Ended June 30, 2004 to the SixMonths Ended June 30, 2003***

 

*Revenues*. Revenue increased from $1.8 millionfor the three months ended June 30, 2003 to $5.9 million for the threemonths ended June 30, 2004.  Revenue increased from $2.9 million for the six months endedJune 30, 2003 to $9.0 million for the six months ended June 30,2004.The revenues for each of these periods were as follows:

 

 
|                                 |   | **For the  three months ended June 30,** |      | **For the  six months ended June 30,** |   |
|--------------------------------------|--------|-----------------------------------------------|-----------|---------------------------------------------|--------|
|                                 |   | **2004**                                      |      | **2003**                                    |   | **2004** |   | **2003** |   |
|                                 |   |                                          |      |                                        |   |   |   |   |   |
| Transaction and data processing fees |   | $                                             | 2,618,000 |                                        | $      | 1,093,000 |   | $ | 3,998,000 |   | $ | 1,822,000 |   |
| Monthly service fees                 |   | 2,474,000                                     |      | 519,000                                     |   | 3,417,000 |   | 911,000 |   |
| Amortization of upfront fees         |   | 801,000                                       |      | 140,000                                     |   | 1,549,000 |   | 212,000 |   |
|                                 |   |                                          |      |                                        |   |   |   |   |   |
| Total                                |   | $                                             | 5,893,000 |                                        | $      | 1,752,000 |   | $ | 8,964,000 |   | $ | 2,945,000 |   |

 

The increase in revenue from 2003 to 2004 was due to a number offactors, including an increase in transaction fees and data purchases(approximately $1.5 million for the three months ended June 30, 2004 andapproximately $2.2 million for the six months ended June 30, 2004), monthlyservice fees (approximately $2.0 million for the three months endedJune 30, 2004 and approximately $2.5 million for the six months endedJune 30, 2004), and amortization of upfront fees (approximately $0.7million for the three months ended June 30, 2004 and approximately $1.3million for the six months ended June 30, 2004).

 

Theincrease in transaction and data processing fees resulted from highertransaction processing volumes for both the three and six months endedJune 30, 2004 compared to the three and six months ended June 30,2003, as well as the inclusion of data processing fee revenue in 2004 due tothe acquisition of PIN in February 2004. The increase in monthly servicefees and amortization of upfront fees for the three and six months ended June 30,2004 compared to the three and six months ended June 30, 2003 was due tothe addition of new customers, the increase in the scope of services fromexisting customers and the acquisition of CTSG in March 2004.

 

*Cost of Revenues*. Cost of revenues increasedfrom $0.3 million for the three months ended June 30, 2003 to $1.2 millionfor the three months ended June 30, 2004. Cost of revenues increased from $0.6 million for the six months endedJune 30, 2003 to $1.8 million for the six months ended June 30,2004   These increases were dueprimarily to expenses incurred to service customer and revenue growth.

 

*Sales and Marketing.*Salesand marketing expenses increased from $1.9 million for the three monthsended June 30, 2003 to $3.8 million for the three months endedJune 30, 2004.  Sales and marketingexpenses increased from $3.7 million for the six months

 

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ended June 30, 2003 to $6.8 million for the six months endedJune 30, 2004.  The increase wasdue primarily to the expansion of our sales force and customer support staff,both internally and from acquisitions (approximately $1.0 million for the threemonths ended June 30, 2004 and approximately $2.1 million for the sixmonths ended June 30, 2004), amortization of intangible assets relating toacquisitions (approximately $0.4 million for the three months endedJune 30, 2004 and approximately $0.4 million for the six months endedJune 30, 2004) and increased travel, advertising, telephone and consulting(approximately $0.5 million for the three months ended June 30, 2004 andapproximately $0.6 million for the six months ended June 30, 2004).

 

*Product Development and Support.*Productdevelopment and support expenses increased from $0.8 million for the threemonths ended June 30, 2003 to $2.1 million for the three months endedJune 30, 2004.  Product developmentand support expenses increased from $1.6 million for the six months endedJune 30, 2003 to $3.7 million for the six months ended June 30,2004. These increases were primarily due to expenses related to increasedheadcount, both internally and from acquisitions, to support the development,enhancement and integration of Kintera Sphere. Costs of approximately $154,000 related to the integration of acquiredproducts into Kintera Sphere is included in product development and support forthe three months ended June 30, 2004.

 

*General and Administrative.*Generaland administrative expenses increased from $0.5 million for the three monthsended June 30, 2003 to $1.9 million for the three months endedJune 30, 2004.  General andadministrative expenses increased from $0.9 million for the six months endedJune 30, 2003 to $3.5 million for the six months ended June 30,2004.  These increases were dueprimarily to increased staffing and costs from the Company’s growth and costsrelated to being a public company including the implementation ofSection 404 of the Sarbanes Oxley Act.

 

*Stock-based Compensation.*  Stock-based compensation increased from $0.5million for the three months ended June 30, 2003 to $1.2 million for thethree months ended June 30, 2004. Stock-based compensation increased from $0.9 million for the six monthsended June 30, 2003 to $2.3 million for the six months ended June 30,2004.  These increases were due to theamortization of deferred compensation expense from stock issuances inacquisitions and additional stock option grants to new and existing employeesprior to our initial public offering in 2003.

 

**Liquidity and Capital Resources**

 

We have historically funded our operations principally through privateplacements of equity securities. In December 2003, we completed ourinitial public offering and received net proceeds of $36.1 million,including $4.9 million from the exercise of the underwriters’ overallotment option.  As of June 30,2004, we had cash, cash equivalents and short-term investments totalingapproximately $29.6 million.   InJuly 2004, we completed a sale of stock in a private placement, whichprovided us with approximately $18.8 million in cash, net of transaction fees.

 

Net cash used in operating activities was $3.0 million and $6.6 millionfor the six months ended June 30, 2003 and June 30, 2004,respectively.   In 2003, this wasprimarily the result of the net loss ($4.7 million), partially offset bychanges in operating assets and liabilities (approximately $0.3 million) andnon-cash expenses (approximately $1.5 million) consisting primarily ofamortization of deferred compensation and intangible assets and depreciation.  In 2004, this was primarily the result ofthe net loss ($8.9 million) and changes in operating assets and liabilities(approximately $1.1 million), partially offset by non-cash expenses(approximately $3.4 million) consisting primarily of amortization of deferredcompensation, software development costs and intangible assets anddepreciation.

 

Net cash provided by investing activities was $1.6 million for the sixmonths ended June 30, 2003.  Thiswas primarily the result of the sale of marketable securities (approximately$2.0 million) partially offset by purchases of property and equipment(approximately $0.1 million) and acquisition and other costs(approximately $0.3 million).

 

Net cash used in investing activities was $23.0 million for the sixmonths ended June 30, 2004. This was primarily the result of the purchaseof marketable securities (approximately $24.3 million), purchases of propertyand equipment (approximately $1.3 million) and acquisition and other costs(approximately $1.1 million) offset by the sale of marketable securities(approximately $3.7 million).

 

Net cash provided by financing activities was $2.8 million for the sixmonths ended June 30, 2003 was primarily from sale of preferred stock.

 

Net cash used for financing activities was relatively unchanged for thesix months ended June 30, 2004. Net cash used for financing activities forthe six months ended June 30, 2004 was primarily for the payment of theline of credit and issuance costs for common stock (approximately $0.5 million)and was offset primarily from sale of our stock in our Employee Stock PurchasePlan and from exercise of stock options (approximately $0.5 million).

 

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We believe that our cash, cash equivalents and short-term investmentsand available borrowings under our line of credit that we may draw from time totime will be sufficient to meet our working capital requirements andcontractual commitments for at least the next 12 months.

 

If we are unable to increase our revenues, we will need to raiseadditional funds to finance our future capital needs. We may need additionalfinancing earlier than we anticipate. If we raise additional funds through thesale of equity or convertible debt securities, these transactions may dilutethe value of our outstanding common stock. We may also decide to issuesecurities, including debt securities, which have rights, preferences andprivileges senior to our common stock. We cannot assure you that we will beable to raise additional funds on terms favorable to us or at all. If futurefinancing is not available or is not available on acceptable terms, we may notbe able to fund our future needs. This may prevent us from increasing ourmarket share, capitalizing on new business opportunities or remainingcompetitive in our industry.

 

We currently do not have any variable interest entities. We do not haveany relationships with unconsolidated entities or financial partnerships, suchas entities often referred to as structured finance or special purposeentities, which would have been established for the purpose of facilitatingoff-balance sheet arrangements or other contractually narrow or limitedpurposes. We are, therefore, not materially exposed to any financing,liquidity, market or credit risk that could arise if we had engaged in suchrelationships.

 

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**RISK FACTORS**

 

You should consider each of the following factors as well as the otherinformation in this Quarterly Report in evaluating our business and ourprospects. The risks and uncertainties described below are not the only ones weface. Additional risks and uncertainties not presently known to us or that wecurrently consider immaterial may also impair our business operations. If any ofthe following risks actually occur, our business and financial results could beharmed. In that case, the trading price of our common stock could decline. Youshould also refer to the other information set forth in this Quarterly Report,including our unaudited financial statements and the related notes.

 

***Because we have alimited operating history, it is difficult to evaluate our prospects.***

 

We incorporated in February 2000 and first achieved meaningfulrevenues in 2001. As a result, we will encounter risks and difficultiesfrequently encountered by early-stage companies in new and rapidly evolvingmarkets. These risks include the following:

 

•                  we may notincrease our sales to our existing customers and expand our customer base;

 

•                  fees related toKintera Sphere have been our principal source of revenues, and we may notsuccessfully introduce new services and enhance existing services of KinteraSphere;

 

•                  we may notsuccessfully expand our sales and marketing efforts;

 

•                  we may notattract and retain key sales, technical and management personnel; and

 

•                  we may noteffectively manage our anticipated growth.

 

In addition, because of our limited operating history and the earlystage of the market for online fundraising solutions, we have limited insightinto trends that may emerge and affect our business.

 

***We have a history oflosses, and we may not achieve or maintain profitability.***

 

We have experienced operating and net losses in each fiscal quartersince our inception, and as of June 30, 2004, we had an accumulateddeficit of $42.7 million. We incurred net losses of $4.2 million forthe three months ended June 30, 2004 and $2.2 million for the threemonths ended June 30, 2003. We incurred net losses of $8.9 millionfor the six months ended June 30, 2004 and $4.7 million for the sixmonths ended June 30, 2003.  Wewill need to increase revenues to achieve profitability, and we may not be ableto do so. Even if we do achieve profitability, we may not be able to sustain orincrease profitability on a quarterly or annual basis in the future. We alsomay fail to accurately estimate our increased operating expenses as we grow. Ifour operating expenses exceed our expectations, our financial performance willbe adversely affected.

 

***Recent acquisitionsand future acquisitions could prove difficult to integrate, disrupt ourbusiness, dilute stockholder value and strain our resources, which couldprevent us from properly servicing and maintaining customer relationships.***

 

Acquisitions have been an important part of our development to date. Werecently completed five acquisitions of complementary businesses—LittleTornadoes, VirtualSprockets, Prospect Information Network, Carol/TrevelyanStrategy Group (“CTSG”) and BNW, Inc. We are in the process of integratingtheir operations with ours and finalizing the purchase price allocation forProspect Information Network and CTSG, and BNW, Inc. We cannot assure you thatwe will succeed in completing these integration efforts on a timely basis, orat all. As part of our business strategy, we may continue to seek to acquirecompanies, services and technologies that we feel could complement or expandour business, augment our market coverage, enhance our technical capabilities,provide us with important customer contacts or otherwise offer growthopportunities. Acquisitions and investments involve numerous risks, including:

 

•                  difficulties inintegrating operations, technologies, services, accounting and personnel;

 

•                  difficulties insupporting and transitioning customers of our acquired companies;

 

•                  diversion offinancial and management resources from existing operations;

 

•                  risks ofentering new sectors of the nonprofit industry;

 

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•                  potential lossof key employees; and

 

•                  inability togenerate sufficient revenues to offset acquisition or investment costs.

 

Acquisitions also frequently result in recording of goodwill and otherintangible assets which are subject to potential impairments in the future thatcould harm our operating results. In addition, if we finance acquisitions byissuing convertible debt or equity securities, our existing stockholders may bediluted which could affect the market price of our stock. As a result, if wefail to properly evaluate and execute acquisitions or investments, we may notachieve the anticipated benefits of any such acquisition, and we may incurcosts in excess of what we anticipate.

 

***Nonprofitorganizations have not traditionally used the Internet or online softwaresolutions, and they may not adopt our solution.***

 

The market for online fundraising solutions for nonprofit organizationsis new and emerging. Nonprofit organizations have not traditionally used theInternet or online software solutions for fundraising. We cannot be certainthat the market will continue to develop and grow or that nonprofitorganizations will elect to adopt our solution rather than continuing to usetraditional offline methods, attempting to develop software solutionsinternally or utilizing standardized software solutions without integratingthem. Nonprofit organizations that have already invested substantial resourcesin other fundraising methods may be reluctant to adopt a new approach like oursto supplement or replace their existing systems or methods. In addition, increasingconcerns about fraud, privacy, reliability and other problems may causenonprofit organizations not to adopt the Internet as a method for fundraising.We expect that we will continue to need to pursue intensive marketing and salesefforts to educate prospective nonprofit organization customers about the usesand benefits of our solution. If demand for and market acceptance of oursolution does not occur, we may not grow our business as we expect.

 

***If our efforts toincrease awareness of Kintera Sphere and expand sales to other sectors of thenonprofit industry do not succeed, our revenue may not increase as we expect.***

 

We have initially sold our Kintera Sphere solution to nonprofitorganizations in the health and human services sectors, in part because theyrely on special events for fundraising. Based on our experience, we believethat many nonprofit organizations in all nonprofit sectors are still unaware ofthe benefits that can be achieved through the use of Kintera Sphere. We intendto commit significant resources to promote awareness of Kintera Sphere, but wecannot assure you that we will be successful in this effort. Developing andmaintaining awareness of Kintera Sphere is important to our success. If we failto successfully promote Kintera Sphere, our financial condition could suffer.

 

We have also begun, and intend to continue, to market Kintera Sphere tononprofit organizations in additional nonprofit sectors. Organizations in theseother sectors may not rely on special events or be as willing to purchase oursolution as health and human services nonprofit organizations. If we are unableto increase awareness of Kintera Sphere and expand sales to other sectors ofthe nonprofit industry, our revenue may not increase as we expect.

 

***Sales cycles tomajor customers can be long, which makes it difficult to forecast our results.***

 

It typically takes us between three and nine months to complete a saleto a major customer account, but it can take us up to one year or longer. It istherefore difficult to predict the quarter in which a particular sale willoccur and to forecast our sales. The period between our initial contact with apotential customer and its purchase of Kintera Sphere is relatively long due toseveral factors, including:

 

•                  our need to educatepotential customers about the uses and benefits of Kintera Sphere;

 

•                  our customershave budget cycles which affect the timing of purchases; and

 

•                  many of ourcustomers have lengthy internal approval processes before purchasing ourservices.

 

Any delay or failure to complete sales in a particular quarter couldreduce our revenues in that quarter, as well as subsequent quarters over whichrevenues for the sale may be recognized. If our sales cycle unexpectedlylengthens in general or for one or more large orders, it would adversely affectthe timing of our revenues.

 

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***If we are not ableto manage our growth effectively, we may not become profitable.***

 

Since commencing operations in 2000, we have experienced significantgrowth, and we anticipate that significant expansion will continue to berequired to address potential market opportunities. We anticipate significantlyexpanding the size of our sales and marketing, product development and generaland administrative staff and operations, as well as our financial andaccounting controls. There can be no assurance that our infrastructure will besufficiently scalable to manage our projected growth. For example, ouranticipated growth will result in a significant increase in the volume oftransactions handled by our payment processing system. If we are unable tosufficiently enhance and improve this system to handle this increased volume,our profitability and growth may suffer. There also can be no assurance that ifwe continue to expand our operations, management will be effective in expandingour physical facilities or that our systems, procedures or controls will beadequate to support such expansion. Our inability to manage our growth may harmour business.

 

***Any failure tomanage and accurately account for large amounts of donations we process coulddiminish the use of Kintera Sphere, which may prevent or delay our becomingprofitable.***

 

Our ability to manage and account accurately for the online donationswe process requires a high level of internal controls. We have a limitedoperating history in maintaining these internal controls. As our businesscontinues to grow, we must monitor our internal controls to ensure they areeffective. Our success requires significant customer and donor confidence inour ability to handle large and growing donation volumes and amounts. Anyfailure to maintain necessary controls or to accurately manage online donationscould severely diminish nonprofit organizations’ and donors’ use of KinteraSphere.

 

***We may experiencecustomer dissatisfaction and lose sales if our solution does not scale toaccommodate a high volume of traffic and transactions.***

 

We seek to generate a high volume of traffic and transactions on thewebsites we host for our customers. A portion of our revenues depends on thenumber of donations raised by our customers using Kintera Sphere. Accordingly,the satisfactory performance, reliability and availability of our solution,including its processing systems and network infrastructure, are critical toour reputation and our ability to attract and retain new customers. Any systeminterruptions that result in the unavailability of our solution or reduceddonor activity would reduce the volume of donations and may also diminish theattractiveness of our solution to our customers. Furthermore, our inability toadd software and hardware or to develop and further upgrade our existingtechnology, payment processing systems or network infrastructure to accommodateincreased traffic or increased transaction volume may cause unanticipatedsystem disruptions, slower response times, degradation in levels of customerservice, impaired quality of the user’s experience, and delays in reportingaccurate financial information. There can be no assurance that we will be ableto effectively upgrade and expand our systems or to integrate smoothly any newtechnologies with our existing systems. Any inability to do so would have anadverse effect on our ability to maintain customer relationships and grow ourbusiness.

 

***We may not be ableto develop new enhancements to or support services for Kintera Sphere at a raterequired to achieve customer acceptance in our rapidly changing market.***

 

Although Kintera Sphere is designed to operate with a variety ofnetwork hardware and software platforms, we will need to continuously modifyand enhance Kintera Sphere to keep pace with changes in Internet-relatedhardware, software, communication, browser and database technologies. Ourfuture success depends on our ability to develop new enhancements to or supportservices for Kintera Sphere that keep pace with rapid technologicaldevelopments and that address the changing needs of our nonprofit customers. Wemay not be successful in either developing such services or introducing them tothe market in a timely manner. In addition, uncertainties about the timing andnature of new network platforms or technologies, or modifications to existingplatforms or technologies, could increase our development expenses. Any failureof our services to operate effectively with the existing and future networkplatforms and technologies could limit or reduce the market for our services,result in customer dissatisfaction or cause our revenue growth to suffer.

 

***If we are unable todetect and prevent unauthorized use of credit cards and bank account numbersand safeguard confidential donor data, our reputation may be harmed andcustomers may be reluctant to use our service.***

 

We rely on encryption and authentication technology to provide securetransmission of confidential information, including customer credit card andbank account numbers, and protect confidential donor data. Identity thieves andcriminals using stolen credit card or bank account numbers could still potentiallycircumvent our anti-fraud systems. Advances in computer capabilities, newdiscoveries in the field of cryptography, or other events or developments mayresult in a compromise or breach of the technology we use to protect sensitivetransaction data. If any such compromise of our security were to occur, itcould result in misappropriation of our proprietary information orinterruptions in our operations and have an adverse impact on our reputation.We may have to spend significant money and time protecting against suchsecurity breaches or alleviating problems caused by such breaches. If we are 

 

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unable to detect and prevent unauthorized use of credit cards and bankaccount numbers or protect confidential donor data, our business may suffer.

 

***If we were foundsubject to or in violation of any laws or regulations governing privacy orelectronic fund transfers, we could be subject to liability or forced to changeour business practices.***

 

It is possible that the payment processing component of Kintera Sphereis subject to various governmental regulations. In addition, we may be subjectto the privacy provisions of the Gramm-Leach-Bliley Act and relatedregulations. Pending legislation at the state and federal levels may alsorestrict further our information gathering and disclosure practices. Existingand potential future privacy laws may limit our ability to develop new productsand services that make use of data gathered through our service. The provisionsof these laws and related regulations are complicated, and we do not haveextensive experience with these laws and related regulations. Even technicalviolations of these laws can result in penalties that are assessed for eachnon-compliant transaction. Given the high volumes of transactions we process,if we were found to be subject to and in violation of any of these laws orregulations, our business would suffer and we would likely have to change ourbusiness practices. In addition, these laws and regulations could imposesignificant costs on us and make it more difficult for donors to make onlinedonations.

 

***System failure couldharm our reputation and reduce the use of Kintera Sphere by nonprofitorganizations, which could cause our revenues and operating results to decline.***

 

If nonprofit organizations believe Kintera Sphere to be unreliable,they will be unlikely to use Kintera Sphere which will harm our revenue andprofits. Our systems and operations are vulnerable to damage or interruptionfrom earthquakes, floods, fires, power loss, telecommunication failures,electronic virus or worm attacks and similar events. They also could be subjectto break-ins, sabotage and intentional acts of vandalism. Our businessinterruption insurance may not be sufficient to compensate us for losses thatmay occur. Despite any precautions we may take, the occurrence of a naturaldisaster or other unanticipated problems at our facilities could result ininterruptions in our services. Interruptions in our service could harm ourreputation and reduce our revenues and profits.

 

***Our operatingresults have fluctuated and may fluctuate significantly, and these fluctuationsmay cause our stock price to fall.***

 

Our operating results have varied significantly in the past and willlikely vary in the future as the result of fluctuations in our revenues andoperating expenses. For example, our revenues increased from $2.9 millionfor the six months ended June 30, 2003 to $9.0 million for the sixmonths ended June 30, 2004 and our net loss increased from$4.7 million for the six months ended June 30, 2003 to$8.9 million for the six months ended June 30, 2004. We expect thatour operating expenses may increase in the future as we expand our selling andmarketing activities and hire additional personnel. Our revenues in any perioddepend substantially on the number and size of donations that we process inthat period for customer sponsored fundraising events. As a result, it ispossible that in some future periods, our revenues may not meet ourexpectations or, due to our increased expense levels, our results of operationsmay be below the expectations of current or potential investors. If thisoccurs, the price of our common stock may decline.

 

***Because a limitednumber of our customers accounts for a substantial portion of our revenues, ourrevenues could decline if we lose a major customer.***

 

A significant portion of our revenue comes from a limited number ofcustomers. For example, 10 nonprofit organizations accounted for approximately30% of our total revenues for the three months endedJune 30, 2004.  We expect thata limited number of customers will continue to account for a substantialportion of our revenues in each fiscal period for the foreseeable future. As aresult, if we lose a major customer, if a major contract is delayed orcancelled or if a major anticipated sale is not made, our revenues coulddecline. In addition, customers that have accounted for significant revenue inthe past may not continue to generate revenue in any future period, dependingon the nature and size of their fundraising events in that period as well asthe scope of their use of Kintera Sphere.

 

***We are dependent onour management team, and the loss of any key member of this team may prevent usfrom achieving our business plan in a timely manner.***

 

Our success depends largely upon the continued services of ourexecutive officers and other key personnel. In particular, we rely onHarry E. Gruber, M.D., our President, Chief Executive Officer andChairman. We do not have employment agreements with our executive officers and,therefore, they could terminate their employment with us at any time withoutpenalty. We do not maintain key person life insurance policies on any of ouremployees. The loss of one or more of our key employees could seriously harmour business, results of operations and financial condition. We cannot assureyou that in such an event we would be able to recruit personnel to replacethese individuals in a timely manner, or at all, on acceptable terms.

 

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***Because competitionfor highly qualified sales and software development personnel is intense, wemay not be able to attract and retain the employees we need to support ourplanned growth.***

 

To execute our growth plan, we need to significantly increase the sizeof our sales force and software development staff. To successfully meet ourobjectives, we must attract and retain highly qualified sales and softwaredevelopment personnel with specialized skill sets focused on the nonprofitindustry. Competition for qualified sales and software development personnelcan be intense, and we cannot assure you that we will be successful inattracting and retaining them. The pool of qualified personnel with experienceworking with or selling to non-profit organizations is limited. Our ability toexpand our sales team will depend on our ability to recruit, train and retaintop quality people with advanced skills who understand sales to nonprofitorganizations. Because the sale of online fund raising solutions is stillrelatively new, there is a shortage of sales personnel with the experience weneed. We have from time to time in the past experienced, and we expect tocontinue to experience in the future, difficulty in hiring and retaining highlyskilled employees with appropriate qualifications for our business. Inaddition, it takes time for our new sales personnel to become productive,particularly with respect to obtaining major customer accounts. In many cases,newly hired sales personnel are unable to develop their skills rapidly enough,which results in a relatively high turnover rate and a corresponding increasedneed to make continual new hires. If we are unable to hire or retain qualifiedsales and software development personnel, or if newly hired personnel fail todevelop the necessary skills or reach productivity slower than anticipated, itwould be more difficult for us to sell our solution, and we may experience ashortfall in revenues and not achieve our planned growth.

 

***Our failure tocompete successfully against current or future competitors could cause ourrevenues or market share to decline.***

 

Our market is fragmented, competitive and rapidly evolving, and thereare limited barriers to entry for some aspects of this market. We mainly facecompetition from four sources:

 

•                  traditionalfundraising methods;

 

•                  custom developedsolutions created by technical staff or outside custom service providers;

 

•                  companies thatoffer specialized software designed to address needs of businesses across avariety of industries; and

 

•                  companies thatoffer integrated software solutions designed to address the needs of nonprofitorganizations.

 

In the past, we have competed with these companies by focusing on andcommitting significant resources to promote awareness of Kintera Sphere tononprofit organizations in the health and human services sector, and bydeveloping features to better meet the needs of our customers. However, thecompanies we compete with may have greater financial, technical and marketingresources, generate greater revenues and better name recognition than we do.These competitive pressures could cause our revenues and market share todecline.

 

***Because we recognizerevenue from upfront payments ratably over the term of the contract, downturnsin sales may not be immediately reflected in our revenues.***

 

We have derived the substantial majority of our historical revenuesfrom fees paid by nonprofit organizations related to their use of KinteraSphere. The fees we receive for Kintera Sphere include upfront fees thatnonprofit organizations pay for the right to access to Kintera Sphere. Werecognize revenue from the upfront service fees over the term of the contract,which is typically one year or more. As a result, a portion of our revenues ineach quarter is deferred revenue from contracts entered into and paid forduring previous quarters. Because of this deferred revenue, the revenues wereport in any quarter or series of quarters may mask significant downturns insales and the market acceptance of Kintera Sphere.

 

***Any failure toprotect our intellectual property rights could impair our ability to protectour proprietary technology and establish our Kintera Sphere brand.***

 

Our success and ability to compete depend in part on our internallydeveloped technology and software applications. We rely on patent, trademark,copyright and trade secret laws and restrictions in the United States and otherjurisdictions, together with contractual restrictions on our employees, strategicpartners and customers, to protect our proprietary rights. Any of ourtrademarks may be challenged by others or invalidated through administrativeprocess or litigation. We currently have one issued patent and 17 pendingpatent applications in the United States. We may not be successful in obtainingthese patents and we may be unable to obtain additional patent protection inthe future. In addition, any issued patents may not provide us with anycompetitive advantages, or may be challenged by third parties. Furthermore,legal standards relating to the validity, enforceability and scope ofprotection of 

 

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intellectual property rights are uncertain. Effective patent,trademark, copyright and trade secret protection may not be available to us inevery country in which our solution is available. As a result, we cannot assureyou that our means of protecting our proprietary rights will be adequate.Furthermore, despite our efforts, we may be unable to prevent third partiesfrom infringing upon or misappropriating our intellectual property. Any suchinfringement or misappropriation could have a material adverse effect on ourrevenues and prospects for growth.

 

***Our ability togenerate increased revenues depends in part on the efforts of our strategicpartners, over whom we have little control.***

 

Our ability to generate increased revenues depends in part upon theability and willingness of our strategic partners to increase awareness of oursolution to their customers. We cannot control the level of effort thesepartners expend or the extent to which any of them will be successful inincreasing awareness of our solution. We may not be able to prevent theseparties from devoting greater resources to support services developed by themor other third parties. If our strategic partners fail to increase awareness ofour solution or to assist us in getting access to decision-makers, then we mayneed to increase our marketing expenses, change our marketing strategy or enterinto marketing relationships with different parties, any of which could impairour ability to generate increased revenues.

 

***Our common stockprice may fluctuate substantially, and your investment could suffer a declinein value.***

 

The market price of our common stock may be volatile and couldfluctuate substantially due to many factors, including:

 

•                  actual oranticipated fluctuations in our results of operations;

 

•                  announcements oftechnological innovations or technology standards by us or our competitors;

 

•                  the introductionof new products or services, or product or service enhancements by us or ourcompetitors;

 

•                  developmentswith respect to our or our competitors’ intellectual property rights;

 

•                  announcements ofsignificant acquisitions or other agreements by us or our competitors;

 

•                  our sale ofcommon stock or other securities in the future;

 

•                  the tradingvolume of our common stock;

 

•                  conditions andtrends in the nonprofit industry;

 

•                  changes in ourpricing policies or the pricing policies of our competitors;

 

•                  changes in theestimation of the future size and growth of our markets; and

 

•                  general economicand geopolitical conditions.

 

In addition, the stock market in general, the Nasdaq National Market,and the market for shares of technology companies in particular, haveexperienced extreme price and volume fluctuations that have often beenunrelated or disproportionate to the operating performance of those companies.Further, the market prices of securities and technology companies have beenparticularly volatile. These broad market and industry factors may materiallyharm the market price of our common stock, regardless of our operatingperformance. In the past, following periods of volatility in the market priceof a company’s securities, securities class action litigation has often beeninstituted against that company. Such litigation, if instituted against us,could result in substantial costs and a diversion of management’s attention andresources.

 

***Because of theirsignificant stock ownership, some of our existing stockholders will be able toexert control over us and our significant corporate decisions.***

 

Our executive officers, directors and their affiliates own, in theaggregate, approximately 41.4% of our outstanding common stock. As a result,these persons, acting together, have the ability to determine the outcome ofall matters submitted to our stockholders for approval, including the electionand removal of directors and any significant transaction involving us. Inaddition, these persons, 

 

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acting together, have the ability to control the management and affairsof our company. This concentration of ownership may harm the market price ofour common stock by, among other things:

 

•                  delaying,deferring, or preventing a change in control of our company;

 

•                  impeding amerger, consolidation, takeover, or other business combination involving ourcompany;

 

•                  causing us toenter into transactions or agreements that are not in the best interests of allstockholders; or

 

•                  discouraging apotential acquirer from making a tender offer or otherwise attempting to obtaincontrol of our company.

 

***Our future capitalneeds are uncertain, and we may need to raise additional funds in the futurewhich may not be available on acceptable terms or at all.***

 

Our capital requirements will depend on many factors, including:

 

•                  acceptance of,and demand for, Kintera Sphere;

 

•                  the costs ofdeveloping new products, services or technology;

 

•                  the extent towhich we invest in new technology and product development;

 

•                  the number andtiming of acquisitions and other strategic transactions; and

 

•                  the costsassociated with the growth of our business, if any.

 

Our existing sources of cash and cash flows may not be sufficient tofund our activities. As a result, we may need to raise additional funds, andsuch funds may not be available on favorable terms, or at all. Furthermore, ifwe issue equity or convertible debt securities to raise additional funds, ourexisting stockholders may experience dilution, and the new equity or debtsecurities may have rights, preferences, and privileges senior to those or ourexisting stockholders. If we incur additional debt, it may increase ourleverage relative to our earnings or to our equity capitalization. If we cannotraise funds on acceptable terms, we may not be able to develop or enhance ourproducts and services, execute our business plan, take advantage of futureopportunities, or respond to competitive pressures or unanticipated customerrequirements.

 

***Our certificate ofincorporation authorizes our board of directors to issue new series ofpreferred stock that may have the effect of delaying or preventing a change ofcontrol, which could adversely affect the value of your shares.***

 

Our certificate of incorporation, as amended, provides that our boardof directors will be authorized to issue from time to time, without furtherstockholder approval, up to 20,000,000 shares of preferred stock in one or moreseries and to fix or alter the designations, preferences, rights and anyqualifications, limitations or restrictions of the shares of each series,including the dividend rights, dividend rates, conversion rights, votingrights, rights of redemption, including sinking fund provisions, redemptionprice or prices, liquidation preferences and the number of shares constitutingany series or designations of any series. Such shares of preferred stock couldhave preferences over our common stock with respect to dividends andliquidation rights. We may issue additional preferred stock in ways which maydelay, defer or prevent a change of control of our company without furtheraction by our stockholders. Such shares of preferred stock may be issued withvoting rights that may adversely affect the voting power of the holders of ourcommon stock by increasing the number of outstanding shares having votingrights, and by the creation of class or series voting rights.

 

***Anti-takeoverprovisions under our charter documents and Delaware law could delay or preventa change of control and could also limit the market price of our stock.***

 

Our certificate of incorporation, as amended, and our bylaws, asamended, contain provisions that could delay or prevent a change of control ofour company or changes in our board of directors that our stockholders mightconsider favorable. In addition, our certificate of incorporation, as amended,and our bylaws, as amended, provide that our board of directors will beclassified into three classes of directors upon consummation of this offering,with each class elected at a separate election. The existence of a staggeredboard could delay a potential acquiror from obtaining majority control of ourboard, and thus deter potential acquisitions that might otherwise provide ourstockholders with a premium over the then current market price for theirshares.

 

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In addition, we are governed by the provisions of Section 203 ofthe Delaware General Corporate Law, which may prohibit certain businesscombinations with stockholders owning 15% or more of our outstanding votingstock. These and other provisions in our certificate of incorporation, asamended, and our bylaws, as amended, and Delaware law could make it moredifficult for stockholders or potential acquirors to obtain control of ourboard of directors or initiate actions that are opposed by the then-currentboard of directors, including delaying or impeding a merger, tender offer, orproxy contest or other change of control transaction involving our company. Anydelay or prevention of a change of control transaction or changes in our boardof directors could prevent the consummation of a transaction in which ourstockholders could receive a substantial premium over the then current marketprice for their shares.

 

**Item 3. Quantitative and QualitativeDisclosures About Market Risk**

 

Due to the nature of our short-term investments, we have concluded thatthere is no material market risk exposure. Therefore, no quantitative tabulardisclosure was required.

 

**Item 4. Controlsand Procedures**

 

Under the supervision and with the participation of our management,including our principal executive officer and principal financial officer, weconducted an evaluation of our disclosure controls and procedures, as such termis defined under Rule 13a—15(e) promulgated under the Securities Exchange Actof 1934, as amended. Based on this evaluation, our principal executive officerand our principal financial officer concluded that our disclosure controls andprocedures were effective as of the end of the period covered by this quarterlyreport.

 

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**PART II. OTHERINFORMATION**

 

**Item1. Legal Proceedings**

 

In our prior periodicreports we disclosed that on February 11, 2002, we filed a complaintagainst Convio, Inc., in the United States District Court for the SouthernDistrict of California and that Convio subsequently served us with an answerand counterclaim.  On April 15,2004, we entered into a confidential settlement agreement with Convio.  The settlement will not have a materialeffect on our business, operating results or financial condition.

 

In addition to the foregoingmatters, from time to time, we may become involved in various lawsuits and legalproceedings which arise in the ordinary course of business. However, litigationis subject to inherent uncertainties, and an adverse result in these or othermatters may arise from time to time that may harm our business. We are notcurrently aware of any such legal proceedings or claims that we believe willhave, individually or in the aggregate, a material adverse affect on ourbusiness, financial condition or operating results.

 

**Item 2. Changes in Securities and Use ofProceeds**

 

TheSecurities and Exchange Commission declared our first registration statements,which we filed on Form S-1 (Registration No. 333-109169 andRegistration Statement No. 333-111340) under the Securities Act of 1933 inconnection with the initial public offering of our common stock, effective onDecember 19, 2003.  The sale of shares of our common stock resultedin aggregate gross proceeds of approximately $40.25 million, approximately$2.8 million of which we applied to underwriting discounts and commissionsand approximately $1.3 million of which we applied to related costs. As aresult, we received approximately $36.1 million of the offering proceeds.

 

As of June 30, 2004, we had used approximately $1.3 million forpurchases of property and equipment, approximately $1.0 million foracquisitions of other businesses and approximately $6.6 million for workingcapital.  Additionally, we have investedapproximately $24.3 million of our proceeds in short-term marketablesecurities.  The proceeds used forworking capital included regular compensation for officers and directors.  The use of proceeds does not represent amaterial change from the use of proceeds described in the prospectus.

 

The following sales of unregistered securities occurred during thethree months ended June 30, 2004:

 

In June 2004, we issued approximately 22,000 shares of commonstock in connection with the acquisition of of BNW, Inc. (“BNW”).  The shares of common stock were issued toinvestors pursuant to an Acquisition Agreement by and among us, BNW and theholders of a majority of BNW securities.

 

OnJuly 12, 2004, the Company sold 2,500,000 shares of its common stock in aprivate placement at a price of $8.00 per share for net proceeds ofapproximately $18.8 million.

 

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

 

(a). *Exhibits*

 
| **Exhibit  Number** |   | **Description of Document**                                                                                                                                                                                                              |
|---------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |   |                                                                                                                                                                                                                                     |
| 2.1(1)†        |   | Agreement and Plan of  Reorganization dated as of January 10, 2003 by and among the Registrant,  Involve Acquisition Corporation, H2O Networks, Inc., and Dean Hollander,  Lance Hollander and John Dartley                         |
| 2.2(1)†        |   | Agreement and Plan of Merger  and Reorganization dated as of September 26, 2003 by and among the  Registrant, 5 Winds, Inc., Spencer Hayman, Valerie Myers, Laura Jones, David  Hilmer, Matt Holland and Calendar Media Corporation |
| 2.3(1)†        |   | Asset Purchase Agreement  dated as of September 25, 2003 by and among the Registrant, VS Asset  Acquisition, Inc., VirtualSprockets LLC, Randy Thomas Yeatts, Laura Kittleman  Yeatts and David M. Barach                      |
| 2.4(2)††  |   | Agreement and Plan of Merger  and Reorganization by and among the Registrant, Sunday Acquisition  Corporation, Carol/Trevelyan Strategy Group, Inc. and Dan Carol, Stryder  Thompkins, Greg Nelson and Stuart Trevelyan                  |
| 3.2(3)              |   | Amended and Restated Certificate  of Incorporation of the Registrant                                                                                                                                                                     |
| 3.4(3)              |   | Amended and Restated Bylaws  of the Registrant                                                                                                                                                                                           |
| 4.1(3)              |   | Specimen Common Stock  Certificate                                                                                                                                                                                                       |
| 31.1                |   | Certification of Chief  Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of  2002                                                                                                                                |
| 31.2                |   | Certification of Chief  Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of  2002                                                                                                                                |
| 32.1                |   | Certification of Chief  Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of  2002                                                                                                                                |
| 32.2                |   | Certification of Chief  Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of  2002                                                                                                                                |

 

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†                                         Confidential treatment has been granted forportions of this exhibit.

††                                   Confidentialtreatment has been requested for portions of this exhibit.  These portions have been omitted from theForm 8-K and have been submitted separately to the Securities and ExchangeCommission.

(1)                                 Previously filed with Amendment No. 5 toRegistration Statement on Form S-1 (File No. 333-109169) datedDecember 16, 2003.

(2)                                 Previously filed on Current Report on Form8-K on April 2, 2004

(3)                                 Previously filed with Amendment No. 4 toRegistration Statement on Form S-1 (File No. 333-109169) datedDecember 10, 2003.

 

(b). *Reports on Form 8-K*

 

We filed a report on Form 8-K to the SEC on April 2, 2004announcing our acquisition of Carol/Trevelyan Strategy Group on March 18,2004.

 

We furnished a report on Form 8-K to the SEC on April 28, 2004with our press release announcing our first quarter financial results.

 

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**SIGNATURE**

 

Pursuant to the requirements of the Securities Act of 1934, as amended,the registrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 

 
|                       | KINTERA, INC.   |
|----------------------------|-----------------|
|                       |            |   |
|                       |   By: |   /s/ James  Rotherham, C.P.A. |   |
|                       |            | **James Rotherham, C.P.A.  Chief Financial Officer** |
|                       |            |   |
| Date: August 13, 2004 |            |   |

 

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