UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2001
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission file number 000-25661
================================================================================
TenFold Corporation
(Exact name of registrant as specified in its charter)
Delaware 83-0302610
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
180 West Election Road
Draper, Utah 84020
(Address of principal executive offices, including zip code)
(801) 495-1010
(Registrant's telephone number, including area code)
================================================================================
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [_]
As of September 30, 2001, there were 36,749,662 shares of the registrant's
Common Stock outstanding.
INDEX
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Page
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PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets at September 30, 2001 and
December 31, 2000 ...................................................................... 3
Condensed Consolidated Statements of Operations for the three and nine months
ended September 30, 2001 and September 30, 2000 ........................................ 4
Condensed Consolidated Statements of Cash Flows for the nine months ended
September 30, 2001 and September 30, 2000 .............................................. 5
Notes to Condensed Consolidated Financial Statements ................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations .......................................................................... 22
Item 3. Quantitative and Qualitative Disclosures About Market Risk ............................. 49
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ...................................................................... 50
Item 3. Defaults Upon Senior Securities ........................................................ 55
Item 4. Submission of Matters to a Vote of Security Holders .................................... 56
Item 6. Exhibits and Reports on Form 8-K ....................................................... 57
SIGNATURES ......................................................................................... 58
2
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
TENFOLD CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(unaudited)
September 30, December 31,
------------- -----------
2001 2000
------------- -----------
Assets
Current assets:
Cash and cash equivalents .................................................. $ 5,471 $ 13,854
Accounts receivable, (net of allowances for doubtful accounts
of $929 and $7,338, respectively) ...................................... 2,361 3,451
Unbilled accounts receivable, (net of allowances for doubtful accounts
of $1,320 and $2,949, respectively) .................................... 1,138 282
Prepaid expenses and other assets .......................................... 964 652
Deferred income taxes ...................................................... - 612
Income taxes receivable .................................................... 372 644
Assets held for sale ....................................................... 2,126 2,944
Other assets, (net of allowances of $182, and $236 respectively) ........... 258 256
----------- -----------
Total current assets ................................................. 12,690 22,695
Restricted cash ............................................................ 8,785 2,598
Property and equipment, net ................................................ 11,813 20,234
Due from stockholders, (net of allowances of $800 and $860 respectively) ... - 40
Other assets ............................................................... 495 770
Goodwill and acquired intangibles, net ..................................... - 18,938
----------- -----------
Total assets ......................................................... $ 33,783 $ 65,275
=========== ===========
Liabilities and Stockholders' Deficit
Current liabilities:
Accounts payable ........................................................... $ 3,218 $ 9,769
Income taxes payable ....................................................... 3,062 766
Accrued liabilities ........................................................ 13,072 12,043
Deferred revenue ........................................................... 14,219 35,853
Current installments of obligations under capital leases ................... 2,199 3,381
Current installments of notes payable ...................................... 6,512 3,377
Other current liabilities .................................................. 1,883 899
----------- -----------
Total current liabilities ............................................ 44,165 66,088
----------- -----------
Long-term liabilities:
Deferred income taxes ...................................................... - 612
Obligations under capital leases, excluding current installments ........... 2,690 3,498
Notes payable, excluding current installments .............................. - 5,284
Other long-term liabilities ................................................ 97 1,241
----------- -----------
Total long-term liabilities .......................................... 2,787 10,635
----------- -----------
Contingencies (Note 9)
Stockholders' deficit:
Common stock, $0.001 par value:
Authorized: 120,000,000 shares
Issued and outstanding shares: 36,749,662 shares at September 30,
2001 and 35,735,858 shares at December 31, 2000 ........................ 37 36
Additional paid-in capital ................................................. 66,238 66,170
Notes receivable from stockholders, (net of allowances of $786, and
$1,686 respectively) ................................................... (377) (429)
Deferred compensation ...................................................... (867) (2,132)
Accumulated deficit ........................................................ (77,660) (74,270)
Accumulated other comprehensive loss ....................................... (540) (823)
----------- -----------
Total stockholders' deficit .......................................... (13,169) (11,448)
----------- -----------
Total liabilities and stockholders' deficit .......................... $ 33,783 $ 65,275
=========== ===========
The accompanying notes are an integral part of these condensed consolidated
financial statements
3
TENFOLD CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- --------------------------
2001 2000 2001 2000
------------ ----------- ------------ -----------
Revenues:
License .................................................. $ 748 $ 4,038 $ 7,844 $ 16,306
Services ................................................. 9,635 14,849 35,256 60,621
----------- ----------- ------------ -----------
Total revenues ..................................... 10,383 18,887 43,100 76,927
----------- ----------- ------------ -----------
Operating expenses:
Cost of revenues (exclusive of non-cash compensation
of $60, $102, $220, and $346, respectively) ........... 2,661 18,053 21,267 46,073
Sales and marketing (exclusive of non-cash
compensation of $5, $64, $64, and $221,
respectively) ......................................... 678 5,634 4,909 18,931
Research and development (exclusive of non-cash
compensation of $39, $80, $168, and $281,
respectively) ......................................... 2,613 6,504 10,527 19,261
General and administrative (exclusive of non-cash
compensation of $81, $29, $246, and $94,
respectively) ......................................... 1,940 8,329 9,211 16,329
Amortization of goodwill and acquired intangibles ........ - 1,150 962 3,452
Amortization of deferred compensation .................... 185 275 698 942
Special charges .......................................... 911 - 8,472 -
----------- ----------- ------------ -----------
Total operating expenses ........................... 8,988 39,945 56,046 104,988
----------- ----------- ------------ -----------
Income (loss) from operations ............................... 1,395 (21,058) (12,946) (28,061)
----------- ----------- ------------ -----------
Other income (expense):
Interest and other income ................................ 271 662 1,104 2,503
Interest expense ......................................... (304) (220) (949) (848)
Gain on sale of The LongView Group, Inc. ................. (1,002) - 12,769 -
----------- ----------- ------------ -----------
Total other income, net ............................ (1,035) 442 12,924 1,655
----------- ----------- ------------ -----------
Income (loss) before income taxes ........................... 360 (20,616) (22) (26,406)
Provision (benefit) for income taxes ........................ 209 543 3,368 (905)
----------- ----------- ------------ -----------
Net income (loss) ........................................... $ 151 $ (21,159) $ (3,390) $ (25,501)
=========== =========== ============ ===========
Basic earnings (loss) per common share ...................... $ 0.00 $ (0.61) $ (0.10) $ (0.74)
=========== =========== ============ ===========
Diluted earnings (loss) per common share .................... $ 0.00 $ (0.61) $ (0.10) $ (0.74)
=========== =========== ============ ===========
Weighted average common and common equivalent
shares used to calculate earnings
(loss) per share:
Basic .................................................... 35,648 34,731 35,523 34,387
=========== =========== ============ ===========
Diluted .................................................. 38,288 34,731 35,523 34,387
=========== =========== ============ ===========
The accompanying notes are an integral part of these condensed consolidated
financial statements
4
TENFOLD CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Nine Months Ended
September 30,
-------------------
2001 2000
-------------------
Cash flows from operating activities:
Net loss ............................................................. $ (3,390) $(25,501)
Adjustments to reconcile net loss to net cash used in operating
activities:
Deferred income tax provision (benefit) ............................ 407 (841)
Amortization of goodwill and acquired intangibles .................. 962 3,451
Depreciation and amortization ...................................... 4,550 3,806
Impaired assets charge ............................................. 3,785 -
Provision for doubtful accounts .................................... 89 7,314
Amortization of deferred compensation .............................. 698 942
Compensation expense related to stock options ...................... 43 -
Gain on sale of The LongView Group, Inc. ........................... (13,948) -
Changes in operating assets and liabilities:
Accounts receivable ................................................ (226) (4,559)
Unbilled accounts receivable ....................................... (996) (6,416)
Prepaid expenses and other assets .................................. (150) (833)
Accounts payable ................................................... (6,206) 2,018
Income taxes payable ............................................... 2,584 (589)
Accrued liabilities ................................................ 1,382 (2,477)
Deferred revenues .................................................. (16,135) 6,489
Other liabilities .................................................. (158) 1,715
--------- ---------
Net cash used in operating activities ....................... (26,709) (15,481)
--------- ---------
Cash flows from investing activities:
Additions to property and equipment ................................ - (10,513)
Additions to restricted cash ....................................... (6,298) (2,840)
Net decrease (increase) in other assets ............................ - (168)
Net proceeds from sale of The LongView Group, Inc. ................. 28,292 -
--------- ---------
Net cash provided by (used in) investing activities ......... 21,994 (13,521)
--------- ---------
Cash flows from financing activities:
Proceeds from employee stock purchase plan stock issuance .......... 533 3,284
Exercise of common stock options ................................... 60 1,483
Proceeds from issuance of notes payable ............................ - 6,047
Principal payments on notes payable ................................ (2,149) (13,573)
Notes receivable from stockholders ................................. (140) -
Payments and reductions of notes receivable from stockholders ...... 232 -
Principal payments on obligations under capital leases ............. (1,966) (1,008)
--------- ---------
Net cash used in financing activities ....................... (3,430) (3,767)
--------- ---------
Effect of exchange rate changes ......................................... (238) (209)
--------- ---------
Net decrease in cash and cash equivalents ............................... (8,383) (32,978)
Cash and cash equivalents at beginning of period ........................ 13,854 58,247
--------- ---------
Cash and cash equivalents at end of period .............................. $ 5,471 $ 25,269
========= =========
Supplemental disclosure of cash flow information:
Cash paid for income taxes ......................................... $ 559 $ 509
Cash paid for interest ............................................. $ 609 $ 1,021
The accompanying notes are an integral part of these condensed consolidated
financial statements
5
TENFOLD CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The accompanying unaudited Condensed Consolidated Financial Statements
included herein have been prepared by TenFold Corporation (the "Company")
pursuant to the rules and regulations of the Securities and Exchange Commission.
In management's opinion, the interim financial data presented includes all
adjustments necessary for a fair presentation. All intercompany accounts and
transactions have been eliminated. Certain reclassifications have been made in
the prior years' financial statements to conform to the current period's
presentation. Certain information required by generally accepted accounting
principles has been condensed or omitted pursuant to rules and regulations of
the Securities and Exchange Commission. Operating results for the three and nine
month periods ended September 30, 2001 are not necessarily indicative of the
results that may be expected for any future period or for the year ending
December 31, 2001.
This report should be read in conjunction with the Company's audited
Consolidated Financial Statements for the year ended December 31, 2000 included
in its Annual Report on Form 10-K filed with the Securities and Exchange
Commission.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions, including for example, estimated project costs and profitability
and accounts receivable allowances, that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from these estimates.
The Company's financial statements have been prepared under the assumption
that the Company will continue as a going concern. During the year ended
December 31, 2000, the Company experienced several difficult quarters as a
result of rapid internal growth, delivery challenges and a difficult sales
environment. The delivery challenges prevented the Company from collecting final
payments on certain projects and led to several customer disputes. As the
Company disclosed the customer disputes in its quarterly filings, the sales
environment became increasingly difficult. The substantial operating losses
incurred in the year ended December 31, 2000 further deteriorated its ability to
sell its products and services. In order to better align its expenses with its
revenues, the Company took aggressive steps to restructure its operations
through consolidating its management structure, reducing its workforce and
closing offices. The Company significantly revised its strategic direction and
aligned its marketing, sales, and operations around its core technology asset,
the Applications platform referred to as the Universal Application.
Additionally, the Company raised cash through the sale of LongView for $29.0
million in March 2001. The Company believes that the strength of its core
technologies, product assets, customer base, and the corrective actions that the
Company is taking, provide a solid foundation for its continued operation in
2001. However, the events of September 11, 2001 have negatively impacted the
Company's ability to sell its products and services as the Company has major
customers in several industries directly affected by the tragedy.
The Company is presently seeking various funding alternatives, including
equity financing and divestiture of its vertical market application assets, to
meet the Company's working capital needs. However, there can be no assurance
that these efforts will prove successful.
2. Revenue Recognition
The Company derives revenues from license fees, application development and
implementation services, support, and training services. License revenues
consist of fees for licensing the Universal Application as a tool or as a
developed application, and license fees for the applications that the Company
develops for its customers. The Company also derives license
6
revenues from the resale of its vertical applications products. Service revenues
consist of fees for application development and implementation, support and
training.
In October 1997, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position ("SOP") 97-2, Software Revenue
Recognition, which supersedes SOP 91-1, Software Revenue Recognition.
Additionally, in 1998, the AICPA issued SOP 98-9, Modification of SOP 97-2 with
Respect to Certain Transactions. Effective January 1, 1998, the Company adopted
the provisions of SOP 97-2, as modified by SOP 98-9.
The Company generally enters into software arrangements that involve
multiple elements, such as software products, enhancements, post-contract
customer support ("PCS"), installation and training. The Company allocates a
portion of the arrangement fee to each undelivered element based on the relative
fair values of the elements. The fair values of an element must be based on
vendor specific objective evidence ("VSOE"). The Company establishes VSOE based
on the price charged when the same element is sold separately. VSOE for services
is based on standard rates for the individuals providing services. These rates
are the same rates charged when the services are sold separately under
time-and-materials contracts. The Company bases VSOE for training on standard
rates charged for each particular training course. These rates are the rates
charged when the training is sold separately for supplemental training courses.
For PCS, VSOE is determined by reference to the renewal rate the Company charges
the customer in future periods. The fee allocated to the delivered software
product is based upon the residual method described in SOP 98-9.
The Company recognizes license revenues from vertical application product
sales and Universal Application development licenses that do not include
services or where the related services are not considered essential to the
functionality of the software, when the following criteria are met: the Company
has signed a noncancellable license agreement with nonrefundable fees; the
Company has shipped the software product; there are no uncertainties surrounding
product acceptance; the fees are fixed and determinable; and collection is
considered probable. This policy applies both when the vertical application
license or the Universal Application development licenses are sold separately or
when a Universal Application development license is sold with an application
development project. License fees recognized upon achieving these criteria, for
the three months ended September 30, 2001 were $0 as compared to $1.7 million
for the three months ended September 30, 2000. License fees recognized upon
achieving these criteria, for the nine months ended September 30, 2001 were $1.2
million as compared to $6.5 million for the nine months ended September 30,
2000. Services relating to the Universal Application development licenses only
include post contract customer support services. Services for vertical
application product licenses do not add significant functionality, features, or
significantly alter the software. In addition, similar services are available
from other vendors; there are no milestones or customer specific acceptance
criteria which affect the realizability of the software license fee; and the
software license fee is non-cancelable and non-refundable.
For software arrangements that include a service element that is considered
essential to the functionality of the software, the Company recognizes license
fees related to the application, and the application development service fees,
over time as the Company performs the services, using the
percentage-of-completion method of accounting and following the guidance in
Statement of Position ("SOP") 81-1, Accounting for Performance of
Construction-Type and Certain Production-Type Contracts. The Company makes
adjustments, if necessary, to the estimates used in the percentage-of-completion
method of accounting as work progresses under the contract and as the Company
gains experience. For presentation purposes within the Condensed Consolidated
Statement of Operations, fixed-price project revenues are split between license
and service based upon the relative fair value of the components.
For certain projects, the Company limits revenue recognition in the period
to the amount of direct and indirect project costs incurred in the same period,
and postpones recognition of profits until results can be estimated more
precisely. At September 30, 2001, the Company is applying this "zero profit"
methodology to all fixed-price projects. The total project values for ongoing
projects at September 30, 2001 accounted for using the "zero profit" methodology
is
7
approximately $22.2 million. Revenue recognized from projects on this "zero
profit" methodology during the three months ended September 30, 2001 was $3.9
million as compared to $858,000 during the three months ended September 30,
2000, while revenue recognized from these projects during the nine months ended
September 30, 2001 was $25.1 million as compared to $8.9 million during the nine
months ended September 30, 2000. Revenue recognized during the three months
ended September 30, 2001 on the "zero profit" methodology for ongoing projects
was $2.0 million with equal amounts of cost; while revenue recognized on
terminated projects during the same period was $1.9 million, representing
profits recognized upon termination of remaining project obligations, with no
corresponding costs.
For time-and-material contracts, the Company generally estimates a profit
range and recognizes the related revenue using the lowest level of profit in the
estimated range. Billings in excess of revenue recognized under
time-and-material contracts are deferred and recognized upon completion of the
time-and-material contract or when the results can be estimated more precisely.
The Company recognizes support revenue from contracts for ongoing technical
support and product updates ratably over the support period. The Company
recognizes training revenue as it performs the services.
The Company records billings and cash received in excess of revenue earned
as deferred revenue. The Company's deferred revenue balance at September 30,
2001 was $14.2 million. The Company's deferred revenue balance generally results
from contractual commitments made by customers to pay amounts to the Company in
advance of revenues earned, and from application of the "zero profit" margin
methodology described above. The Company's unbilled accounts receivable
represents revenue that the Company has earned but which the Company has not yet
billed. The Company bills customers as payments become due under the terms of
the customer's contract. The Company considers current information and events
regarding its customers and their contracts and establishes allowances for
doubtful accounts when it is probable that the Company will be unable to collect
amounts due under the terms of existing contracts.
3. Earnings (Loss) Per Share
The following table sets forth the computation of basic and diluted
earnings (loss) per share (in thousands except per share data):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ ------------------
2001 2000 2001 2000
-------- -------- --------- --------
Numerator:
Numerator for basic earnings (loss) per share -
net income (loss) available to common stockholders ................... $ 151 $(21,159) $ (3,390) $(25,501)
======== ======== ======== ========
Assumed dilution related to subsidiaries'
earnings applicable to minority stockholders ......................... - 66 - -
-------- -------- -------- --------
Numerator for diluted earnings (loss) per share .......................... $ 151 $(21,093) $ (3,390) $(25,501)
======== ======== ======== ========
Denominator:
Denominator for basic earnings (loss) per share -
weighted average shares .............................................. 35,648 34,731 35,523 34,387
======== ======== ======== ========
Employee stock options ................................................ 2,640 - - -
-------- -------- -------- --------
Denominator for diluted earnings (loss) per share ..................... 38,288 34,731 35,523 34,387
======== ======== ======== ========
Earnings (loss) per common share:
Basic earnings (loss) per common share ................................ $ 0.00 $ (0.61) $ (0.10) $ (0.74)
======== ======== ======== ========
Diluted earnings (loss) per common share .............................. $ 0.00 $ (0.61) $ (0.10) $ (0.74)
======== ======== ======== ========
8
Employee stock options of 13,014,870 and 15,586,420 outstanding during the
three and nine months ended September 30, 2001, respectively, that have a
weighted average exercise price of $11.07 and $9.31 per share, respectively, and
that could potentially dilute basic earnings per share in the future, were not
included in the computation of diluted earnings per share because to do so would
have been anti-dilutive for the periods. Employee stock options of 10,915,186
and 9,818,479 outstanding during the three and nine months ended September 30,
2000, respectively and that could potentially dilute basic earnings per share in
the future, were not included in the computation of diluted earnings per share
because to do so would have been anti-dilutive for the periods.
Warrants to purchase 1,181,600 shares of common stock in a wholly-owned
subsidiary outstanding during the three and nine months ended September 30, 2001
and 2000 that could potentially dilute basic earnings per share were not
included in the computation of diluted earnings per share because to do so would
have been anti-dilutive. These warrants were terminated during the three months
ended September 30, 2001 in conjunction with the settlement of a dispute with
the related customer who had previously purchased these warrants.
4. Cash Equivalents
Cash equivalents include all highly liquid investments purchased with
remaining maturities of three or fewer months. Cash equivalents are recorded at
cost, which approximates fair value, and consist primarily of investments in
money market mutual funds, commercial paper, auction rate money market preferred
stock investments, and taxable and non-taxable municipal bonds and notes.
5. Restricted Cash
Restricted cash relates to $3.5 million to collateralize letters of credit
that secure the Company's office facilities in Chicago and San Francisco; $2.9
million held in an escrow account as part of the Company's agreement with
Linedata Services related to the sale of The LongView Group, Inc.; $2.2 million
held in an escrow account to secure a lease on office space in South Jordan,
Utah; and $165,000 held in the Company's cash accounts to secure letters of
credit used to secure leases on office space in Dallas, Texas. See Note 12 for
additional information related to the escrow arrangement with Linedata Services.
6. Comprehensive Income (Loss)
The Company has adopted the provisions of Statement of Financial Accounting
Standards No. 130, Reporting Comprehensive Income ("SFAS No. 130"). SFAS No. 130
establishes standards for reporting comprehensive income (loss) and its
components in financial statements. Comprehensive income (loss) for the three
and nine months ended September 30, 2001 and 2000, ignoring the insignificant
impact of taxes on foreign currency translation, was as follows (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- --------------------------
2001 2000 2001 2000
------------ ------------ ------------ -----------
Net income (loss) ................... $ 151 $ (21,159) $ (3,390) $ (25,501)
Foreign currency translation ........ 94 67 283 (209)
------------ ------------ ------------ -----------
Comprehensive income (loss) ......... $ 245 $ (21,092) $ (3,107) $ (25,710)
============ ============ ============ ===========
9
7. Income Taxes
The provision for income taxes for the three months ended September 30,
2001 is for foreign taxes. The provision for income taxes for the nine months
ended September 30, 2001 includes income taxes on the gain from the sale of The
LongView Group, Inc., foreign taxes, and an adjustment to record a valuation
allowance against all net deferred tax assets.
The valuation allowance as of September 30, 2001 was recorded in accordance
with the provisions of Statement of Financial Accounting Standards ("SFAS") No.
109, Accounting for Income Taxes, which requires that a valuation allowance be
established when there is significant uncertainty as to the realizability of
deferred tax assets. Based on a number of factors, the currently available,
objective evidence indicates that it is more likely than not that the Company's
net deferred tax assets will not be realized.
8. Commitments
The Company has commitments under long-term operating leases, principally
for office space and computer equipment. Future minimum lease payments under
non-cancelable operating lease obligations, in excess of one year and excluding
obligations accrued as part of restructurings, at September 30, 2001 are as
follows (in thousands):
Year Amount
---- ---------
Q4, 2001 $ 1,562
2002 6,913
2003 7,047
2004 7,175
2005 7,470
Thereafter 28,172
---------
Total minimum lease commitments $ 58,339
=========
During the three and nine months ended September 30, 2001, the Company
subleased a portion of its office space in San Francisco for sublease amounts in
excess of the Company's contractual lease commitment. During the three months
ended September 30, 2001, the Company received sublease payments of $503,000 of
which $424,000 was recorded as an offset to operating expenses, and $79,000 was
recorded as other income in the Condensed Consolidated Statements of Operations
for the three months ended September 30, 2001. During the nine months ended
September 30, 2001, the Company received sublease payments of $2.2 million of
which $1.5 million was recorded as an offset to operating expenses, and $492,000
was recorded as a prepayment for future periods. The remaining $154,000 was
recorded as other income in the Condensed Consolidated Statements of Operations
for the nine months ended September 30, 2001.
During the year ended December 31, 2000 and the nine months ended September
30, 2001, the Company received prepayments on certain sublease agreements, which
the Company recorded as other current liabilities and other long-term
liabilities. At September 30, 2001, the balance of these prepayments was $1.9
million in current liabilities and $97,000 in long-term liabilities.
The table of future minimum lease payments above has not been reduced by
future minimum rentals due under subleases of $728,000 for the remainder of
2001, $2.4 million for 2002, $1.4 million for 2003, $1.0 million for 2004,
$363,000 for 2005 and $141,000 for periods thereafter.
In May of 2000, the Company signed a 10-year lease for approximately
170,000 square feet of office space in South Jordan, Utah. This lease is part of
a development project and commences on December 1, 2001. It is expected that
this lease will be an operating lease. In December of 2000, the Company
negotiated an agreement with the developer of the project to reduce its
commitments under this lease obligation by 65,431 square feet. During the nine
months ended
10
September 30, 2001, the Company began pursuing options to reduce this commitment
further, including the possible sublease of a significant portion of this space.
As of the date of these financial statements, the Company continues to negotiate
a reduction to this commitment. The future minimum lease payments under the
modified lease are included in the table above.
The Company did not incur any additional capital lease obligations during
the nine months ended September 30, 2001. During the three months ended
September 30, 2001, the Company was temporarily in default on capital lease
obligations to three lessors for late payment of lease payments. The Company has
negotiated restructured payment arrangements with these lessors and is no longer
in default with these lessors. The payment restructuring will reduce the
Company's payments by approximately $497,000 per quarter from the fourth quarter
of 2001 through the 1st quarter of 2002. Beginning in April 2002, the Company is
required to resume paying its pre-restructuring lease payment amounts through
September 30, 2002. After September 30, 2002, the Company is required to pay
pre-restructuring lease payment amounts plus approximately one twelfth of the
deferred amount until paid in full. As of September 30, 2001 the Company had
leases payable to these lessors totaling approximately $4.9 million.
In October 2001 the Company received a notice of default from its primary
lender and equipment lessor demanding repayment of past due lease payments
totaling approximately $647,000. In its notice, the lender agreed to temporarily
forebear accelerating amounts due to the lender and other remedies, including
foreclosure of liens and security interests securing this indebtedness, until
October 31, 2001. The Company is currently working with the lender to negotiate
a restructured payment arrangement and a new forbearance agreement. However, as
of the date of this filing, the Company remains in default and there can be no
assurance that the Company will be successful in negotiating a new arrangement
with this lender, or that the lender will not pursue its remedies. As of
September 30, 2001 the Company had notes payable to this lender totaling
approximately $6.5 million, and was contingently liable for approximately $5.5
million in letters of credit issued by this lender under its credit facility
with the Company.
9. Legal Proceedings and Contingencies
Recently Resolved Customer Disputes
During the nine months ended September 30, 2001, the Company has settled
seven of its customer disputes.
Westfield
On September 17, 1999, Ohio Farmers Insurance Company doing business as
Westfield Companies ("Westfield"), filed a complaint in the United States
District Court for the District of Ohio seeking $5.8 million from the Company.
The complaint alleged that the Company failed to deliver on contractual
commitments under a license agreement with Westfield and included specific
claims of anticipatory breach of contract, breach of express warranty, and
negligent misrepresentation. On November 4, 1999, the Company filed an Answer
and Counterclaim denying these allegations and seeking recovery of $3.9 million
that Westfield owed the Company under the license agreement together with claims
for additional damages. Effective April 26, 2001, the parties entered into a
Settlement Agreement and Mutual Release in which the parties agreed to settle
and resolve all claims between the two companies in consideration for each
dismissing all claims against the other and in further consideration of a
compromised and confidential payment from the Company's errors and omissions
carrier to Westfield in excess of the Company's self-insured retention of
$25,000 already paid by the Company to cover legal defense costs. The complaint
and counterclaim have been dismissed and all claims have been released.
11
Nielsen
On June 14, 2000, Nielsen Media Research, Inc. ("Nielsen"), filed a
complaint in the Circuit Court of Cook County, Illinois seeking $4.5 million,
plus out of pocket expenses paid by Nielsen to the Company. The complaint
alleged that the Company failed to deliver on contractual commitments under a
license and services agreement with Nielsen and included specific claims of
breach of contract and violation of the Illinois Consumer Fraud and Deceptive
Practices Act. On August 30, 2000, the Company filed an Answer and Counterclaim
denying Nielsen's claims and seeking recovery of at least $1.7 million that
Nielsen owed the Company under the license agreement, plus the Company's
attorney fees and costs. Effective May 30, 2001, the parties entered into a
Settlement Agreement and Mutual Release in which the parties agreed to settle
and resolve all claims between the two companies in consideration for each
dismissing all claims against the other and in further consideration of a
compromised and confidential payment from the Company's errors and omissions
carrier to Nielsen in excess of the Company's self-insured retention of $100,000
already paid by the Company to cover legal defense costs. The complaint and
counterclaim have been dismissed and all claims have been released.
Trumbull
On August 18, 2000, Trumbull Services, L.L.C. ("Trumbull"), filed a demand
for arbitration with the American Arbitration Association seeking a refund of at
least $2.8 million paid by Trumbull to the Company. The demand alleged that the
Company failed to deliver on contractual commitments under the Master Software
License and Service Agreement as amended. Trumbull claimed it was entitled to a
refund of fees paid to the Company from the second quarter of 1999 through the
second quarter of 2000. On September 13, 2000, the Company filed an Answer and
Counterclaim denying Trumbull's allegations and seeking recovery of
approximately $2.0 million in fees that Trumbull owed the Company under the
Trumbull Agreement. On May 10, 2001, the Company and Trumbull entered into a
Settlement Agreement and Mutual Release in which the parties agreed to settle
and resolve all claims between the two companies in consideration for each
dismissing all claims against the other and in further consideration of a
compromised and confidential payment from the Company's errors and omissions
carrier to Trumbull in excess of the Company's self-insured retention of
$100,000. The arbitration proceeding has been cancelled and all claims have been
released.
Unitrin
On October 4, 2000, Unitrin Services Company, Inc. ("Unitrin") sent the
Company a notice of dispute letter requesting non-binding mediation. Unitrin was
seeking a refund of fees paid by Unitrin to the Company for the PowerPAC
application of approximately $13.3 million, plus other unspecified damages. On
March 8, 2001, the parties entered a Confidential Settlement Agreement and
Release, dismissing all of Unitrin's claims. The Company's errors and omissions
insurance carrier paid the entire amount of the compromised and confidential
settlement sum above the $100,000 of self-insurance retention already paid by
the Company to cover legal defense costs.
SCEM
On November 22, 2000, Southern Company Energy Marketing L.P. ("SCEM") filed
a demand for arbitration with the American Arbitration Association seeking
damages for delays in delivering a suite of software applications. The Company
responded in a timely manner to the demand denying that the Company breached the
contract and filed detailed Counterclaims including a breach of contract claim
against SCEM for improper and ineffective termination of the contract and
nonpayment. An arbitration hearing was conducted in Dallas, Texas during the
week of June 18, 2001. SCEM sought damages from the Company of approximately
$13.7 million, while the Company sought recovery of approximately $6.8 million
from SCEM. On August 27, 2001, the Company and SCEM entered into a Confidential
Settlement Agreement and Release in which the parties agreed to settle and
resolve all claims between the two companies in consideration for each
dismissing all claims against the other and in further consideration of a
compromised and confidential payment from the Company's errors and omissions
carrier to
12
SCEM in excess of the Company's self-insured retention of $100,000. The
arbitration proceeding has been cancelled and all claims have been released.
Utica
On January 3, 2001, Utica Mutual Insurance Company ("Utica") filed a
complaint against the Company in the Federal District Court of Utah, and
asserted claims for breach of contract, breach of warranties and guarantees,
false advertising under a Utah statute, negligent misrepresentation, and fraud.
Utica sought monetary damages of approximately $15.5 million in fees and
expenses under the contract, plus any additional amount recoverable under the
contractual guarantee, as well as punitive damages, prejudgment interest,
attorneys' fees, and costs. Utica also sought an injunction against alleged
false advertising by the Company under a Utah truth-in-advertising statute. On
January 23, 2001, the Company filed an Answer denying Utica's claims. On August
16, 2001, the Company and Utica entered into a Confidential Settlement Agreement
and Release in which the parties agreed to settle and resolve all claims
asserted by Utica in consideration of a compromised and confidential payment
from the Company's errors and omissions carrier to Utica in excess of the
Company's self-insured retention of $100,000. The complaint has been dismissed
and all claims have been released.
Other
On April 4, 2001, the Company received a letter from another customer
alleging that the Company had materially breached the Company's contract with
that customer. On May 2, 2001, the Company entered a Termination and Settlement
Agreement with this customer under which the customer agreed to pay the Company
a compromised and confidential settlement amount for services the Company has
provided to this customer.
Unresolved Customer Disputes
Although the Company has settled seven of its customer disputes, the
Company has three unresolved customer disputes.
Crawford
On December 14, 2000, Crawford & Company ("Crawford") sent a letter to the
Company purporting to give notice of breach under the terms of the Master
Software License and Services Agreement between the Company and Crawford (the
"Crawford Agreement"). Crawford's letter also purports to give notice of
Crawford's election to terminate the Crawford Agreement. Crawford's letter
asserts that the Company failed to deliver the NIMBUS software application
within the agreed schedule for doing so. On September 4, 2001, Crawford filed a
demand for arbitration with the American Arbitration Association seeking $16.7
million from the Company for alleged breach of contract, breach of warranty and
failure to deliver contracted software. On September 20, 2001, the Company and
Crawford agreed to put the arbitration in abeyance pending ongoing discussions
between them and/or a possible mediation. If the discussions and/or mediation
are unsuccessful, either party may activate the arbitration. For the three
months ended September 30, 2001, the Company recognized no revenue from Crawford
and recognized $163,000 in revenues from Crawford during the same period in
2000. The Company recognized no revenue from the Crawford Agreement for the nine
months ended September 30, 2001, and recognized $2.3 million during the same
period of 2000.
Based on current knowledge, the Company does not believe it materially
breached the Crawford Agreement. Should the parties be unable to satisfactorily
resolve the issues between them, the Company will vigorously assert the its
rights under the Crawford Agreement and defend against Crawford's claims,
including recovery of the amounts that Crawford owes the Company and the
remaining amounts due under the Crawford Agreement totaling at least $1.8
million. An unfavorable outcome of this matter may have a material adverse
impact on the Company's business, results of operations, financial position, or
liquidity.
13
SkyTel
In March 2001, SkyTel Communications, Inc. ("SkyTel") orally informed the
Company of its intent to terminate the Master Software License and Services
Agreement between SkyTel and the Company (the "SkyTel Agreement"). On May 15,
2001, SkyTel sent the Company a letter purporting to terminate the SkyTel
Agreement based on the Company's alleged material breach of the SkyTel
Agreement. SkyTel's letter also demands a refund of approximately $11 million
paid by SkyTel under the SkyTel Agreement. On September 24, 2001, SkyTel filed a
complaint against the Company in the First Circuit Court of the First Judicial
District of Hinds County, Mississippi. In its complaint, SkyTel claims breach of
contract, breach of express warranties and breach of implied warranties. SkyTel
seeks monetary damages of at least $17.5 million, plus other damages it may
prove at trial, together with pre- and post-judgment interest, attorneys' fees
and expenses and costs. The matter is in its preliminary stages, and based on
the information currently available, the Company will vigorously assert the its
rights under the agreement and defend against the customer's claims, including
payment of the amounts that the customer owes the Company and the remaining
amounts due under the agreement totaling at least $ 6.2 million. This claim may
be covered by the supplemental extended reporting period policy the Company
maintains on one of its prior errors and omissions liability policies. The total
contract value involved in this customer dispute is approximately $17.6 million,
of which $11.4 million has been received by the Company to date. An unfavorable
outcome of this matter may have a material adverse impact on the Company's
business, results of operations, financial position, or liquidity.
Other Matters
On November 14, 2001, the Company received a letter from a customer
alleging that the Company has materially breached its contract with that
customer. The letter requests that the parties engage in an executive dispute
resolution procedure required by the contract. The Company does not believe that
it has materially breached the contract, and it has continued to perform under
the contract. Should the customer continue to assert that the Company has
materially breached the contract, the Company will vigorously assert its rights
under the contract and defend itself against any claims the customer may assert.
An unfavorable outcome of this matter may have a material adverse impact on the
Company's results of operations, financial position, or liquidity.
On November 19, 2001, the Company received a demand for arbitration from
Perot Systems Corporation ("Perot") alleging that the Company has materially
breached its prior purported agreements with Perot. The demand requests relief
of $3.1 million. The Company intends to vigorously assert its rights under the
contract and defend itself against the claims Perot has asserted. An unfavorable
outcome of this matter may have a material adverse impact on the Company's
results of operations, financial position, or liquidity. The Company has $2.0
million in accrued liabilities and $673,000 in accounts payable in the Condensed
Consolidated Balance Sheet at September 30, 2001, that it previously accrued
related to its agreements with Perot.
As a result of the legal proceedings and contingencies noted above, the
Company has provided an allowance for doubtful accounts of $818,000 related to
billed accounts receivable and $1.3 million related to unbilled accounts
receivable at September 30, 2001.
The Company maintained errors and omissions and umbrella liability
insurance coverage to protect itself in the event of claims for damages related
to the performance of or failure to perform computer-related services that
occurred after March 1, 1998 but prior to March 1, 2001. The Company also
maintains a limited supplemental extended reporting period policy on one of its
prior errors and omissions liability policies. The Company believes that this
insurance covers the types of alleged damages (but not unpaid or unbilled
accounts receivable) that may be claimed in the legal cases and customer
disputes noted above, to the extent that they occurred during the policy
periods, as well as covering the costs of legal defense, subject to the
policies' total limit, and any stated reservation of rights by the carrier
regarding conditions or findings that might exclude coverage for a particular
matter. The Company does not believe that the disputes with the unnamed
customer and Perot will be covered by this insurance. The Company has reserved
against certain of the billed and unbilled accounts receivable related to these
disputed amounts for which a loss is considered probable. An unfavorable outcome
or claim not covered by an insurance policy on one or more of these matters may
have a material adverse impact on the Company's business, results of operations,
financial position, or liquidity.
On November 18, 2000, the Company's excess errors and omissions policy
expired. On March 1, 2001, the Company's primary errors and omissions policy
expired. On March 1, 2001, the Company secured a new, industry standard, errors
and omissions policy that covers claims made after March 1, 2001. The Company's
new policy excludes contractual related disputes such as cost and time
guarantees, and only covers software errors or omissions that occur after the
14
delivery of software. The Company believes this policy provides adequate
coverage for potential damages related to errors and omissions in the Company's
delivered software.
The Company may in the future face other litigation or disputes with
customers, employees, partners, stockholders, or other third parties. Such
litigation or disputes could result in substantial costs and diversion of
resources that would harm the Company's business. An unfavorable outcome of
these matters may have a material adverse impact on the Company's business,
results of operations, financial position, or liquidity.
Stockholder Matters
On or after August 12, 2000, six complaints were filed in the United States
District Court of Utah alleging that the Company and certain of its officers
violated certain federal securities laws. All six complaints were virtually
identical and allege that 1) the Company improperly recognized revenues on some
of its projects; 2) the Company failed to maintain sufficient accounting
reserves to cover the risk of contract disputes or cancellations; 3) the Company
issued falsely optimistic statements that did not disclose these accounting
issues; and 4) Company insiders sold stock in early calendar year 2000 while
knowing about these issues.
On October 30, 2000, the Company's motion to consolidate the six complaints
into one class action complaint was granted. On March 7, 2001, the court
appointed lead plaintiffs and lead class counsel. On May 1, 2001, the plaintiffs
filed an amended consolidated complaint that repeats their earlier allegations
while adding additional details regarding the projects on which revenue was
allegedly improperly recognized. The Company filed a motion to dismiss the
amended complaint on June 19, 2001. The court has scheduled a hearing on the
motion to dismiss for November 26, 2001.
Management and outside legal counsel believe that the defendants have
meritorious defenses to the allegations made in these lawsuits. Because the
matter is in its preliminary stages, the Company's outside legal counsel is not
able to provide an opinion on the probable outcome of the claim and therefore,
no provision for loss has been recorded in the Company's Condensed Consolidated
Financial Statements. Although the Company carries directors and officers
liability insurance that the Company believes is sufficient for such class
action claims, the Company intends to vigorously defend itself and the Company
denies any wrongdoing. An unfavorable outcome of this matter may have a material
adverse impact on the Company's business, results of operations, financial
position, or liquidity.
On November 6, 2001, a class action complaint alleging violations of the
federal securities laws was filed in the United States District Court for the
Southern District of New York naming the Company, certain of its officers and
directors, and certain underwriters of the Company's initial public offering as
defendants. The complaint alleges, among other things, that the underwriters of
the Company's initial public offering violated the securities laws by failing to
disclose certain alleged compensation arrangements (such as undisclosed
commissions or stock stabilization practices) in the offering's registration
statement. The Company and certain of its officers and directors are named in
the complaint pursuant to Sections 11 and 15 of the Securities Act of 1933.
Similar complaints have been filed against over 180 other issuers that have had
initial public offerings since 1998. The Company intends to defend this action
vigorously. Although no assurance can be given that this matter will be resolved
in the Company's favor, the Company believes that the resolution of this lawsuit
will not have a material adverse effect on the Company's financial position,
results of operations or cash flows. An unfavorable outcome of this matter may
have a material adverse impact on the Company's business, results of operations,
financial position, or liquidity.
SEC Inquiry
On May 26, 2000, the United States Securities and Exchange Commission
("SEC") issued a Formal Order Directing Private Investigation. The Order
contains no specific factual allegations. The Company understands, however, that
the SEC is conducting a non-public fact-finding
15
inquiry into the Company's revenue recognition decisions on approximately 15
contracts. The Company has received several document subpoenas from the SEC and
the Company has complied or is in the process of complying with them. The
Company has learned that the SEC has issued subpoenas to the Company's
independent auditors and to several of the Company's current and former
customers. Since February 2001, the SEC has taken testimony from several of the
Company's current or former executives and personnel, including former chief
financial officers and sales executives and personnel. The SEC has scheduled to
take testimony from other of the Company's current and former executives and
personnel during October and December 2001.
The inquiry is in its preliminary stages and the Company has retained
outside legal counsel to represent the Company concerning the investigation. The
SEC has a number of statutory remedies that it may use in both fraud and
non-fraud (books and records) enforcement proceedings. These remedies include
various forms of injunctive relief, monetary penalties, and orders barring
individuals from future employment in public companies. It is too early in the
inquiry to say which of these remedies, if any, the SEC might seek against the
Company and its officers. Management and outside legal counsel believe that the
Company has meritorious defenses to any allegations the SEC may make and intend
to continue to cooperate fully with the SEC. However, because the inquiry is in
its preliminary stages, the Company's outside legal counsel is not able to
provide an opinion on the probable outcome of the inquiry. An unfavorable
outcome of this matter may have a material adverse impact on the Company's
business, results of operations, financial position, or liquidity.
10. Special Charges
Special charges for the nine months ended September 30, 2001 include $3.8
million in asset impairment charges, and $4.7 million in restructuring charges.
Asset Impairment Charge. During the nine months ended September 30, 2001,
the Company restructured operations to reduce operating expenses. As part of the
restructuring, the Company closed facilities in Atlanta, Georgia; Foster City,
California; Irving, Texas; Raleigh, North Carolina; Park Ridge, New Jersey; and
Salt Lake City, Utah. The Company had $1.8 million of leasehold improvements,
furniture and fixtures, and other assets in these offices that it determined had
no future value to the Company and are no longer in active use. In addition the
Company determined that $1.1 million of computer equipment was also similarly
impaired as a result of these restructuring activities. The Company also
determined that it would not be able to sell its Marin County land and building
for the amount it had previously expected, and as a result the Company recorded
a further asset impairment charge of $865,000 on this asset. Accordingly, the
Company recorded asset impairment charges of $135,000 and $3.8 million for the
three and nine months ended September 30, 2001, respectively.
Second Quarter 2001 Restructuring Charge. During the three months ended
June 30, 2001, the Company incurred a restructuring charge of $1.2 million as
part of its continuing efforts to reduce operating expenses. As part of this
restructuring, the Company decided to vacate a portion of its Salt Lake City,
Utah facilities, terminate its office lease expansion requirement in Chicago,
Illinois, vacate its office in Park Ridge, New Jersey, and reduce its workforce
by 70 individuals. The restructuring charge was comprised of $300,000 for
headcount reductions, and $900,000 for facilities related costs. During the
three months ended September 30, 2001, the Company increased the restructuring
charge related to these facilities by $47,000 due to changes in estimated future
net facilities related payments. As of September 30, 2001, $696,000 had been
paid out on this restructuring accrual.
The Company determined its restructuring charge in accordance with Emerging
Issues Task Force Issue No. 94-3 ("EITF 94-3") and Staff Accounting Bulletin No.
100 ("SAB 100"). EITF 94-3 and SAB 100 require that the Company commit to an
exit plan before it accrues employee termination costs and exit costs. Before
June 30, 2001, the Company's senior management prepared a detailed exit plan
that included the termination of 70 employees and the termination of certain
facilities leases.
16
In connection with the restructuring actions, the Company terminated the
employment of 70 employees, consisting primarily of administrative employees and
applications development employees in various locations. All employees
associated with these restructuring actions were notified as of June 14, 2001.
As of the date of these financial statements, the Company has terminated the
Chicago, Illinois expansion requirement and Park Ridge, New Jersey lease, and is
pursuing sublease arrangements for a vacated portion of its Salt Lake City, Utah
facilities.
The second quarter restructuring reserves are included in accounts payable
and accrued liabilities at September 30, 2001. Details related to the
restructuring charges for the period ended September 30, 2001 are summarized
below:
Balance at
Original September 30,
Second Quarter 2001 Restructuring Actions: Charge Increases Utilized 2001
- -------------------------------------------- ---------- ----------- ---------- -------------
Employee related $ 340 $ - $ 337 $ 3
Facilities related 905 47 359 593
---------- ----------- ---------- -------------
$ 1,245 $ 47 $ 696 $ 596
========== =========== ========== =============
Balance at
Original September 30,
Balance Sheet Components: Charge Increases Utilized 2001
- -------------------------------------------- ---------- ----------- ---------- -------------
Accounts payable and accrued liabilities $ 1,245 $ 47 $ 696 $ 596
---------- ----------- ---------- -------------
$ 1,245 $ 47 $ 696 $ 596
========== =========== ========== =============
First Quarter 2001 Restructuring Charge. During the three months ended
March 31, 2001, the Company incurred a restructuring charge of $2.7 million as
part of its continuing efforts to reduce operating expenses. As part of this
restructuring, the Company closed offices in Atlanta, Georgia; Foster City,
California; Irving, Texas; and Raleigh, North Carolina, and reduced its
workforce by 38 individuals. The restructuring charge was comprised of $226,000
for headcount reductions, and $2.5 million for facilities related costs. During
the three months ended September 30, 2001, the Company increased the
restructuring charge related to these facilities by $729,000 due to a decrease
in estimated future sublease rental rates from changes in real estate market
conditions. As of September 30, 2001 $1.3 million had been paid out on this
restructuring accrual.
The Company determined its restructuring charge in accordance with EITF
94-3 and SAB 100. EITF 94-3 and SAB 100 require that the Company commit to an
exit plan before it accrues employee termination costs and exit costs. On March
15, 2001, the Company's senior management prepared a detailed exit plan that
included the termination of 38 employees and closure of certain facilities.
In connection with the restructuring actions, the Company terminated the
employment of 38 employees, consisting primarily of applications development
employees, technical and other support employees, and administrative employees
in all of its locations. All employees associated with these restructuring
actions were notified as of March 31, 2001. At March 31, 2001 the Company had
exited facilities in Atlanta, Georgia; Foster City, California; Irving, Texas;
and Raleigh, North Carolina. As of the date of these financial statements, the
Company has terminated the Atlanta, Georgia lease, and is pursuing sublease
arrangements for the other facilities.
17
The first quarter restructuring reserves are included in accounts payable
and accrued liabilities at September 30, 2001. Detail related to the
restructuring charges for the period ended September 30, 2001 are summarized
below:
Balance at
Original September 30,
First Quarter 2001 Restructuring Actions: Charge Increases Utilized 2001
- -------------------------------------------- ---------- ----------- ---------- -------------
Employee related $ 226 $ - $ 225 $ 1
Facilities related 2,465 729 1,069 2,125
---------- ----------- ---------- -------------
$ 2,691 $ 729 $ 1,294 $ 2,126
========== =========== ========== =============
Balance at
Original September 30,
Balance Sheet Components: Charge Increases Utilized 2001
- -------------------------------------------- ---------- ----------- ---------- -------------
Accounts payable and accrued liabilities $ 2,691 $ 729 $ 1,294 $ 2,126
---------- ----------- ---------- -------------
$ 2,691 $ 729 $ 1,294 $ 2,126
========== =========== ========== =============
11. Operating Segments
The Company has adopted the provisions of Statement of Financial Accounting
Standards No. 131, Disclosure About Segments of an Enterprise and Related
Information ("SFAS No. 131"). SFAS No. 131 establishes standards for the
reporting by public business enterprises of information about operating
segments, products and services, geographic areas, and major customers. The
method for determining what information to report is based on the way that
management organizes the operating segments within the Company for making
operating decisions and assessing financial performance. The Company's chief
operating decision-maker is considered to be the Company's CEO.
In the fourth quarter of 1999, the Company implemented a vertical business
strategy. This vertical business strategy involved segmenting the Company's
business along industry lines, through the creation of separate subsidiaries,
and having these subsidiaries evolve into separate operating companies. During
the year ended December 31, 2000, the CEO reviewed financial information
presented on a consolidated basis accompanied by disaggregated information about
revenues by Vertical Business Group for purposes of making operating decisions
and assessing financial performance. Beginning in 2001, the Company's CEO
reviews the Company's financial information on a consolidated basis only. The
consolidated financial information reviewed by the CEO for the three and nine
months ended September 30, 2001 is identical to the information presented in the
accompanying consolidated statements of operations. Therefore, the Company
operates in a single operating segment, which is applications products and
services.
Revenues from operations outside of North America were approximately 25
percent of total revenues for the three months ended September 30, 2001 as
compared to 22 percent of total revenues for the same period in 2000 while
revenues from operations outside of North America were approximately 28 percent
of total revenues for the nine months ended September 30, 2001 as compared to 14
percent during the same period in 2000. The Company's long-lived assets continue
to be deployed predominantly in the United States.
Three customers accounted for 18 percent, 14 percent, and 14 percent of the
Company's total revenues for the three months ended September 30, 2001, as
compared to two customers accounting for 19 percent and 12 percent of the
Company's total revenues for the same period in 2000. No other single customer
accounted for more than 10 percent of the Company's total revenues for the three
months ended September 30, 2001 or the same period in 2000. Two customers
accounted for 27 percent and 17 percent of the Company's total revenue during
the nine months ended September 30, 2001 as compared to three customers
accounting for 15 percent, 13 percent, and 10 percent of the Company's revenues
for the same period in 2000. No other single customer accounted for more than 10
percent of the Company's total revenues for the nine months ended September 30,
2001 or the same period in 2000.
18
12. Acquisition and Disposition
On September 30, 1999, the Company entered into a Stock Purchase Agreement
("Agreement") with Barclays California Corporation ("BarCal") whereby the
Company purchased the entire equity interest of BarCal in its wholly owned
subsidiary, The LongView Group, Inc. ("LongView"). On October 7, 1999, the
acquisition was closed. On March 15, 2001, the Company sold LongView for $29.0
million to Linedata Services. Accordingly, the operations of LongView have been
included in the accompanying consolidated statements of operations for the
Company from the acquisition through March 15, 2001. The Condensed Consolidated
Statement of Operations for the nine months ended September 30, 2001 includes
revenues of approximately $3.4 million and net income of approximately $370,000
related to the operations of LongView. The acquisition was accounted for using
the purchase method of accounting.
In connection with the sale of LongView, the Company deposited $2.9 million
in an interest bearing escrow account to be used for settlement of indemnified
claims that might arise over the eighteen months following sale, which is
included in restricted cash on the Condensed Consolidated Balance Sheet at
September 30, 2001. The Company also incurred a state income tax liability of
approximately $1.5 million on the sale.
The gain recognized on the sale of LongView is summarized as follows (in
thousands):
Amount
---------
Total purchase price ............................... $ 29,000
Less costs associated with sale ............... (885)
---------
Net proceeds from sale ............................. 28,115
Net book value of subsidiary .......................
Current assets ................................ $ (1,455)
Long-term assets .............................. (21,441)
Current liabilities ........................... 5,745
Long-term liabilities ......................... 2,807
---------
(14,344)
---------
Initial gain on sale $ 13,771
---------
Proceeds for accounts receivable collection, less
additional expenses ................................ 177
Agreement to release $1.2 million of escrowed funds
to Linedata ........................................ (1,179)
---------
Cumulative gain on sale ............................ $ 12,769
=========
During the quarter ended September 30, 2001 the Company received an
additional $177,000 from collection of accounts receivable, less additional
closing costs.
During the quarter ended September 30, 2001, the Company began negotiations
of an agreement with Linedata, that was signed by the parties in October 2001,
under which the parties agreed to release each other from certain claims they
had or may have had against each other, and Linedata agreed to immediately
release to the Company $1.8 million of the previously escrowed funds, with
Linedata retaining the balance of $1.2 million. As a result, the Company reduced
its gain on sale of LongView by $1.2 during the quarter ended September 30,
2001, and recognized a corresponding liability to Linedata of $1.2 million which
is included in accrued liabilities in the Condensed Consolidated Balance Sheet
at September 30, 2001. During October 2001, the Company received the $1.8
million released from the escrow account and Linedata received $1.2 million, as
contemplated in the related agreement.
13. Subsidiary Stock Plans
During 1999, the Company formed six subsidiaries in each of which the
Company holds 20,000,000 issued and outstanding shares of common stock.
19
Each of the six subsidiaries formed during 1999, with approval of its
respective Board of Directors, adopted its own stock plan during 1999. The terms
of the plans are similar to the Company's 1999 Stock Plan. A total of 3,740,000
shares of common stock of each subsidiary has been reserved under the Stock
Plans for each of the six subsidiaries. The Company accounts for the sale of
common stock in the Company's subsidiaries as an equity transaction.
The stock underlying each subsidiary option grant is Class A common stock
of the subsidiary. The Company currently holds 10,000,000 shares of Class A
common stock in each subsidiary. Each subsidiary also has a Class B common stock
which is similar to the Class A common stock, except that the Class B common
stockholders as a class are entitled to elect 80 percent of the subsidiary's
directors. The Company currently holds 100 percent of the Class B common stock
authorized and issued by each of the subsidiaries, or 10,000,0000 shares. The
Company has no current intent to dispose of its Class A and Class B ownership
interests in any subsidiary.
The subsidiary common stock is not convertible into Company stock.
Employees can sell or transfer the subsidiary common stock, subject to
applicable securities laws and the subsidiary's right of first refusal on any
bona-fide offer to purchase such stock that the employee receives from a
third-party. Exercise of the subsidiary's right of first refusal is at the
subsidiary's choice. The right of first refusal terminates upon the public
registration of the subsidiary's stock. Neither the Company nor any subsidiary
is required to purchase these shares if the employee terminates employment.
Each subsidiary's Board of Directors determines the fair market value for
its stock at the date of option grant based upon its knowledge of the
subsidiary's financial condition, prospects, success in the marketplace, counsel
from their professional advisors such as outside counsel or independent
appraisers, and other factors.
The Company has not issued any options to purchase common stock in its
horizontal subsidiary, TenFold Technology, Inc.
One employee, who is no longer with the Company, exercised stock options
for the purchase of 200,000 shares at a purchase price of $4.80 per share in the
Company's insurance subsidiary during the three months ended March 31, 2000. No
compensation expense has been provided for this option exercise as the exercise
price was equivalent to the estimated fair market value of the insurance
subsidiary stock at the date of grant. The insurance subsidiary provides
large-scale e-business applications for leading customers in the insurance
industry. In connection with this option exercise, the Company loaned the
employee $960,000. During the three months ended December 31, 2000, the Company
established an allowance against the total amount of this note. As of September
30, 2001, the related minority interest has been reduced to zero due to net
operating losses incurred subsequent to the exercise of the stock options.
During the three months ended June 30, 2001, the employee resigned from the
subsidiary and agreed to transfer the shares back to the Company; and the
Company agreed to cancel the outstanding loan. As a result of this event, the
Company again owns 100 percent of its insurance subsidiary.
In March 2001, under the terms of its existing option plan, and in
connection with its sale of The LongView Group, Inc. the Company's Argenesis
subsidiary accelerated vesting of its outstanding stock options. Under the terms
of the existing option plan, optionees had a specified time to exercise their
options, or they would terminate. No optionee chose to exercise their options.
As a result, the options terminated, no Argenesis options remain outstanding and
the Company owns 100 percent of this subsidiary.
No grants of subsidiary stock options and no issuances of subsidiary stock
occurred during the three and nine months ended September 30, 2001.
20
14. Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities ("SFAS No. 133"). SFAS No. 133 establishes
new accounting and reporting standards for companies to report information about
derivative instruments, including certain derivative instruments embedded in
other contracts (collectively referred to as derivatives), and for hedging
activities. It requires that an entity recognize all derivatives as either
assets or liabilities in the balance sheet and measure those instruments at fair
value. For a derivative not designated as a hedging instrument, changes in the
fair value of the derivative are recognized in earnings in the period of change.
The Company adopted SFAS No. 133 on January 1, 2001. The adoption of SFAS No.
133 did not have a material effect on the Company's business, results of
operations, financial position, or liquidity. The Company has no derivatives as
of September 30, 2001.
In September 2000, the FASB issued SFAS No. 140, Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities -- a
replacement of FASB Statement No. 125. This standard revises the standards for
accounting for securitizations and other transfers of financial assets and
collateral and requires certain disclosures. This standard is effective for
transfers and servicing of financial assets and extinguishments of liabilities
occurring after March 31, 2001 and for disclosures relating to securitization
transactions and collateral for fiscal years ending after December 15, 2000. The
adoption of SFAS No. 140 did not have a material effect on the Company's
business, results of operations, financial position, or liquidity.
In July 2001, the FASB issued SFAS No. 141 Business Combinations and SFAS
No. 142 Goodwill and Other Intangible Assets. SFAS No. 141 requires business
combinations initiated after June 30, 2001 to be accounted for using the
purchase method of accounting, and broadens the criteria for recording
intangible assets separate from goodwill. SFAS No. 142 requires the use of a
non-amortization approach to account for purchased goodwill and certain
intangibles. Under a non-amortization approach, goodwill and certain intangibles
will not be amortized into results of operations, but instead will be reviewed
for impairment and written down and charged to results of operations only in the
periods in which the recorded value of goodwill and certain intangibles is more
than its fair value. The Company is required to adopt the provisions of SFAS No.
141 immediately, and SFAS No. 142 on January 1, 2002.
In June 2001, the FASB issued SFAS No. 143 Accounting for Asset Retirement
Obligations. SFAS No. 143 addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. This Statement applies to legal obligations
associated with the retirement of long-lived assets that result from the
acquisition, construction, development and (or) the normal operation of a
long-lived asset, except for certain obligations of lessees. The Company is
required to adopt the provisions of SFAS No. 143 on January 1, 2003.
In August 2001, the FASB issued SFAS No. 144 Accounting for the Impairment
or Disposal of Long-Lived Assets. SFAS No. 144 addresses financial accounting
and reporting for the impairment of long-lived assets and for long-lived assets
to be disposed of. The Company is required to adopt the provisions of SFAS No.
144 on January 1, 2002.
The Company is currently evaluating these statements but does not expect
that they will have a material effect on the Company's business, results of
operations, financial position, or liquidity.
21
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Forward Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements that
involve risks and uncertainties that may cause actual future events or results
to differ materially from those described in the forward-looking statements.
Words such as "expects," "intends," "anticipates," "should," "believes," "will,"
"plans," "estimates," "may," variations of such words and similar expressions
are intended to identify such forward-looking statements. We disclaim any
intention or obligation to revise any forward-looking statements whether as a
result of new information, future developments, or otherwise. There are many
factors that could cause actual results to differ materially from those
contained in the forward-looking statements. These factors include: ability to
generate sufficient cash flow; collectibility of final project payments; future
customer revenue; increased employee and consultant costs due to project delays;
limited operating history; ability to achieve cost reductions; general economic
conditions arising from the events of September 11, 2001; customer complaints
concerning our products and services, and the possibility of future additional
complaints; shareholder complaints concerning alleged violation of securities
laws, and the possibility of future additional complaints; possible de-listing;
reduced comprehensive errors and omissions insurance coverage; attraction,
training and retention of employees; variability of quarterly operating results;
dependence on a small number of customers; customer's fulfillment of various
responsibilities; completion of fixed-time, fixed-price contracts; risks
associated with the functionality and timing of new product releases; longer
than expected sales cycles; ability to accurately estimate resources required
for new and existing projects; changes in industry accounting guidance;
competitive factors; the mix of revenues derived from license sales as compared
to services; protection of intellectual property; retention of key project and
management personnel; entering into, maintaining and ending strategic
partnerships; and risks associated with the separation of The LongView Group,
Inc. from TenFold's operations. In addition, such statements could be affected
by general industry and market conditions and growth rates, general domestic and
international economic conditions including interest rate and currency exchange
rate fluctuations and other factors. Additional information concerning factors
that could cause actual results to differ materially from those in the
forward-looking statements is contained from time to time in documents filed by
TenFold Corporation with the Securities and Exchange Commission, including but
not limited to, the most recent reports on Forms 10-Q and 10-K. Some of these
factors are described under the section entitled "Factors That May Affect Future
Results and Market Price of Stock."
Business Overview
TenFold is the provider of the Universal Application(TM) Applications
platform, a software environment which simplifies the development, deployment
into production and maintenance of mission-critical, enterprise applications.
The Universal Application enables teams of predominantly business users to
design, build, test, deploy, and maintain complex, transaction-intensive,
internet-ready applications faster and at significantly lower cost than other
applications development technologies.
The Universal Application is a tightly integrated development and
maintenance environment and a powerful, efficient, scalable run-time
environment. This integrated development and maintenance environment includes:
business rules definitions; automatic Structured Query Language (SQL)
generation; automated user interface generation; Windows and Web-enablement;
integrated product testing, report generation, and data analysis; portability
across relational databases, operating systems and networks; and, code-less
means for integrating Universal Application-based applications with legacy and
third party applications.
The Universal Application platform has been in development over 8 years,
contains more than 2.5 million lines of C and C++ code, and is protected by
three issued patents. With the Universal Application, applications developers
with little or no traditional programming skills can build and maintain an
application by describing the application's desired data and functionality
without needing to program in C, C++, Java, HTML, SQL or other programming
languages.
22
While there are many companies supplying application development tools,
TenFold believes there is no other Applications platform supplier with
technology capable of addressing the scale and robustness required by the
complex applications which have been built on the Universal Application.
Several enterprise-scale, mission-critical applications are in production
using the underlying Universal Application technology at companies such as Abbey
National Bank, Allstate, Ameritech, Barclays Global Investors, iplan networks,
and others. Our customers are deriving previously difficult to realize business
benefits from their applications through the ability to maintain business rules
on-the-fly. A major insurance company, for example, determined that it can
introduce new multi-state insurance rate structures (i.e., business rules) in
hours versus weeks. Speed to application production and application
maintainability - of both business rules and underlying hardware, operating
system and databases - are the hallmarks of the Universal Application.
TenFold has a technology that makes building complex applications three to
ten times cheaper, easier, and faster. TenFold has learned that customer
business analysts can use the Universal Application to build better applications
than consultants or traditional programmers due to their detailed knowledge of
their business requirements. With this understanding, we have re-focused our
business from building applications for customers to providing the Universal
Application to customers and providing assistance and oversight as their
business teams build applications. The power of the Universal Application lies
not only in the foundation it provides to build robust, transaction-intensive
and complex rule-based applications, but that it can be efficiently used by
business analysts versus a traditional team of IT developers.
TenFold will continue to market the Universal Application and support
future customers using this model.
On November 16, 2001 we entered into an expanded relationship with an
existing customer, Allstate, which exemplifies this new business model. Through
this relationship, Allstate will receive support, training, and
time-and-material services from TenFold with the aim of enhancing Allstate's
ability to independently use Universal Application for applications development
within Allstate. Additionally, Allstate will have certain of its representatives
join the TenFold development team to receive training on core Universal
Application technology with the aim of providing Allstate with the ability to
maintain Universal Application internally, should it so desire.
Business History
From 1993 through 1995, we engaged primarily in the development of our
patented Universal Application technology and derived revenue primarily from
technology development and consulting projects, generally on a
time-and-materials basis. In 1996, we began using our Universal Application to
develop Universal Application-based applications. From 1997 through 2000, we
derived the majority of our revenues from fixed-price, fixed-time applications
development projects in which we offered a money-back guarantee (the "TenFold
Guarantee"). Starting in 1998, we also began reselling vertical applications
products that we had previously developed for other customers. In 1999 and early
2000 we signed several large, fixed-price, build-for-hire contracts with
customers and hired many new employees. Also, at this time, we formed and began
operation of six vertical market and two horizontal subsidiary companies or
divisions.
During the year ended December 31, 2000, we experienced several difficult
quarters. Our guaranteed fixed-price business model and difficulties in
delivering some projects by the guaranteed date led to several customer disputes
and prevented us from collecting final payments on several projects. We
currently have unresolved disputes with three customers and one business
partner.
As we disclosed these and other previous customer disputes in our quarterly
filings, the sales environment became increasingly difficult for us. The
substantial operating losses we incurred for the year ended December 31, 2000
further deteriorated our ability to sell our products and services. These sales
challenges occurred at a time when industry-wide technology spending appeared to
be slowing, making it even more difficult for us to attract new customers.
In addition to experiencing lower sales, our operating results were
negatively impacted by our operating structure. We conducted most of our
business operations during 2000 through largely autonomous vertical subsidiaries
in the communications, energy, financial services, healthcare, and insurance
industries. This decentralization structure promoted redundant overhead and
increased our operating costs.
23
Current Business Status
We began to change our business in early 2001, breaking away from our
legacy business model and coincident challenges of the past. During 2001, we
have:
1. Set a new strategic direction;
2. Laid the groundwork for future success; and,
3. Resolved most of the issues that damaged TenFold in recent quarters (and
established plans for resolving remaining issues).
Set a New Strategic Direction
-----------------------------
During 2001, we evaluated strategic alternatives for exploiting the
substantial value inherent in our technology, selected a new strategic
direction, and changed our business model. We are beginning to realize the value
of our vertical applications portfolio.
Evaluated Strategic Alternatives - We evaluated three potential,
alternative, strategic options for TenFold: technology platform company;
vertical applications product company; or, systems integration services company.
We have chosen, and we believe that we are solidly positioned, to transform
TenFold into a technology platform company built on our Universal Application
technology platform.
Changed Business Model - Beginning in the fourth quarter of 2000, we no
longer offer the TenFold Guarantee, and we provide new applications development
and implementation services on a time-and-materials basis, rather than on a
fixed-price, fixed-time basis.
Launched Universal Application Sales - During the first quarter of 2001 we
began to more actively promote the Universal Application to customers desiring
to use it to build their own Universal Application-based applications. In the
first half of 2001, one of our customers, a major insurance company, implemented
in ten states an insurance application that it developed using the Universal
Application.
Realizing the Value of Our Vertical Applications Portfolio - Over the past
twelve months, we have completed several best-of-breed applications products for
the communications, energy, financial services, and insurance markets. We
continue to build other vertical market applications products which we expect to
complete over the next several quarters. During the second quarter of 2001, we
formalized our vertical applications portfolio strategy. We hope to enter into
value added reseller (VAR) agreements with application companies which will take
ownership of the intellectual property, support, maintenance and marketing of
specific vertical market applications products. TenFold hopes to structure these
agreements to include up-front and/or ongoing payment streams to TenFold. We
believe this will accelerate broader market distribution at a significantly
lower cost than TenFold could achieve through development of its own
applications marketing and sales, and improve economies of scale in support,
training and maintenance to the benefit of potential customers. We believe that
because this will accelerate and broaden distribution of Universal
Application-based applications, it will also accelerate introduction of the
Universal Application.
From time to time, we expect to continue to identify unmet vertical
applications market needs, enter into time-and-materials build-for-hire
arrangements, build applications using the Universal Application and exploit the
value of the applications products in the manner described above. We expect
these projects to provide opportunities for us to showcase our technology, to
maintain world-class Universal Application-based applications development
expertise, and to generate cash from service and license revenue and/or from the
sale of vertical applications product assets.
24
Laid Groundwork for Future Success
----------------------------------
During 2001, we strengthened our delivery capabilities, improved customer
relationships and commenced Universal Application sales initiatives.
Strengthened Delivery Capabilities - During the first quarter of 2001, we
centralized management of our delivery organization. We achieved positive
delivery results during 2001 as we leveraged our experienced personnel for each
of our customer projects, improved project management controls, and provided
centralized oversight of all on-going projects. The improvements in our
applications delivery process has led to a significant improvement in our
ability to estimate project man-days remaining.
During the fourth quarter of 2000, we implemented a securities lending
application at two international locations of a large global institutional
investment manager.
During the first quarter of 2001, we completed some significant product
delivery milestones including implementing TenFold Wealth Manager in production
at a major mortgage lender, and passing a major scalability performance
benchmark for a large customer relationship management outsourcing company that
included demonstrating 2,400 concurrent end-user performance against a 3
terabyte database.
In the second quarter of 2001, we achieved significant project delivery
milestones for a large property and casualty insurance company, delivered a
billing and settlement application to a major energy and transmission provider,
and implemented customer management and product and order processing application
modules for an international communications company.
During the third quarter of 2001, we completed the production
implementation of Enterprise Relationship Manager, an end-to-end business
infrastructure platform designed exclusively for next-generation Internet and
communications service providers, for an international communications company;
and completed delivery of an integrated insurance policy rating and
administration application for production testing to a major property and
casualty insurance provider. Working with a major property and casualty insurer
and a hardware provider, at a scalability benchmarking center, we demonstrated
that the Universal Application scales vertically by supporting 5000+
simultaneous users on one computer, scales horizontally by doubling capacity to
10,000+ simultaneous users on two computers, and effectively parallelizes batch
processes by renewing 30,000 policies, in 60 batches of 500 each, in 39 minutes
total.
Improving Customer Relationships - Strengthened account management and
delivery capabilities have enabled improvement in our customer relationships.
Our customers' affirmation of their commitment to TenFold's technology and our
ability to deliver their business applications has, in many instances, resulted
in our applications moving (or being scheduled to move) into production, formal
acceptance of TenFold's completion of existing fixed-price contracts, expansion
of license scope and entering into new time-and-materials based services
contracts.
Commenced Sales Initiatives - During the second quarter of 2001, we took
two important actions to begin to rebuild momentum for new sales of our
Universal Application technology and related products and services. First, we
made a commitment to securing an indirect sales and delivery channel for the
Universal Application. We are in active negotiations with information technology
and consulting services and applications products organizations to enter into
VAR relationships. We hope that VAR relationships will be a significant source
of revenue growth for TenFold in 2002 and beyond. Second, we hired a seasoned
technology sales executive to lead our direct sales initiatives of the Universal
Application and our vertical applications products. We hired additional
technical and industry-specific sales talent during the third quarter of 2001 to
execute against our focused business model. In addition, we began developing
marketing initiatives around the Universal Application. Strategic marketing
initiatives including focused print advertising and rebuilding of our Web site
have been in development with plans for launch during the fourth quarter of
2001.
On November 16, 2001 we entered into an expanded relationship with an
existing customer, Allstate, which represents our first significant transaction
under our new sales and business model. Through this relationship, Allstate will
receive support, training, and time-and-materials services from TenFold with the
aim of enhancing Allstate's ability to independently use Universal Application
for applications development within Allstate. Additionally, Allstate will have
certain of its representatives join the TenFold development team to receive
training on core Universal Application technology with the aim of providing
Allstate with the ability to maintain Universal Application internally, should
it so desire.
25
Demonstrated Ability to Execute - During the third quarter of 2001, we
demonstrated our ability to execute to our new business model with significant
ongoing time-and-materials services and new customer pilots. However, like most
businesses, we have experienced the ripple effect of the events of September 11,
2001. In several cases, existing customers decided to scale-back project
commitments or delay project expansions and prospective customers decided to
postpone entering into new contracts. These decisions reduced our revenue and
cash flow for the third quarter of 2001 from what we previously expected.
Resolved Historical Issues
--------------------------
During 2001, we made significant strides towards resolving many of the
negative issues created by our historical business model. Specific areas of
accomplishment include consolidating operations, restructuring the business,
resolving customer disputes and progressing in other legal matters.
Consolidated Operations - In January 2001, we consolidated our vertical
business operations into one corporate organization to reduce costs, provide
better focus for employees and to solidify our core delivery and operational
infrastructure.
Restructured Business - From November 2000 to September 30, 2001, we have
reduced our headcount from approximately 744 to 246, and reduced the number of
principal operating offices from 13 to 4.
We commenced a restructuring of our business in November 2000 through a
reduction in force of 159 employees and the closure of redundant offices in San
Francisco, California; Chicago, Illinois; and Dallas, Texas. A second
restructuring in March 2001 further reduced the workforce by 58 employees,
including 20 employees who resigned voluntarily, and we closed offices in
Atlanta, Georgia; Irving, Texas; Foster City, California; and Raleigh, North
Carolina. A third restructuring in June 2001 further reduced the workforce by 70
employees.
We anticipate the impact of the three restructurings to generate annualized
savings of $57 million. As a consequence of our November 2000 restructuring we
reduced annualized operating costs by approximately $40 million. We expect the
March 2001 restructuring to generate additional annualized savings of
approximately $9 million. We expect the June 2001 restructuring to generate
additional annualized savings of approximately $8 million.
In addition to headcount reductions and office closures, we have taken
other aggressive steps to lower operating costs. In March 2001, we issued a
revised travel policy to significantly reduce travel expenses, which for the
year ended December 31, 2000 were approximately 13% of operating costs. We
performed a comprehensive review of our network costs and expect significant
reductions by canceling services in closed offices and other actions. We are
continuing to review expenses for company events, telecommunications,
contractors, and all other expenses with the objective of minimizing operating
expenses in 2001.
During the third quarter of 2001, we terminated or subleased 22,000 square
feet of office space lease obligations resulting in monthly savings of $62,000.
Through the first three quarters of 2001 we have terminated or subleased a total
of 105,000 square feet of office space lease obligations.
We recently restructured our financial obligations with three equipment
lessors. The payment restructuring will reduce our payments by approximately
$497,000 per quarter from the fourth quarter of 2001 through the 1st quarter of
2002. Beginning in April 2002, we are required to resume paying
pre-restructuring lease payment amounts through September 30, 2002. After
September 30, 2002, we are required to pay pre-restructuring lease payment
amounts plus approximately one twelfth of the deferred amount until paid in
full. In addition, we are in the process of working with our primary lender to
restructure payment obligations. See "Liquidity and Capital Resources" for
additional information.
26
Resolving Customer Disputes - In the first nine months of 2001, we have
favorably resolved seven customer disputes, one in Q1, four in Q2, and two in
Q3, as follows:
Unitrin - On March 8, 2001, we entered a Confidential Settlement
Agreement and Release with Unitrin Services Company, Inc. ("Unitrin")
dismissing all of Unitrin's claims. Our errors and omissions insurance
carrier paid the entire amount of the compromised and confidential
settlement sum above the $100,000 of self-insurance retention we
already paid to cover legal defense costs.
Westfield - Effective April 26, 2001, we entered into a Settlement and
Mutual Release with Ohio Farmers Insurance Company, doing business as
Westfield Companies, dismissing all claims each party had against the
other. Our errors and omissions insurance carrier paid a confidential
settlement sum above the $25,000 of self-insurance retention already
paid by us to cover legal defense costs.
Trumbull - On May 10, 2001, we entered into a Settlement Agreement and
Mutual Release with Trumbull Services LLC dismissing all claims each
party had against the other. Our errors and omissions insurance
carrier paid the entire amount of the compromised and confidential
settlement sum above the $100,000 of self-insurance retention we
already paid to cover legal defense costs.
Nielsen - Effective May 30, 2001, we entered into a Confidential
Settlement Agreement and Release with Nielsen Media Research, Inc.
dismissing all claims each party had against the other. Our errors and
omissions insurance carrier paid the entire amount of the compromised
and confidential settlement sum above the $100,000 of self-insurance
retention we already paid to cover legal defense costs.
SCEM - On August 27, 2001, we entered into a Confidential Settlement
Agreement and Release with Southern Company Energy Marketing L.P.
("SCEM") dismissing all claims each party had against the other. Our
errors and omissions insurance carrier paid the entire amount of the
compromised and confidential settlement sum above the $100,000 of
self-insurance retention we already paid to cover legal defense costs.
Utica - On August 16, 2001, we entered into a Confidential Settlement
Agreement and Release with Utica Mutual Insurance Company dismissing
all claims each party had against the other. Our errors and omissions
insurance carrier paid the entire amount of the compromised and
confidential settlement sum above the $100,000 of self-insurance
retention we already paid to cover legal defense costs.
Unnamed Customer - As we have previously disclosed, on April 4, 2001,
we received a letter from a customer alleging that we had materially
breached our contract with that customer. On May 2, 2001, we entered a
Termination and Settlement Agreement with this customer under which
the customer agreed to pay TenFold a compromised and confidential
settlement amount for services we provided to this customer.
In none of these settlement agreements did any party admit liability.
Our errors and omissions insurance carrier paid the entire amount of the
compromised and confidential settlement sum above the self-insurance
retention we paid to cover legal defense costs. With the resolution of
these disputes, we now have unresolved disputes with three customers and
one business partner. See "Legal Proceedings" for additional information.
Other Legal Matters - There are two other legal matters worthy of summary:
Stockholder Matters - On or after August 12, 2000, six complaints were
filed in the United States District Court of Utah alleging that we and
certain of our officers violated certain federal securities laws. On
October 30, 2000, our motion to consolidate the six
27
complaints into one class action complaint was granted. On March 7,
2001, the court appointed lead plaintiffs and lead class counsel. On
May 1, 2001, the plaintiffs filed an amended consolidated complaint.
TenFold filed a motion to dismiss the amended complaint on June 19,
2001. The court has scheduled a hearing on this motion to dismiss for
November 26, 2001. Our outside legal counsel is not able to provide an
opinion on the probable outcome of the claim. No provision for loss
has been recorded in our Condensed Consolidated Financial Statements.
See "Legal Proceedings" for additional information.
On November 6, 2001, a class action complaint alleging violations of
the federal securities laws was filed in the United States District
Court for the Southern District of New York naming TenFold, certain of
its officers and directors, and certain underwriters of TenFold's
initial public offering as defendants. The complaint alleges, among
other things, that the underwriters of our initial public offering
violated the securities laws by failing to disclose certain alleged
compensation arrangements (such as undisclosed commissions or stock
stabilization practices) in the offering's registration statement.
TenFold and certain of its officers and directors are named in the
complaints pursuant to Sections 11 and 15 of the Securities Act of
1933. TenFold intends to defend this action vigorously. No provision
for loss has been recorded in our Condensed Consolidated Financial
Statements. See "Legal Proceedings" for additional information.
SEC Inquiry - During the year ended December 31, 2000, the United
States Securities and Exchange Commission commenced a non-public,
fact-finding inquiry into TenFold. We have received several document
subpoenas from the SEC and we have complied or are in the process of
complying with them. Because this inquiry is still in the early
stages, management is unsure of the scope or the likely outcome of
this inquiry. See "Legal Proceedings" for additional information.
Recent Developments - We have seen some softening of demand on key customer
accounts subsequent to the events of September 11, 2001. Industry and financial
experts are specifically forecasting a slowing trend in upcoming months in four
specific business sectors:
. Insurance services
. Travel and hospitality services
. Retail support services
. Financial services
We have industry sector exposure with at least four of our major customers.
Our project managers are proactively monitoring and working closely with
customer teams and customer executive management to maintain full project
staffing, to increase utilization, and to ensure continuation of projects during
the fourth quarter of 2001.
Subsequent to the end of the third quarter of 2001, one of our customers
notified us of their intention to cancel their applications development project
and some notified us of their intention to reduce their time and materials
commitment due to changes in their businesss priorities. See "Revenue
Recognition" for additional information about the possible financial effects of
these cancellations on results for the fourth quarter of 2001.
On November 16, 2001 we significantly expanded our relationship with
Allstate. This expanded relationship includes a Universal Application license
and specific commitments for support, training, and time-and-materials services.
Additionally, Allstate will have certain of its representatives join the TenFold
development team to receive training on core Universal Application technology
with the aim of providing Allstate with the ability to maintain Universal
Application internally, should it so desire.
28
Results of Operations
We had third quarter 2001 revenues of $10.4 million, operating profits of
$1.4 million, and net income of $151,000.
The following table sets forth, for the periods indicated, the percentage
relationship of selected items from TenFold's statements of operations to total
revenues.
Three Months Nine Months
Ended September 30, Ended September 30,
-------------------- ---------------------
2001 2000 2001 2000
------- ------- -------- ---------
Revenues:
License ............................................. 7% 21% 18% 21%
Services ............................................ 93% 79% 82% 79%
------- -------- -------- --------
Total revenues .................................. 100% 100% 100% 100%
------- -------- -------- --------
Operating expenses:
Cost of revenues .................................... 26% 96% 49% 60%
Sales and marketing ................................. 6% 30% 11% 25%
Research and development ............................ 25% 34% 25% 25%
General and administrative .......................... 19% 44% 21% 21%
Amortization of goodwill and acquired intangibles ... - 6% 2% 4%
Amortization of deferred compensation ............... 2% 1% 2% 1%
Special charges ..................................... 9% - 20% -
------- -------- -------- --------
Total operating expenses ........................ 87% 211% 130% 136%
------- -------- -------- --------
Income (loss) from operations ............................ 13% -111% -30% -36%
Total other income, net .................................. -10% 2% 30% 2%
------- -------- -------- --------
Income (loss) before income taxes ........................ 3% -109% 0% -34%
Provision (benefit) for income taxes ..................... 2% 3% 8% -1%
Net income (loss) ........................................ 1% -112% -8% -33%
======= ======== ======== ========
Revenue Recognition
We derive our revenues from license fees, application development and
implementation services, support, and training services. License revenues
consist of fees for licensing the Universal Application as a tool or as a
developed application, and license fees for the applications that we develop for
our customers. We also derive license revenues from the resale of our vertical
applications products. Service revenues consist of fees for application
development and implementation, support and training.
In October 1997, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position ("SOP") 97-2, Software Revenue
Recognition, which supersedes SOP 91-1, Software Revenue Recognition.
Additionally, in 1998, the AICPA issued SOP 98-9, Modification of SOP 97-2 with
Respect to Certain Transactions. Effective January 1, 1998, we adopted the
provisions of SOP 97-2, as modified by SOP 98-9.
We generally enter into software arrangements that involve multiple
elements, such as software products, enhancements, post-contract customer
support ("PCS"), installation and training. We allocate a portion of the
arrangement fee to each undelivered element based on the relative fair values of
the elements. The fair values of an element must be based on vendor specific
objective evidence ("VSOE"). We establish VSOE based on the price charged when
the same element is sold separately. VSOE for services is based on standard
rates for the individuals providing services. These rates are the same rates
charged when the services are sold separately under time-and-materials
contracts. We base VSOE for training on standard rates charged for each
particular training course. These rates are the rates charged when the training
is sold separately for supplemental training courses. For PCS, VSOE is
determined by reference to the renewal rate that we charge the customer in
future periods. The fee allocated to the delivered
29
software product is based upon the residual method described in SOP 98-9.
We recognize license revenues from vertical application product sales and
Universal Application development licenses that do not include services or where
the related services are not considered essential to the functionality of the
software, when the following criteria are met: we have signed a noncancellable
license agreement with nonrefundable fees; we have shipped the software product;
there are no uncertainties surrounding product acceptance; the fees are fixed
and determinable; and collection is considered probable. This policy applies
both when the vertical application license or the Universal Application
development licenses are sold separately or when a Universal Application
development license is sold with an application development project. License
fees recognized upon achieving these criteria, for the three months ended
September 30, 2001 were $0 as compared to $1.7 million for the three months
ended September 30, 2000. License fees recognized upon achieving these criteria,
for the nine months ended September 30, 2001 were $1.2 million as compared to
$6.5 million for the nine months ended September 30, 2000. Services relating to
the Universal Application development licenses only include post contract
customer support services. Services for vertical application product licenses do
not add significant functionality, features, or significantly alter the
software. In addition, similar services are available from other vendors; there
are no milestones or customer specific acceptance criteria which affect the
realizability of the software license fee; and the software license fee is
non-cancelable and non-refundable.
The following table sets forth, for the periods indicated, the revenue
recognized by type (in thousands):
Three Months ended Nine Months
September 30, ended September 30,
------------------------ -------------------------
2001 2000 2001 2000
------------------------ -------------------------
Products:
Universal Application development license
revenue $ - $ 1,693 $ - $ -
Vertical application product license revenue - - 1,182 6,480
Solutions:
Percentage-of-completion license revenue 748 2,345 6,662 9,826
------------------------ -------------------------
Total license revenues $ 748 $ 4,038 $ 7,844 $ 16,306
Percentage-of-completion service revenue 3,132 12,971 21,624 55,512
Time-and-materials service revenue 4,854 - 9,782 -
Maintenance revenue 1,095 1,296 2,809 3,239
Training revenue 554 582 1,041 1,870
------------------------ -------------------------
Total services revenues $ 9,635 $ 14,849 $ 35,256 $ 60,621
------------------------ -------------------------
Total revenues $ 10,383 $ 18,887 $ 43,100 $ 76,927
======================== =========================
For software arrangements that include a service element that is considered
essential to the functionality of the software, we recognize license fees
related to the application, and the application development service fees, over
time as we perform the services, using the percentage-of-completion method of
accounting and following the guidance in Statement of Position ("SOP") 81-1,
Accounting for Performance of Construction-Type and Certain Production-Type
Contracts. We determined our proposed fixed price for a project using a formal
estimation process that takes into account the project's timetable, complexity,
technical environment, risks, and other available alternatives. Members of our
senior management team approve each proposal. We make adjustments, if necessary,
to the estimates used in the percentage-of-completion method of accounting as
work progresses under the contract and as we gain experience. For presentation
purposes within the Condensed Consolidated Statement of Operations, fixed-price
project revenues are split between license and service based upon the relative
fair value of the components. In 2001, we intend to provide new application
development and implementation services on a time-and-materials basis, rather
than on a fixed-price basis. In addition, we have converted certain of, and
expect to convert more of, our existing fixed-time, fixed-price application
development and implementation contracts to a time-and-materials basis.
30
For certain projects, we limit revenue recognition in the period to the
amount of direct and indirect project costs incurred in the same period, and
postpone recognition of profits until results can be estimated more precisely.
Beginning with the three months ended June 30, 2000 we applied this "zero
profit" methodology to two existing projects. We added two additional existing
projects and one new project to the "zero profit" methodology during the three
months ended September 30, 2000. At December 31, 2000, we applied this "zero
profit" methodology to all fixed-price projects except those relating to our
Revenue Manager and LongView applications. At September 30, 2001, we are
applying this "zero profit" methodology to all fixed-price projects. The total
project values for ongoing projects at September 30, 2001 accounted for using
the "zero profit" methodology is approximately $22.2 million. Revenue recognized
from projects on this "zero profit" methodology during the three months ended
September 30, 2001 was $3.9 million as compared to $858,000 during the three
months ended September 30, 2000, while revenue recognized from these projects
during the nine months ended September 30, 2001 was $25.1 million as compared to
$8.9 million during the nine months ended September 30, 2000. Revenue recognized
during the three months ended September 30, 2001 on the "zero profit"
methodology for ongoing projects was $2.0 million with equal amounts of cost;
while revenue recognized on terminated projects during the same period was $1.9
million, representing profits recognized upon termination of remaining project
obligations, with no corresponding costs.
In mid-1998, we began offering the TenFold Guarantee, a money-back
guarantee for large-scale software applications. As a result, in some of our
contracts, we have guaranteed that we will complete our projects within a fixed
time period or we will refund the fees paid. This guarantee also requires the
customer to fulfill various responsibilities within a specified time period,
including reviewing and approving requirements, providing timely feedback, and
providing adequate staffing, or the guarantee is voided. Accordingly, we treat
this guarantee as a conditional guarantee. We recognize revenue under contracts
with performance guarantees using the percentage-of-completion method of
accounting. If necessary, we make provisions for estimated refunds or losses on
uncompleted contracts on a contract-by-contract basis and recognize the refunds
or losses in the period in which the refunds or losses become probable and we
can reasonably estimate them. Beginning in the fourth quarter of 2000, we no
longer offer a performance guarantee as a standard part of our contracts.
During October 2001, we received notice that a customer was canceling their
fixed-price contract. Effective November 14, 2001, we entered into a Termination
Agreement with the customer which releases each party of remaining obligations
under the fixed-price contract including obligations under the TenFold
Guarantee. We have recognized no revenue from this contract during the three
months ended September 30, 2001, and recognized $673,000 during the same period
of 2000. We recognized no revenue from this contract during the nine months
ended September 30, 2001, and recognized $3.3 million during the same period of
2000. As a result of the Termination Agreement we expect to recognize $2.0
million of deferred revenue and $2.0 million of deferred project expenses during
the three months ending December 31, 2001. Additionally, we recorded an accrual
for costs to complete the contract obligations under the fixed-price contract of
$84,000 at September 30, 2001. We incurred these costs during October 2001 prior
to the cancellation of the contract.
We have two customers with guarantees in their fixed-price contracts. We
believe that the application and required deliveries under the contracts will
comply with the contractual terms of our customer agreements; however these
guarantees represent a risk to us. Missing any of the deliveries for these
customers may have a material adverse impact on our business, results of
operations, financial position, or liquidity.
For time-and-material contracts, we generally estimate a profit range and
recognize the related revenue using the lowest probable level of profit
estimated in the range. Billings in excess of revenue recognized under
time-and-material contracts are deferred and recognized upon completion of the
time-and-material contract or when the results can be estimated more precisely.
We recognize support revenue from contracts for ongoing technical support
and product updates ratably over the support period. We recognize training
revenue as we perform the
31
services.
Revenues
Total revenues decreased $8.5 million, or 45 percent, to $10.4 million for
the three months ended September 30, 2001, as compared to $18.9 million for the
same period in 2000, while total revenues decreased $33.8 million, or 44
percent, to $43.1 million for the nine months ended September 30, 2001, as
compared to $76.9 million for the same period in 2000. The decrease in revenues
during the three and nine months ended September 30, 2001 is primarily due to
lower sales, and limiting revenue recognition on certain fixed-price projects to
costs incurred. Revenue recognized during the three months ended September 30,
2001 on the "zero profit" methodology for ongoing projects was $2.0 million with
equal amounts of cost; while revenue recognized on terminated projects during
the same period was $1.9 million, representing profits recognized upon
termination of remaining project obligations, with no corresponding costs.
License revenues decreased $3.3 million, or 81 percent, to $748,000 for the
three months ended September 30, 2001 as compared to $4.0 million for the same
period in 2000, while license revenues decreased $8.5 million, or 52 percent, to
$7.8 million for the nine months ended September 30, 2001 as compared to $16.3
million for the same period in 2000. We recognize license revenues from vertical
application product sales and some Universal Application development license
sales when we have a signed noncancellable license agreement with fixed and
determinable nonrefundable fees, we have shipped the product, and there are no
uncertainties surrounding acceptance of the product or collection of the stated
fees. Due primarily to the reasons for lower overall revenues described above,
license sales for these products were lower for the three and nine months ended
September 30, 2001 than for the same periods in 2000.
Service revenues decreased $5.2 million, or 35 percent, to $9.6 million for
the three months ended September 30, 2001 as compared to $14.8 million for the
same period in 2000, while service revenues decreased $25.4 million, or 42
percent, to $35.3 million for the nine months ended September 30, 2001 as
compared to $60.6 million for the same period in 2000. Service revenues
decreased for the three and nine months ended September 30, 2001 compared to the
same periods in 2000 due primarily to the reasons for lower overall revenues
described above.
Revenues from operations outside of North America were approximately 25
percent of total revenues for the three months ended September 30, 2001 as
compared to 22 percent of total revenues for the same period in 2000 while
revenues from operations outside of North America were approximately 28 percent
of total revenues for the nine months ended September 30, 2001 as compared to 14
percent during the same period in 2000. The Company's long-lived assets continue
to be deployed predominantly in the United States.
Three customers accounted for 18 percent, 14 percent, and 14 percent of the
Company's total revenues for the three months ended September 30, 2001, as
compared to two customers accounting for 19 percent and 12 percent of the
Company's total revenues for the same period in 2000. No other single customer
accounted for more than 10 percent of the Company's total revenues for the three
months ended September 30, 2001 or the same period in 2000. Two customers
accounted for 27 percent and 17 percent of the Company's total revenue during
the nine months ended September 30, 2001 as compared to three customers
accounting for 15 percent, 13 percent, and 10 percent of the Company's revenues
for the same period in 2000. No other single customer accounted for more than 10
percent of the Company's total revenues for the nine months ended September 30,
2001 or the same period in 2000.
We believe that period to period comparisons between license and services
revenues are not necessarily indicative of future performance given the nature
of our product and services offerings, the relative emphasis we apply to these
offerings in any given period, and changes in our business model.
Operating Expenses
32
Cost of Revenues. Cost of revenues consists primarily of compensation and
other related costs of personnel to provide application development and
implementation, support, and training services. Cost of revenues decreased $15.4
million, or 85 percent, to $2.7 million for the three months ended September 30,
2001 compared to $18.1 million for the same period in 2000, while cost of
revenues decreased $24.8 million, or 54 percent, to $21.3 million for the nine
months ended September 30, 2001 compared to $46.1 million for the same period in
2000. Cost of revenues as a percentage of total revenues was 26 percent for the
three months ended September 30, 2001 as compared to 96 percent for the same
period in 2000, while cost of revenues as a percentage of total revenues was 49
percent for the nine months ended September 30, 2001 as compared to 60 percent
for the same period in 2000. The decrease in absolute dollars, and as a
percentage of total revenues, between periods was primarily due to having fewer
employees working on customer projects, support and training due to the
reduction in our workforce associated with our restructuring actions and
employee attrition. In addition, costs of revenues decreased during the three
months ended September 30, 2001 due to a net decrease in estimated project loss
accruals of $2.8 million, due primarily to the settlement of related customer
litigation without further cost to TenFold. See "Legal Proceedings" for
additional information.
Sales and Marketing. Sales and marketing expenses consist primarily of
compensation, travel, and other related expenses for sales and marketing
personnel, as well as advertising and other marketing expenses. Sales and
marketing expenses decreased $5.0 million, or 88 percent, to $678,000 for the
three months ended September 30, 2001 as compared to $5.6 million for the same
period in 2000, while sales and marketing expenses decreased $14.0 million, or
74 percent, to $4.9 million for the nine months ended September 30, 2001 as
compared to $18.9 million for the same period in 2000. Sales and marketing
expenses as a percentage of total revenues were 6 percent for the three months
ended September 30, 2001 as compared to 30 percent for the same period in 2000,
while sales and marketing expenses as a percentage of total revenues were 11
percent for the nine months ended September 30, 2001 as compared to 25 percent
for the same period in 2000. The decrease in sales and marketing expenses in
absolute dollars, and as a percentage of total revenues, was due to having fewer
sales and marketing employees and our allocation of our resources towards
completion of our application development projects rather than to sales and
marketing activities.
Research and Development. Research and development expenses consist
primarily of compensation and other related costs of personnel dedicated to
research and development activities. Research and development expenses decreased
$3.9 million, or 60 percent, to $2.6 million for the three months ended
September 30, 2001 as compared to $6.5 million for the same period in 2000,
while research and development expenses decreased $8.7 million, or 45 percent,
to $10.5 million for the nine months ended September 30, 2001 as compared to
$19.3 million for the same period in 2000. Research and development expenses as
a percentage of total revenues were 25 percent for the three months ended
September 30, 2001 as compared to 34 percent for the same period in 2000, while
research and development expenses as a percentage of total revenues were 25
percent for the nine months ended September 30, 2001 as compared to 25 percent
for the same period in 2000. Research and development expenses decreased due
primarily to having fewer research and development employees during the three
and nine months ended September 30, 2001, than in the same periods of 2000.
General and Administrative. General and administrative expenses consist
primarily of allowances for doubtful accounts, the costs of executive
management, finance and administrative staff, recruiting, business insurance,
and professional fees. General and administrative expenses decreased $6.4
million, or 77 percent, to $1.9 million for the three months ended September 30,
2001 as compared to $8.3 million for the same period in 2000, while general and
administrative expenses decreased $7.1 million, or 44 percent, to $9.2 million
for the nine months ended September 30, 2001 as compared to $16.3 million for
the same period in 2000. General and administrative expenses as a percentage of
total revenues were 19 percent for the three months ended September 30, 2001 as
compared to 44 percent for the same period in 2000, while general and
administrative expenses as a percentage of total revenues were 21 percent for
the nine months ended September 30, 2001 as compared to 21 percent for the same
period in 2000. The decreases in general and administrative expenses during the
three and nine months ended
33
September 30, 2001 compared to the same periods in 2000 was primarily due to
lower provisions for doubtful accounts during the current periods, and having
fewer general and administrative employees due to the reduction in our workforce
associated with our restructuring actions and employee attrition.
Amortization of Goodwill and Acquired Intangibles. Amortization of goodwill
and acquired intangibles resulted from the acquisition of The LongView Group,
Inc. ("LongView"). The remaining intangible assets, after the write-off of in
process research and development, totaled $24.6 million and were amortized over
the expected lives of the goodwill and intangibles until we sold LongView on
March 15, 2001. These lives ranged from five to seven years. We recorded
amortization expense of goodwill and acquired intangibles of $0 and $962,000 for
the three and nine months ended September 30, 2001, respectively, as compared to
$1.2 million for the three months ended September 30, 2000, and $3.5 million for
the nine months ended September 30, 2000.
On March 15, 2001 we sold The LongView Group, Inc. to Linedata Services for
$29.0 million in cash. See Note 12 of "Notes to Condensed Consolidated Financial
Statements" for additional information. As a result, we did not incur any
further charges for amortization of goodwill and acquired intangibles related to
LongView after March 15, 2001.
Amortization of Deferred Compensation. Deferred compensation, along with
the associated amortization, results from the granting of stock or stock options
when there is a difference between the purchase or exercise price and the deemed
fair value of the common stock at the time of such grants. Certain grants during
1997, 1998, 1999 and 2001 were issued at a price that was less than the deemed
fair value at the grant date. We are amortizing these amounts over the vesting
periods of the applicable options, resulting in amortization expense of $185,000
for the three months ended September 30, 2001 as compared to $275,000 for the
same period in 2000, and amortization expense of $698,000 for the nine months
ended September 30, 2001 as compared to $942,000 for the same period in 2000.
When employees who were granted these options leave TenFold, we reduce the
associated deferred compensation. The decreases in amortization expense for the
three and nine months ended September 30, 2001 as compared to the same periods
of 2000, are due to employees leaving TenFold, and were partially offset by an
increase in amortization expense related to a restricted stock grant made in
2001 that has deferred compensation of $280,000 associated with it.
Special Charges. Special charges for the nine months ended September 30,
2001 include $3.8 million in asset impairment charges, and $4.7 million in
restructuring charges.
Asset Impairment Charge. During the nine months ended September 30, 2001,
we restructured operations to reduce operating expenses. As part of the
restructuring, we closed facilities in Atlanta, Georgia; Foster City,
California; Irving, Texas; Raleigh, North Carolina; Park Ridge, New Jersey; and
Salt Lake City, Utah. We had $1.8 million of leasehold improvements, furniture
and fixtures, and other assets in these offices that we determined had no future
value to us and are no longer in active use. In addition we determined that $1.1
million of computer equipment was also similarly impaired as a result of these
restructuring activities. We also determined that we would not be able to sell
our Marin County land and building for the amount we had previously expected,
and as a result we recorded a further asset impairment charge of $865,000 on
this asset. Accordingly, the Company recorded asset impairment charges of
$135,000 and $3.8 million for the three and nine months ended September 30,
2001, respectively.
Second Quarter 2001 Restructuring Charge. During the three months ended
June 30, 2001, we incurred a restructuring charge of $1.2 million as part of our
continuing efforts to reduce operating expenses. As part of this restructuring,
we decided to vacate a portion of our Salt Lake City, Utah facilities, terminate
our office lease expansion requirement in Chicago, Illinois, vacate our office
in Park Ridge, New Jersey, and reduce our workforce by 70 individuals. The
restructuring charge was comprised of $300,000 for headcount reductions, and
$900,000 for facilities related costs. During the three months ended September
30, 2001, we increased the restructuring charge related to these facilities by
$47,000 due to changes in estimated future net
34
facilities related payments. As of September 30, 2001, $696,000 had been paid
out on this restructuring accrual.
We determined our restructuring charge in accordance with Emerging Issues
Task Force Issue No. 94-3 ("EITF 94-3") and Staff Accounting Bulletin No. 100
("SAB 100"). EITF 94-3 and SAB 100 require that we commit to an exit plan before
we accrue employee termination costs and exit costs. Before June 30, 2001, our
senior management prepared a detailed exit plan that included the termination of
70 employees and the termination of certain facilities leases.
In connection with the restructuring actions, we terminated the employment
of 70 employees, consisting primarily of administrative employees and
applications development employees in various locations. All employees
associated with these restructuring actions were notified as of June 14, 2001.
As of the date of these financial statements, we have terminated the Chicago,
Illinois expansion requirement and Park Ridge, New Jersey lease, and are
pursuing sublease arrangements for a vacated portion of our Salt Lake City, Utah
facilities.
We expect to generate annualized savings of approximately $7.9 million
($0.22 per share) as a result of this restructuring in the following areas: $4.0
million in reduced cost of revenues, $900,000 in reduced sales and marketing
expenses, $1.2 million in reduced research and development expenses, and $1.8 in
reduced general and administrative expenses.
The second quarter restructuring reserves are included in accounts payable
and accrued liabilities at September 30, 2001. Details related to the
restructuring charges for the period ended September 30, 2001 are summarized
below:
Balance at
Second Quarter 2001 Restructuring Original September 30,
Actions: Charge Increases Utilized 2001
- ------------------------------------------ -------- --------- -------- -------------
Employee related $ 340 $ - $ 337 $ 3
Facilities related 905 47 359 593
-------- -------- -------- -------------
$ 1,245 $ 47 $ 696 $ 596
======== ======== ======== =============
Balance at
Original September 30,
Balance Sheet Components: Charge Increases Utilized 2001
- ------------------------------------------ -------- --------- -------- -------------
Accounts payable and accrued liabilities $ 1,245 $ 47 $ 696 $ 596
-------- -------- -------- -------------
$ 1,245 $ 47 $ 696 $ 596
======== ======== ======== =============
First Quarter 2001 Restructuring Charge. During the three months ended
March 31, 2001, we incurred a restructuring charge of $2.7 million as part of
our continuing efforts to reduce operating expenses. As part of this
restructuring, we closed offices in Atlanta, Georgia; Foster City, California;
Irving, Texas; and Raleigh, North Carolina, and reduced our workforce by 38
individuals. The restructuring charge was comprised of $226,000 for headcount
reductions, and $2.5 million for facilities related costs. During the three
months ended September 30, 2001, we increased the restructuring charge related
to these facilities by $729,000 due to a decrease in estimated future sublease
rental rates from changes in real estate market conditions. As of September 30,
2001 $1.3 million had been paid out on this restructuring accrual.
We determined our restructuring charge in accordance with EITF 94-3 and SAB
100. EITF 94-3 and SAB 100 require that we commit to an exit plan before we
accrue employee termination costs and exit costs. On March 15, 2001, our senior
management prepared a detailed exit plan that included the termination of 38
employees and closure of certain facilities.
In connection with the restructuring actions, we terminated the employment
of 38 employees, consisting primarily of applications development employees,
technical and other support employees, and administrative employees in all of
its locations. All employees associated with these restructuring actions were
notified as of March 31, 2001. At March 31, 2001 we had exited facilities in
Atlanta, Georgia; Foster City, California; Irving, Texas; and Raleigh, North
35
Carolina. As of the date of these financial statements, we have terminated the
Atlanta, Georgia lease, and are pursuing sublease arrangements for the other
facilities.
We expect to generate annualized savings of approximately $9 million ($0.26
per share) as a result of this restructuring in the following areas: $5 million
in reduced cost of revenues, $200,000 in reduced sales and marketing expenses,
$3 million in reduced research and development expenses, and $500,000 in reduced
general and administrative expenses.
The first quarter restructuring reserves are included in accounts payable
and accrued liabilities at September 30, 2001. Details related to the
restructuring charges for the period ended September 30, 2001 are summarized
below:
Balance at
Original September 30,
First Quarter 2001 Restructuring Actions: Charge Increases Utilized 2001
- ------------------------------------------- ---------- ----------- ---------- --------------
Employee related $ 226 $ - $ 225 $ 1
Facilities related 2,465 729 1,069 2,125
---------- ----------- ---------- --------------
$ 2,691 $ 729 $ 1,294 $ 2,126
========== =========== ========== ==============
Balance at
Original September 30,
Balance Sheet Components: Charge Increases Utilized 2001
- ------------------------------------------- ---------- ----------- ---------- --------------
Accounts payable and accrued liabilities $ 2,691 $ 729 $ 1,294 $ 2,126
---------- ----------- ---------- --------------
$ 2,691 $ 729 $ 1,294 $ 2,126
========== =========== ========== ==============
Total Other Income, net
Net total other income decreased $1.5 million, to a loss of $1.0 million
for the three months ended September 30, 2001 compared to income of $442,000 for
the same period in 2000, while net other income increased $11.3 million, to
$12.9 million for the nine months ended September 30, 2001 compared to $1.7
million for the same period in 2000. The decrease for the three months ended
September 30, 2001 as compared to the same period in 2000 was due primarily to
our reducing our gain on sale of LongView by $1.2 million during this period, as
a result of our agreeing to release $1.2 million of previously escrowed funds to
Linedata. Linedata agreed to release the remaining $1.8 million of previously
escrowed funds to us. The increase for the nine months ended September 30, 2001
as compared to the same period in 2000, was primarily due to a gain of
approximately $12.8 million on the sale of The LongView Group, Inc. to Linedata
Services on March 15, 2001. See Note 12 of "Notes to Condensed Consolidated
Financial Statements" for additional information.
Provision for Income Taxes
The provision for income taxes was $209,000 for the three months ended
September 30, 2001 as compared to a provision of $543,000 for the same period of
2000, while the provision for income taxes was $3.4 million for the nine months
ended September 30, 2001 as compared to a benefit of $905,000 for the same
period of 2000. The provision for the three months ended September 30, 2001 is
for foreign taxes, while the provision for the nine months ended September 30,
2001 is primarily for income taxes on the gain from our sale of The LongView
Group, Inc., foreign taxes, and an adjustment to record a valuation allowance
against the remaining net tax assets.
As of September 30, 2001, management continues to recognize a valuation
allowance for the net deferred tax assets related to temporary differences,
foreign tax credit carryforwards and net operating loss carryforwards. The
valuation allowance was recorded in accordance with the provisions of Statement
of Financial Accounting Standards ("SFAS") No. 109, Accounting for Income Taxes,
which requires that a valuation allowance be established when there is
significant uncertainty as to the realizability of the deferred tax assets.
Based on a number of factors, the currently available, objective evidence
indicates that it is more likely than not that the net
36
deferred tax assets will not be realized.
Other Matters
The timing and amount of cash received from customers can vary
significantly depending on specific contract terms and can therefore have a
significant impact on the amount of deferred revenue and unbilled accounts
receivable in any given period. We record billings and cash received in excess
of revenue earned as deferred revenue. Our deferred revenue balance at September
30, 2001 was $14.2 million. We expect to recognize most of this amount as
revenue within the next twelve months. Our deferred revenue balance generally
results from contractual commitments made by customers to pay amounts to us in
advance of revenues earned, and from application of the "zero profit" margin
methodology described above. Our unbilled accounts receivable represents revenue
that we have earned but which we have not yet billed. We bill customers as
payments become due under the terms of the customer's contract. We consider
current information and events regarding our customers and their contracts and
establish allowances for doubtful accounts when it is probable that we will be
unable to collect amounts due under the terms of existing contracts.
Liquidity and Capital Resources
We have funded our operations to date primarily through cash flows from
operations, through cash generated from our initial public offering in May 1999,
the private sale of securities, and through the use of lines of credit and
equipment leases. During the nine months ended September 30, 2001 we also used
proceeds from our sale of The LongView Group, Inc. to help fund operations.
Net cash used in operating activities was $26.7 million for the nine months
ended September 30, 2001 as compared to $15.5 million net cash used in operating
activities during the nine months ended September 30, 2000. The increase in cash
flows used in operating activities was due primarily to lower cash inflows from
lower new sales and revenues.
Net cash provided by investing activities was $22.0 million for the nine
months ended September 30, 2001 as compared to net cash used of $13.5 million
during the nine months ended September 30, 2000. During the three months ended
March 31, 2001, we sold The LongView Group, Inc. to Linedata Services for $29.0
million. The additions to restricted cash for the nine months ended September
30, 2001, are primarily for deposits to secure letters of credit in the amount
of $3.5 million and $2.9 million placed in escrow as required by our agreement
with Linedata Services. See Note 12 of "Notes to Condensed Consolidated
Financial Statements" for additional information related to the escrow
arrangement with Linedata Services.
Net cash used in financing activities was $3.4 million for the nine months
ended September 30, 2001 as compared to $3.8 million net cash used in financing
activities during the nine months ended September 30, 2000. Net cash used by
financing activities for the nine months ended September 30, 2001 resulted
primarily from principal payments on notes and capital leases of $4.1 million,
which were partially offset by proceeds of $533,000 from the issuance of shares
under the employee stock purchase plan.
On January 18, 1999, we entered into a Revolving Line of Credit (the
"Credit Facility") providing for borrowings of up to $5.0 million. The Credit
Facility included covenants relating to the maintenance of certain financial
ratios and cash balances and limiting the payment of dividends. Through a series
of modifications, we increased the availability under the Credit Facility to
$15.0 million and established the ability to issue letters of credit against
this availability. We agreed to secure outstanding letters of credit with
compensating cash balances upon default or expiration of the Credit Facility.
During 2000, we obtained letters of credit of approximately $3.5 million related
to office leases and $2.0 million to secure a performance bond. On November 15,
2000 our ability to borrow under the Credit Facility expired. We had no
borrowings under the Credit Facility. On December 1, 2000, we received notice of
a right to cure,
37
referencing failure to provide the lender with cash collateral to secure the
outstanding letters of credit and our failure to meet and maintain certain
financial covenants described in the Credit Facility. Upon receiving this
notice, we commenced negotiations with the lender to satisfy the right to cure.
On January 19, 2001 we allowed the lender to secure a perfected lien under its
security agreement. On February 23, 2001, we further modified the Credit
Facility with a Modification and Forbearance Agreement. This agreement provides
us with a limited waiver of defaults and forbearance of remedies. The limited
waiver and forbearance of remedies applies to the cash collateral and financial
covenant requirements. The waiver had an expiration date of the earlier of May
31, 2001 or on the occurrence of an event of default on any of our obligations
to the lender, including a $2.4 million property loan and $6.3 million in notes
payable outstanding at December 31, 2000. The Agreement also allows for cross
default on all of our obligations with the bank. The cash collateral agreement
required us to bring the balance of a restricted cash collateral account to $3.5
million prior to September 30, 2001. On March 16, 2001, we complied with the
requirements of the cash collateral agreement and, using $3.5 million of the
cash proceeds received from the sale of LongView, increased the balance in the
restricted cash collateral account to $3.5 million. On April 2, 2001 we extended
the waiver expiration date in the Modification and Forbearance Agreement from
May 31, 2001 to January 1, 2002. As the waiver expiration date is within 12
months of the date of these financial statements, we have classified the amounts
outstanding to the lender as current liabilities in the Condensed Consolidated
Balance Sheet at September 30, 2001. We expect to enter into further discussions
with the lender regarding these requirements and other matters prior to the
waiver expiration date. Additional cash collateral amounts may be required upon
expiration of the waiver to secure a $2 million performance bond. In October
2001 we received a notice of default from this lender demanding repayment of
past due lease payments totaling approximately $647,000. In its notice, the
lender agreed to temporarily forebear accelerating amounts due to the lender and
other remedies, including foreclosure of liens and security interests securing
this indebtedness, until October 31, 2001. We are currently working with the
lender to negotiate a restructured payment arrangement and a new forbearance
agreement. However, as of the date of this filing, we remain in default and
there can be no assurance that we will be successful in negotiating a new
arrangement with this lender, or that the lender will not pursue its remedies.
As of September 30, 2001 we had notes payable to this lender totaling
approximately $6.5 million, and were contingently liable for approximately $5.5
million in letters of credit issued by this lender under its credit facility
with us.
During the quarter ended September 30, 2001 we were temporarily in default
to other equipment lessors for late payment of lease payments. We have
negotiated restructured payment arrangements with these lessors and are no
longer in default with these lessors. As of September 30, 2001 we had leases
payable to these lessors totaling approximately $4.9 million.
During November 2001 we signed a large Universal Application licensing and
support, training, and time-and-materials services contract and received a
significant initial payment. As of the date of this filing, our unrestricted
cash is now in excess of $13 million.
While our financial statements have been prepared under the assumption that
we will continue as a going concern, the independent auditors' report on our
December 31, 2000 financial statements, prepared by KPMG LLP, included an
explanatory paragraph relating to their substantial doubt as to our ability to
continue as a going concern, based upon our historical operating performance,
our financial position at December 31, 2000 and our involvement in significant
legal proceedings. Our business model relies upon generating new sales and
receiving payments from existing customers. If we do not generate sufficient new
sales and receive payments from existing customers, we will be required to
pursue one or a combination of the following remedies: seek additional sources
of financing, further reduce operating expenses, sell part or all of our assets,
and re-evaluate the TenFold business model. While we were unable to raise
additional capital in the three months ended September 30, 2001, we will
continue to seek additional capital to finance our operations through the
remainder of 2001 and 2002. However, there can be no assurance that these
efforts will prove successful.
Recent Accounting Pronouncements
38
In September 2000, the FASB issued SFAS No. 140, Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities -- a
replacement of FASB Statement No. 125. This standard revises the standards for
accounting for securitizations and other transfers of financial assets and
collateral and requires certain disclosures. This standard is effective for
transfers and servicing of financial assets and extinguishments of liabilities
occurring after March 31, 2001 and for disclosures relating to securitization
transactions and collateral for fiscal years ending after December 15, 2000. The
adoption of SFAS No. 140 did not have a material effect on our business, results
of operations, financial position, or liquidity.
In July 2001, the FASB issued SFAS No. 141 Business Combinations and SFAS
No. 142 Goodwill and Other Intangible Assets. SFAS No. 141 requires business
combinations initiated after June 30, 2001 to be accounted for using the
purchase method of accounting, and broadens the criteria for recording
intangible assets separate from goodwill. SFAS No. 142 requires the use of a
non-amortization approach to account for purchased goodwill and certain
intangibles. Under a non-amortization approach, goodwill and certain intangibles
will not be amortized into results of operations, but instead will be reviewed
for impairment and written down and charged to results of operations only in the
periods in which the recorded value of goodwill and certain intangibles is more
than its fair value. We are required to adopt the provisions of SFAS No. 141
immediately, and SFAS No. 142 on January 1, 2002.
In June 2001, the FASB issued SFAS No. 143 Accounting for Asset Retirement
Obligations. SFAS No. 143 addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. This Statement applies to legal obligations
associated with the retirement of long-lived assets that result from the
acquisition, construction, development and (or) the normal operation of a
long-lived asset, except for certain obligations of lessees. We are required to
adopt the provisions of SFAS No. 143 on January 1, 2003.
In August 2001, the FASB issued SFAS No. 144 Accounting for the Impairment
or Disposal of Long-Lived Assets. SFAS No. 144 addresses financial accounting
and reporting for the impairment of long-lived assets and for long-lived assets
to be disposed of. We are required to adopt the provisions of SFAS No. 144 on
January 1, 2002.
We are currently evaluating these statements but do not expect that they
will have a material effect on our business, results of operations, financial
position, or liquidity.
Factors that May Affect Future Results and Market Price of Stock
We operate in a rapidly changing environment that involves numerous risks,
some of which are beyond our control. The following discussion highlights some
of these risks.
Our future prospects are difficult to evaluate.
In light of our operating results for recent periods and the economic
effects resulting from the terrorist attacks of September 11, 2001, it is
difficult to evaluate our future prospects. The terrorist attacks on September
11, 2001 have negatively affected our business and caused some of our current
and potential customers to delay and change their purchasing decisions. We have
only a limited number of applications completed and currently in use and there
can be no assurance that we will be able to successfully complete any current or
new projects. We have received customer complaints concerning some of our
projects. We cannot be certain that we will not receive more customer complaints
in the future. Additionally, our failure to successfully complete any current or
new projects may have a material adverse impact on our financial position and
results of operations. We cannot be certain that our business strategy will
succeed.
39
If we are unable to generate sufficient cash flow from operations, or
secure additional sources of financing, we may be unable to continue
operations as a going concern.
While our financial statements have been prepared under the assumption that
we will continue as a going concern, the independent auditors' report on our
December 31, 2000 financial statements, prepared by KPMG LLP, included an
explanatory paragraph relating to their substantial doubt as to our ability to
continue as a going concern, based upon our historical operating performance,
our financial position at December 31, 2000 and our involvement in significant
legal proceedings. Our business model relies upon generating new sales and
receiving payments from existing customers. If we do not generate sufficient new
sales and receive payments from existing customers, we will be required to
pursue one or a combination of the following remedies: seek additional sources
of financing, further reduce operating expenses, sell part or all of our assets,
and re-evaluate the TenFold business model. While we were unable to raise
additional capital in the three months ended September 30, 2001, we will
continue to seek additional capital to finance our operations through the
remainder of 2001 and 2002. However, there can be no assurance that these
efforts will prove successful.
If we do not complete our existing projects, we may not receive final
payments, which would impair our ability to continue operations.
We believe that if we fail to complete our delivery commitments on our
existing contracts, our customers may withhold their final payments. In most
cases, the amounts associated with final delivery are significant. If we do not
receive final payments on existing contracts, our operations, financial
condition, liquidity, and prospects could be materially and adversely affected,
and we will be required to pursue one or a combination of the following
remedies: seek additional sources of financing, further reduce operating
expenses, sell part or all of our assets, and re-evaluate the TenFold business
model. There can be no assurance that additional financing sources will be
available to us when needed or that we will be able to execute the other
potential remedies sufficiently to continue operations.
We continue to experience difficulty in securing future customer revenue.
We believe that some prospective customers are delaying and canceling
purchase decisions as a result of the litigation and customer disputes against
us, the decline in our stock price, our financial results for the last several
quarters, and the economic effects resulting from the terrorist attacks of
September 11, 2001. There is no assurance that we will be able to convince
prospective customers to purchase products or services from us or that any
customer revenue that is achieved can be sustained. If we are unable to obtain
future customer revenue, our operations, financial condition, liquidity, and
prospects will be materially and adversely affected, and we will be required to
pursue one or a combination of the following remedies: seek additional sources
of financing, further reduce operating expenses, sell part or all of our assets,
and re-evaluate the TenFold business model. There can be no assurance that
additional financing sources will be available to us when needed or that we will
be able to execute the other potential remedies sufficiently to continue
operations.
Our failure to achieve cost reductions would negatively impact quarterly
operating results.
Although we have taken substantial steps in 2000 and 2001 to reduce
operating costs, such as headcount reductions, and consolidation of facilities,
there can be no assurance that we will be successful in our efforts to reduce
operating expenses in future periods.
Our existing errors and omissions coverage may not cover all existing
claims.
While we maintain errors and omissions insurance coverage to cover claims
related to customer disputes that arise directly from our customer contracts and
fall within the coverage scope and term, given the nature and complexity of the
factors affecting the estimated liabilities, the actual liabilities may exceed
or be outside the scope of our current errors and omissions coverage. We can
give no assurance that our insurance carrier will extend coverage to any of the
40
current claims. In addition, no assurance can be given that we will not be
subject to material additional liabilities and significant additional litigation
relating to errors and omissions for existing claims and future claims. In the
event that liabilities from such claims exceed our errors and omissions
coverage, our business, results of operations, financial position, or liquidity
could be materially and adversely affected.
Our new errors and omissions insurance policy coverage does not cover
contractual disputes.
The errors and omissions insurance policy that we secured on March 1, 2001
is in the form of an industry standard software errors and omissions policy. As
such, the policy excludes contractual related disputes such as cost and time
related guarantees, and only covers software errors and omissions that occur
after the delivery of software. We have previously had these types of
contractual disputes related to our guarantees. No assurance can be given that
we will not be subject to these types of claims in the future, which would not
be covered by our current errors and omissions insurance policy, and could
therefore have a material effect on our business, results of operations,
financial position, or liquidity.
If our software contains defects or other limitations, we could face
product liability exposure.
Because of our limited operating history and our small number of customers,
we have completed a limited number of projects that are now in production. As a
result, there may be undiscovered material defects in our products or
technology. Furthermore, complex software products often contain errors or
defects, particularly when first introduced or when new versions or enhancements
are released. Despite internal testing and testing by current and potential
customers, our current and future products may contain serious defects. Serious
defects or errors could result in lost revenues or a delay in market acceptance,
which would damage our reputation and business.
Because our customers may use our products for mission-critical
applications, errors, defects, or other performance problems could result in
financial or other damages to customers. Our customers could seek damages for
these losses. Any successful claims for these losses, to the extent not covered
by insurance, could result in us being obligated to pay substantial damages,
which would cause operating results to suffer. Although our license agreements
typically contain provisions designed to limit our exposure to product liability
claims, existing or future laws or unfavorable judicial decisions could negate
these limitations of liability provisions. A product liability claim brought
against us, even if not successful, would likely be time consuming and costly.
We are involved in litigation and disputes and may in the future be
involved in further litigation or disputes which may be costly and
time-consuming, and if we suffer adverse judgements our operating results
could suffer.
We are currently involved in significant litigation and customer disputes.
Additionally, two consolidated complaints have been filed alleging that TenFold
and certain officers have violated federal securities laws. See "Legal
Proceedings" for more information concerning these matters. We may in the future
face other litigation or disputes with customers, employees, partners,
stockholders, or other third parties. Such litigation or disputes could result
in substantial costs and diversion of resources that would harm our business. An
unfavorable outcome of these matters may have a material adverse impact on our
business, results of operations, financial position, or liquidity.
Our agreements with Perot Systems may restrict our sources of additional
financing.
Under agreements with Perot Systems that a former officer signed on
December 8, 2000 without Board approval to do so, we are purportedly required to
make six monthly payments of $441,000 each to Perot Systems beginning on
January 15, 2001. However, because of recent
41
TenFold management changes, TenFold's continuing restructuring, and the fact
that the Board did not approve these agreements, we continue to be in active
discussions with Perot Systems to consider the scope of our future relationship.
Therefore, we have not yet made these payments. On November 19, 2001, we
received a demand for arbitration from Perot Systems demanding payment under
these agreements. Our failure to make these payments in a timely manner to Perot
Systems and our dispute over the validity of these agreements has made effective
a stipulation in the original strategic alliance agreement which prohibits us
from licensing our technology or selling an equity interest in TenFold or any of
our affiliates to certain Perot Systems competitors. Our inability to license
our technology or sell an equity interest in TenFold or any of our affiliates to
certain potential customers or investors may inhibit our ability to raise
capital, if necessary, to continue operations. An unfavorable outcome in the
arbitration may have a material adverse impact on our results of operations,
financial position, or liquidity.
Our stock may be subject to de-listing.
Our Common Stock is currently traded on the Nasdaq SmallCap Market
("Nasdaq") under the symbol "TENF." Due to the recent decline in the share price
of our Common Stock, we have failed to meet certain of Nasdaq's continued
listing requirements and, as a result of this failure to comply with this
listing criteria, our Common Stock could be de-listed from Nasdaq. Nasdaq
continued listing requirements include a series of financial tests relating to
market capitalization/net income/net tangible assets, public float, number of
market makers and shareholders, and a $1.00 minimum share price. On September
27, 2001, Nasdaq implemented a moratorium on the minimum bid price and market
value of public float requirements for continued listing on Nasdaq. Under the
moratorium, those requirements were suspended until January 2, 2002, at which
time the 30 and 90 day periods provided by marketplace rule 4310(c)(8)(B) will
start anew. Accordingly, Nasdaq determined to continue the listing of our
securities on The Nasdaq Small Cap Market. If, after Nasdaq lifts the moratorium
we are not able to meet the continued listing requirements and our stock is
de-listed from Nasdaq, there would likely be a substantial reduction in the
liquidity of any investment in our common stock. This lack of liquidity also may
make it more difficult for us to raise capital in the future. There can be no
assurance that an active trading market will be sustained in the future.
There are many factors that may cause fluctuations in our quarterly
financial results, and if results are below the expectations of securities
market analysts, our stock price will likely decline.
Recently and in the past, the software industry has experienced significant
downturns. This occurs particularly when general economic conditions decline and
spending on management information systems decreases. Our business, financial
condition, and operating results may continue to fluctuate substantially from
quarter-to-quarter as a consequence of general economic conditions in the
software industry. In addition, our revenues and operating results may continue
to vary significantly from quarter-to-quarter due to a number of factors that
affect our business and the software industry, including:
. the number, size, and scope of projects in which we are engaged;
. the contractual terms and degree of completion of our projects;
. any delays or changes in customer requirements incurred in connection
with new or existing projects;
. the accuracy of our estimates of the resources required to complete
ongoing, as well as new, projects;
. the adequacy of provisions for losses associated with fixed-price
contracts;
. the adequacy of allowances for doubtful billed and unbilled accounts
receivable;
. the timing of sales of our products and services; and
42
. delays in introducing new applications.
Due to these factors, some of which are discussed in more detail elsewhere
in this section, we believe that quarter-to-quarter comparisons of our operating
results are not a good indication of our future performance. In future quarters,
our operating results may continue to be below the expectations of securities
market analysts and investors. In this event, the price of our common stock will
likely fall.
Our historical quarterly operating results have varied significantly and
future adverse quarterly operating results could cause our stock price to
fall.
Historically, our quarterly operating results have varied significantly.
For example, during some years, we have had quarterly profits followed by losses
in subsequent quarters. Our future quarterly operating results may continue to
vary significantly. Furthermore, there can be no assurance that we will not
continue to suffer losses in future periods.
We may continue to incur increased employee and consulting costs due to
project delays on fixed-price contracts.
We have experienced delays on some of our fixed-price customer projects. In
an effort to complete these projects, we have added additional employee and
consulting personnel to the projects. Each of these resources creates an
increased cost on the project. To the extent that the cost of such additions in
personnel are not contemplated in the contract price, the profit, if any, for
the projects would be adversely affected. There is no assurance that we will
complete these fixed-price customer contracts or that the projects will not
require additional personnel. If we cannot complete these customer projects or
if these customer projects continue to require additional personnel, our
business, results of operations, financial condition and liquidity would be
materially affected.
If we fail to accurately estimate the resources required for a
fixed-price project, or the resources required to complete existing
fixed-price projects, quarterly operating results could suffer.
Our failure to accurately estimate the resources required for a fixed-price
project or our failure to complete our contractual fixed-price obligations in a
manner consistent with the project plan would likely cause us to have lower
margins or to suffer a loss on the project, which would negatively impact our
operating results. Our revenue recognition policy requires us to make periodic
adjustments to our project estimates used in the percentage-of-completion method
of accounting (which includes the "zero profit" methodology) as work progresses
under the contract and as we gain experience. Although we believe that we made
all appropriate adjustments to properly reflect the completion percentage and
status of contracts in process, we cannot be certain that future adjustments
will not be required. See "Legal Proceedings" for information about litigation
and disputes related to some of our projects.
If we fail to adequately anticipate employee and resource utilization
rates, quarterly operating results could suffer.
Our operating expenses are largely based on anticipated revenue trends and
a high percentage of our operating expenses, particularly personnel and rent,
are relatively fixed in advance of any particular quarter. As a result,
unanticipated variations in the number, or progress toward completion, of our
projects or in employee utilization rates did and may continue to cause
significant variations in operating results in any particular quarter and could
result in quarterly losses. An unanticipated termination of a major project, the
delay of a project, or the completion during a quarter of several major projects
did and may continue to result in under-utilized employees and could, therefore,
cause us to suffer quarterly losses or adverse results of operations.
43
We have experienced project delays, causing our quarterly operating results
to suffer.
Because we recognize service revenues on fixed-price obligations over the
period we develop an application, project delays have had and may continue to
have a significant negative impact on operating results. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Revenue Recognition" for a discussion of our revenue recognition
policies. We have recently and in the past experienced delays. See "Management
Discussion and Analysis of Financial Condition and Results of Operations -
Revenues" for more information concerning our customers and revenues. There can
be no assurance that we will not experience project delays in the future.
Our historical guaranteed fixed-price, fixed-time contracts have had and
may continue to have an adverse impact on our financial results.
Prior to 2001, an important element of our strategy was to enter into
fixed-price, fixed-time contracts, rather than time-and-materials contracts.
These contracts involved risk because in certain instances they required us to
absorb possible cost overruns and, if we failed to meet our performance
obligations, may have required us to satisfy our performance guarantee.
Historically, we guaranteed that we would complete our projects within a fixed
time or the customer had the option to return the software and receive a refund
of any fees paid under the contract. For fixed-price contracts, we recognized
license fees related to the application and the application development service
fees over time as we performed the services, using the percentage-of-completion
method of accounting. Our failure to accurately estimate the resources required
for a project or our failure to complete our contractual obligations in a manner
consistent with the project plan has caused us to have lower margins or to
suffer a loss on some projects, which has negatively impacted our operating
results. In specific circumstances, we were required to commit unanticipated
additional resources to complete projects. We will likely experience similar
situations in the future. Beginning in the fourth quarter of 2000, we no longer
offer the TenFold Guarantee as a standard part of our contracts.
Our sales cycle is lengthy and subject to delays and these delays could
cause our quarterly operating results to suffer and our stock price to
fall.
We believe that a customer's decision to purchase our software involves a
significant commitment of resources and is influenced by customer budget cycles.
To successfully sell our products, we generally must educate our potential
customers regarding the use and benefit of our products, which can require
significant time and resources. Consequently, the period between initial contact
and the purchase of our products is often long and subject to delays associated
with the lengthy budgeting, approval, and competitive evaluation processes that
typically accompany significant capital expenditures. Our sales cycles are
lengthy and variable, typically ranging between three to twelve months from
initial contact with a potential customer to the signing of a contract. In
addition, the events of September 11, 2001 have caused current and potential
customers to delay or change their purchasing decisions. Sales delays could
cause our operating results to vary widely. We have recently experienced sales
delays due to longer than expected sales cycles, which we believe contributed to
lower than expected revenues. See "Management Discussion and Analysis of
Financial Condition and Results of Operations - Revenues" for more information
concerning our customers and revenues. There can be no assurance that we will
not experience sales delays in the future. In addition, we have not made a sale
to a new customer in over eight months and there can be no assurance that we
will have sales in the future.
We are dependent on a small number of large customers and the loss of one
or more of these customers may cause revenues to continue to decline.
As a result of our limited operating history, we have derived, and over the
near term we expect to continue to derive, a significant portion of our revenues
from a limited number of large customers. The loss of any of these large
customers, without their replacement by new large customers, has had and may
continue to have an adverse effect on our revenues. For example, we
44
lost several customers during the year ended December 31, 2000. As noted under
"Business Overview", we have lost customers recently. In the future, revenues
from a single customer or a few large customers may constitute a significant
portion of our total revenues in a particular quarter. The volume of work
performed for specific customers is likely to vary from year to year, and a
major customer in one year may not hire us to develop applications in a
subsequent year. In addition, if a customer is involved in a corporate
reorganization or business combination, that fact may delay a decision to hire
us or cause the customer to choose not to hire us to develop applications in a
given year. See "Management Discussion and Analysis of Financial Condition and
Results of Operations - Revenues" for more information concerning our customers
and revenues.
We have historically derived a significant portion of our revenues from
customers in a small number of vertical industries.
We developed software applications for companies in a small number of
vertical industries. Our reliance on customers from particular industries
subjects our business to the economic conditions impacting those industries,
including those industries' demand for information technology resources. If we
continue to rely on a small number of vertical industries as a major source of
revenues, and those industries suffer adverse economic conditions, there will
likely be a significant reduction in the demand for our products, causing
revenues to suffer. For example, the events of September 11, 2001 have adversely
affected some of our customers in the insurance and financial services
industries. Although we intend to seek to diversify our customer base, there can
be no assurance that we will be able to do so in the near term or at all.
If we are unable to successfully market our services on a
time-and-materials basis, our future operating results could suffer.
An element of our prior strategy was to enter into fixed-price, fixed-time
contracts, and to provide the TenFold Guarantee as a standard part of our
contracts. Beginning in the fourth quarter of 2000, we no longer offer
fixed-price, fixed-time contracts or the TenFold Guarantee. We now offer our
services on a time-and-materials basis. Although we believe that our prior
guaranteed fixed-price offering was only one element of what motivated customers
to work with us, we do not yet have much experience marketing our services on a
time-and-materials basis. If we are unsuccessful marketing our services on a
time-and-materials basis, or are forced to reduce our rates for such services,
or are required to provide significant concessions to convert existing
fixed-price projects to time-and-materials based projects, it may have a
material adverse impact on our business, results of operations, financial
position, or liquidity.
If we are unable to successfully divest our vertical applications products,
our future financial results could suffer.
An element of our business strategy is to develop and then divest vertical
applications lines of business. Our ability to divest such assets in accordance
with management's plans is critical to providing us with additional liquidity as
we complete our restructuring to a Universal Application technology led
enterprise. If we are unable to successfully implement this strategy or within
the time frames anticipated, our revenues, growth, and operating results will
suffer.
Our growth and success depends on our ability to license the Universal
Application; however, we have limited experience licensing the Universal
Application to date.
As we change our business strategy to licensing the Universal Application,
the success of our business is dependent, in part, upon our ability to license
the Universal Application. If our strategy for marketing the Universal
Application is unsuccessful, or if we are unable to license the Universal
Application successfully or within the time frames anticipated, our revenues,
growth, and operating results will suffer.
45
Our failure to manage our organizational structure could impair our
business.
With our recent closing of offices and reductions in force, we may be
unable to manage our organization and projects effectively. This inability could
have a material adverse effect on our ability to deliver applications in the
required timeframes, the quality of our services and products, our ability to
retain key personnel, our business, our financial condition, and our results of
operations. Our ability to manage our current organizational structure
effectively will require us to continue to develop and improve our operational,
financial, and other internal systems, as well as our business development
capabilities, and to train, motivate, and manage our employees, and to maintain
project quality.
A loss of Nancy M. Harvey, Jeffrey L. Walker, or any other key employee
could impair our business.
Our industry is competitive and we are substantially dependent upon the
continued service of our existing executive personnel, especially Nancy M.
Harvey, President and Chief Executive Officer. Furthermore, our products and
technologies are complex and we are substantially dependent upon the continued
service of our senior technical staff, including Jeffrey L. Walker, Chairman of
the Board of Directors, Executive Vice President, and Chief Technology Officer;
Sameer E. Shalaby, Senior Vice President of Development; and Adam Slovik, Senior
Vice President. If a key employee resigns to join a competitor or to form a
competing company, the loss of the employee and any resulting loss of existing
or potential customers to the competing company would harm our business. We do
not carry key man life insurance on any of our key employees. We have entered
into an employment agreement with our President and Chief Executive Officer,
Nancy M. Harvey. We have entered into and are currently in the process of
negotiating employment agreements with other key executive officers. However,
such agreements do not ensure their continued service to TenFold. In the event
of the loss of key personnel, there can be no assurance that we would be able to
prevent their unauthorized disclosure or use of our technical knowledge,
practices, or procedures.
Our failure to attract and retain highly skilled employees, particularly
project managers and other senior technical personnel, could impair our
ability to complete projects and expand our business.
Our business is labor intensive. Our success will depend in large part upon
our ability to attract, retain, train, and motivate highly skilled employees,
particularly project managers and other senior technical personnel. Any failure
on our part to do so would impair our ability to adequately manage and complete
existing projects, bid for and obtain new projects, and expand business. There
exists significant competition for employees with the skills required to perform
the services we offer. Qualified project managers and senior technical staff are
in great demand and are likely to remain a limited resource for the foreseeable
future. The collapsing of our vertical business group structure along with our
restructuring and related headcount reductions, may make it more difficult for
us to retain and compete for such employees. In addition, many of the stock
options that we granted to employees are priced in excess of the current market
price of our common stock. There can be no assurance that we will be successful
in retaining, training, and motivating our employees or in attracting new,
highly skilled employees. If we are unsuccessful in this effort or if our
employees are unable to achieve expected performance levels, our business will
be harmed.
Our growth and success depends on our ability to resell applications
products; however, we have limited experience reselling applications
products to date and our current and future agreements with our customers
may limit our ability to resell applications products in the future.
While it is no longer our primary business strategy, the success of our
business is dependent, in part, upon our ability to develop software
applications for customers that we can resell to other customers or resellers in
the same industry without significant modification. If we are unable to
46
develop and license these applications successfully or within the time frames
anticipated, our revenues, growth, and operating results will suffer. Some
customers have prohibited us from marketing the applications developed for them
generally or for specified periods of time or to specified third parties, or
have required that we pay them a royalty on licenses of the application to third
parties. Customers may continue to make similar demands in the future.
Furthermore, there can be no assurance that we will be able to develop software
applications that can be marketed generally within a particular industry without
the need for significant modification. Our current product plans include the
introduction of multiple resalable products in the near term.
If we cannot protect or enforce our intellectual property rights, our
competitive position would be impaired and we may become involved in costly
and time-consuming litigation.
Our success is dependent, in part, upon our proprietary Universal
Application technology and other intellectual property rights. If we are unable
to protect and enforce these intellectual property rights, our competitors will
have the ability to introduce competing products that are similar to ours, and
our revenues, market share, and operating results will suffer. To date, we have
relied primarily on a combination of patent, copyright, trade secret, and
trademark laws, and nondisclosure and other contractual restrictions on copying
and distribution to protect our proprietary technology. We have been granted
three patents in the United States and intend to continue to seek patents on our
technology where appropriate. There can be no assurance that the steps we have
taken in this regard will be adequate to deter misappropriation of our
proprietary information or that we will be able to detect unauthorized use and
take appropriate steps to enforce our intellectual property rights. The laws of
some countries may not protect our intellectual property rights to the same
extent, as do the laws of the United States. Furthermore, litigation may be
necessary to enforce our intellectual property rights, to protect our trade
secrets, to determine the validity and scope of the proprietary rights of
others, or to defend against claims of infringement or invalidity. This
litigation could result in substantial costs and diversion of resources that
would harm our business.
To date, we have not been notified that our products infringe the
proprietary rights of third parties, but there can be no assurance that third
parties will not claim infringement by us with respect to current or future
products. We expect software developers will increasingly be subject to
infringement claims as the number of products and competitors in our industry
segment grows and the functionality of products in different industry segments
overlaps. Any of these claims, with or without merit, could be time-consuming to
defend, result in costly litigation, divert management's attention and
resources, cause product shipment delays, or require us to enter into royalty or
licensing agreements. These royalty or licensing agreements, if required, may
not be available on terms acceptable to us, or at all. A successful claim
against us of product infringement and our failure or inability to license the
infringed or similar technology on favorable terms would harm our business.
If we fail to successfully compete, our growth and market share will be
adversely affected.
The market for our products and services is highly competitive, and if we
are not successful in competing in this market, our growth and market share will
suffer. We believe that we currently compete principally with vertical software
providers, ERP packaged software providers, consulting and software integration
firms, e-Services consultants, and internal information technology
organizations. Many of these competitors have significantly greater financial,
technical and marketing resources, generate greater revenues, and have greater
name recognition than we do. In addition, there are relatively low barriers to
entry into our markets and we have faced, and expect to continue to face,
additional competition from new entrants into our markets.
We believe that the principal competitive factors in our markets include
quality of services and products, functionality, speed of development and
implementation, price, project management capability, and technical and business
expertise. We believe that our ability to compete also depends in part on a
number of competitive factors outside our control, including
47
the ability of our competitors to hire, retain, and motivate project managers
and other senior technical staff, the development by others of software and
services that are competitive with our products and services, and the extent of
our responsiveness to customer needs. There can be no assurance that we will be
able to compete successfully with our competitors.
If we fail to release new versions of our products or product enhancements
in a timely manner to accommodate technological change, our ability to grow
our business will suffer.
The market in which we compete is characterized by rapid technological
change, including new versions of operating systems, relational databases or new
hardware technologies. We may need to modify our products to accommodate these
changes. Our revenues and market share will decline if we fail to release new
versions of our products or product enhancements in a timely manner or if these
products and product enhancements fail to achieve market acceptance when
released. In addition, customers may defer or forego purchases of our products
if our competitors or major hardware, systems, or software vendors introduce or
announce new products or product enhancements.
No corporate actions requiring stockholder approval can take place without
the approval of our controlling stockholders.
The executive officers, directors, and entities affiliated with them, in
the aggregate, beneficially own approximately 62 percent of our outstanding
common stock. Jeffrey L. Walker, Chairman, Executive Vice President and Chief
Technology Officer, and the Walker Children's Trust, in the aggregate, currently
beneficially own approximately 48 percent of our outstanding common stock. Mr.
Walker, acting with others, would be able to decide or significantly influence
all matters requiring approval by our stockholders, including the election of
directors and the approval of mergers or other business combination
transactions. This concentration of ownership may have the effect of delaying or
preventing a merger or other business combination transaction, even if the
transaction would be beneficial to our other stockholders.
The anti-takeover provisions in our charter documents and under Delaware
law could discourage a takeover that stockholders may consider favorable.
Provisions of our Certificate of Incorporation, Bylaws, stock incentive
plans and Delaware law may discourage, delay, or prevent a merger or acquisition
that a stockholder may consider favorable.
48
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Interest Rate Risk. As of September 30, 2001, we had cash and cash
equivalents of $5.5 million and $8.8 million in restricted cash. All of the cash
equivalents consist of highly-liquid investments with remaining maturities at
the date of purchase of less than ninety days. These investments are subject to
interest rate risk and will decrease in value if market interest rates increase.
A hypothetical increase or decrease in market interest rates by 10 percent from
the September 30, 2001 rates would cause the fair value of these investments to
change by an insignificant amount. Risk is mitigated through limits regarding
investment concentration in particular securities and institutions, and
investments in varying maturities. We do not invest in any financial derivatives
or any other complex financial instruments. TenFold does not own any equity
investments. Therefore, we do not currently have any direct equity price risk.
Currency Risk. A portion of our operations consists of applications
development and sales activities in the United Kingdom. These transactions are
primarily denominated in British pounds. As a result, our financial results
could be affected by factors such as a change in the foreign currency exchange
rate between the U.S. dollar and the British pound, or by weak economic
conditions in the United Kingdom. When the U.S. dollar strengthens against the
British pound, the value of revenues in the United Kingdom decreases. When the
U.S. dollar weakens against the British pound, the value of revenues in the
United Kingdom increases. The monetary assets and liabilities in our foreign
subsidiary which are impacted by foreign currency fluctuations are cash,
accounts receivable, accounts payable, and certain accrued liabilities. A
hypothetical 10 percent increase or decrease in the exchange rate between the
U.S. dollar and the British pound from the September 30, 2001 rate would cause
the fair value of such monetary assets and liabilities in the United Kingdom to
change by approximately $11,000. We are not currently engaged in any foreign
currency hedging activities.
49
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Recently Resolved Customer Disputes
During the nine months ended September 30, 2001, we have settled seven of
our customer disputes.
Westfield
On September 17, 1999, Ohio Farmers Insurance Company doing business as
Westfield Companies ("Westfield"), filed a complaint in the United States
District Court for the District of Ohio seeking $5.8 million from us. The
complaint alleged that we failed to deliver on contractual commitments under a
license agreement with Westfield and included specific claims of anticipatory
breach of contract, breach of express warranty, and negligent misrepresentation.
On November 4, 1999, we filed an Answer and Counterclaim denying these
allegations and seeking recovery of $3.9 million that Westfield owed us under
the license agreement together with claims for additional damages. Effective
April 26, 2001, the parties entered into a Settlement Agreement and Mutual
Release in which the parties agreed to settle and resolve all claims between the
two companies in consideration for each dismissing all claims against the other
and in further consideration of a compromised and confidential payment from our
errors and omissions carrier to Westfield in excess of our self-insured
retention of $25,000 already paid by TenFold to cover legal defense costs. The
complaint and counterclaim have been dismissed and all claims have been
released.
Nielsen
On June 14, 2000, Nielsen Media Research, Inc. ("Nielsen"), filed a
complaint in the Circuit Court of Cook County, Illinois seeking $4.5 million,
plus out of pocket expenses paid by Nielsen to us. The complaint alleged that we
failed to deliver on contractual commitments under a license and services
agreement with Nielsen and included specific claims of breach of contract and
violation of the Illinois Consumer Fraud and Deceptive Practices Act. On August
30, 2000, we filed an Answer and Counterclaim denying Nielsen's claims and
seeking recovery of at least $1.7 million that Nielsen owed us under the license
agreement, plus our attorney fees and costs. Effective May 30, 2001, the parties
entered into a Settlement Agreement and Mutual Release in which the parties
agreed to settle and resolve all claims between the two companies in
consideration for each dismissing all claims against the other and in further
consideration of a compromised and confidential payment from our errors and
omissions carrier to Nielsen in excess of our self-insured retention of $100,000
already paid by us to cover legal defense costs. The complaint and counterclaim
have been dismissed and all claims have been released.
Trumbull
On August 18, 2000, Trumbull Services, L.L.C. ("Trumbull"), filed a demand
for arbitration with the American Arbitration Association seeking a refund of at
least $2.8 million paid by Trumbull to us. The demand alleged that we failed to
deliver on contractual commitments under the Master Software License and Service
Agreement as amended. Trumbull claimed it was entitled to a refund of fees paid
to us from the second quarter of 1999 through the second quarter of 2000. On
September 13, 2000, we filed an Answer and Counterclaim denying Trumbull's
allegations and seeking recovery of approximately $2.0 million in fees that
Trumbull owed us under the Trumbull Agreement. On May 10, 2001, TenFold and
Trumbull entered into a Settlement Agreement and Mutual Release in which the
parties agreed to settle and resolve all claims between the two companies in
consideration for each dismissing all claims against the other and in further
consideration of a compromised and confidential payment from our errors and
omissions carrier to Trumbull in excess of our self-insured retention of
$100,000. The arbitration proceeding has been cancelled and all claims have been
released.
50
Unitrin
On October 4, 2000, Unitrin Services Company, Inc. ("Unitrin") sent us a
notice of dispute letter requesting non-binding mediation. Unitrin was seeking a
refund of fees paid by Unitrin to us for the PowerPAC application of
approximately $13.3 million, plus other unspecified damages. On March 8, 2001,
the parties entered a Confidential Settlement Agreement and Release, dismissing
all of Unitrin's claims. Our errors and omissions insurance carrier paid the
entire amount of the compromised and confidential settlement sum above the
$100,000 of self-insurance retention already paid by us to cover legal defense
costs.
SCEM
On November 22, 2000, Southern Company Energy Marketing L.P. ("SCEM") filed
a demand for arbitration with the American Arbitration Association seeking
damages for delays in delivering a suite of software applications. We responded
in a timely manner to the demand denying that we breached the contract and filed
detailed Counterclaims including a breach of contract claim against SCEM for
improper and ineffective termination of the contract and nonpayment. An
arbitration hearing was conducted in Dallas, Texas during the week of June 18,
2001. SCEM sought damages from TenFold of approximately $13.7 million, while
TenFold sought recovery of approximately $6.8 million from SCEM. On August 27,
2001, TenFold and SCEM entered into a Confidential Settlement Agreement and
Release in which the parties agreed to settle and resolve all claims between the
two companies in consideration for each dismissing all claims against the other
and in further consideration of a compromised and confidential payment from our
errors and omissions carrier to SCEM in excess of our self-insured retention of
$100,000. The arbitration proceeding has been cancelled and all claims have been
released.
Utica
On January 3, 2001, Utica Mutual Insurance Company ("Utica") filed a
complaint against us in the Federal District Court of Utah, and asserted claims
for breach of contract, breach of warranties and guarantees, false advertising
under a Utah statute, negligent misrepresentation, and fraud. Utica sought
monetary damages of approximately $15.5 million in fees and expenses under the
contract, plus any additional amount recoverable under the contractual
guarantee, as well as punitive damages, prejudgment interest, attorneys' fees,
and costs. Utica also sought an injunction against alleged false advertising by
TenFold under a Utah truth-in-advertising statute. On January 23, 2001, we filed
an Answer denying Utica's claims. On August 16, 2001, TenFold and Utica entered
into a Confidential Settlement Agreement and Release in which the parties agreed
to settle and resolve all claims asserted by Utica in consideration of a
compromised and confidential payment from our errors and omissions carrier to
Utica in excess of our self-insured retention of $100,000. The complaint has
been dismissed and all claims have been released.
Other
On April 4, 2001, we received a letter from another customer alleging that
we had materially breached our contract with that customer. On May 2, 2001, we
entered a Termination and Settlement Agreement with this customer under which
the customer agreed to pay TenFold a compromised and confidential settlement
amount for services we have provided to this customer.
Unresolved Customer Disputes
Although we have settled seven of our customer disputes, we have three
unresolved customer disputes.
Crawford
On December 14, 2000, Crawford & Company ("Crawford") sent a letter to us
purporting to give notice of breach under the terms of the Master Software
License and Services Agreement between us and Crawford (the "Crawford
Agreement"). Crawford's letter also purports to give
51
notice of Crawford's election to terminate the Crawford Agreement. Crawford's
letter asserts that we failed to deliver the NIMBUS software application within
the agreed schedule for doing so. On September 4, 2001, Crawford filed a demand
for arbitration with the American Arbitration Association seeking $16.7 million
from TenFold for alleged breach of contract, breach of warranty and failure to
deliver contracted software. On September 20, 2001, TenFold and Crawford agreed
to put the arbitration in abeyance pending ongoing discussions between them
and/or a possible mediation. If the discussions and/or mediation are
unsuccessful, either party may activate the arbitration. For the three months
ended September 30, 2001, we recognized no revenue from Crawford and recognized
$163,000 in revenues from Crawford during the same period in 2000. We recognized
no revenue from the Crawford Agreement for the nine months ended September 30,
2001, and recognized $2.3 million during the same period of 2000.
Based on current knowledge, we do not believe we materially breached the
Crawford Agreement. Should the parties be unable to satisfactorily resolve the
issues between them, we will vigorously assert our rights under the Crawford
Agreement and defend against Crawford's claims, including recovery of the
amounts that Crawford owes us and the remaining amounts due under the Crawford
Agreement totaling at least $1.8 million. An unfavorable outcome of this matter
may have a material adverse impact on our business, results of operations,
financial position, or liquidity.
SkyTel
In March 2001, SkyTel Communications, Inc. ("SkyTel") orally informed us of
its intent to terminate the Master Software License and Services Agreement
between SkyTel and us (the "SkyTel Agreement"). On May 15, 2001, SkyTel sent us
a letter purporting to terminate the SkyTel Agreement based on our alleged
material breach of the SkyTel Agreement. SkyTel's letter also demands a refund
of approximately $11 million paid by SkyTel under the SkyTel Agreement. On
September 24, 2001, SkyTel filed a complaint against us in the First Circuit
Court of the First Judicial District of Hinds County, Mississippi. In its
complaint, SkyTel claims breach of contract, breach of express warranties and
breach of implied warranties. SkyTel seeks monetary damages of at least $17.5
million, plus other damages it may prove at trial, together with pre- and
post-judgment interest, attorneys' fees and expenses and costs. The matter is in
its preliminary stages, and based on the information currently available, we
will vigorously assert our rights under the agreement and defend against the
customer's claims, including payment of the amounts that the customer owes us
and the remaining amounts due under the agreement totaling at least $ 6.2
million. This claim may be covered by the supplemental extended reporting period
policy we maintain on one of our prior errors and omissions liability policies.
The total contract value involved in this customer dispute is approximately
$17.6 million, of which $11.4 million has been received by us to date. An
unfavorable outcome of this matter may have a material adverse impact on our
business, results of operations, financial position, or liquidity.
Other Matters
On November 14, 2001, we received a letter from a customer alleging that we
have materially breached our contract with that customer. The letter requests
that we engage in an executive dispute resolution procedure required by the
contract. We do not believe that we have materially breached the contract, and
we have continued to perform under the contract. Should the customer continue to
assert that we have materially breached the contract, we will vigorously assert
our rights under the contract and defend ourselves against any claims the
customer may assert. An unfavorable outcome of this matter may have a material
adverse impact on our results of operations, financial position, or liquidity.
On November 19, 2001, we received a demand for arbitration from Perot
Systems Corporation ("Perot") alleging that we have materially breached our
prior purported agreements with Perot. The demand requests relief of $3.1
million. We intend to vigorously assert our rights under the contract and defend
ourselves against the claims Perot has asserted. An unfavorable outcome of this
matter may have a material adverse impact on our results of operations,
financial position, or liquidity. We have $2.0 million in accrued liabilities
and $673,000 in accounts payable in the Condensed Consolidated Balance Sheet at
September 30, 2001, that we previously accrued related to our agreements with
Perot.
As a result of the legal proceedings and contingencies noted above, we have
provided an allowance for doubtful accounts of $818,000 related to billed
accounts receivable and $1.3 million related to unbilled accounts receivable at
September 30, 2001.
We maintained errors and omissions and umbrella liability insurance
coverage to protect ourselves in the event of claims for damages related to the
performance of or failure to perform
52
computer-related services that occurred after March 1, 1998 but prior to March
1, 2001. We also maintain a limited supplemental extended reporting period
policy on one of our prior errors and omissions liability policies. We believe
that this insurance covers the types of alleged damages (but not unpaid or
unbilled accounts receivable) that may be claimed in the legal cases and
customer disputes noted above, to the extent that they occurred during the
policy periods, as well as covering the costs of legal defense, subject to the
policies' total limit, and any stated reservation of rights by the carrier
regarding conditions or findings that might exclude coverage for a particular
matter. We do not believe that the disputes with the unnamed customer and Perot
will be covered by this insurance. We have reserved against certain of the
billed and unbilled accounts receivable related to these disputed amounts for
which a loss is considered probable. An unfavorable outcome or claim not covered
by an insurance policy on one or more of these matters may have a material
adverse impact on our business, results of operations, financial position, or
liquidity.
On November 18, 2000, our excess errors and omissions policy expired. On
March 1, 2001, our primary errors and omissions policy expired. On March 1,
2001, we secured a new, industry standard, errors and omissions policy that
covers claims made after March 1, 2001. Our new policy excludes contractual
related disputes such as cost and time guarantees, and only covers software
errors or omissions that occur after the delivery of software. We believe this
policy provides adequate coverage for potential damages related to errors and
omissions in our delivered software.
We may in the future face other litigation or disputes with customers,
employees, partners, stockholders, or other third parties. Such litigation or
disputes could result in substantial costs and diversion of resources that would
harm our business. An unfavorable outcome of these matters may have a material
adverse impact on our business, results of operations, financial position, or
liquidity.
Stockholder Matters
On or after August 12, 2000, six complaints were filed in the United States
District Court of Utah alleging that we and certain of our officers violated
certain federal securities laws. All six complaints were virtually identical and
allege that 1) we improperly recognized revenues on some of our projects; 2) we
failed to maintain sufficient accounting reserves to cover the risk of contract
disputes or cancellations; 3) we issued falsely optimistic statements that did
not disclose these accounting issues; and 4) Company insiders sold stock in
early calendar year 2000 while knowing about these issues.
On October 30, 2000, our motion to consolidate the six complaints into one
class action complaint was granted. On March 7, 2001, the court appointed lead
plaintiffs and lead class counsel. On May 1, 2001, the plaintiffs filed an
amended consolidated complaint that repeats their earlier allegations while
adding additional details regarding the projects on which revenue was allegedly
improperly recognized. TenFold filed a motion to dismiss the amended complaint
on June 19, 2001. The court has scheduled a hearing on the motion to dismiss for
November 26, 2001.
Management and outside legal counsel believe that the defendants have
meritorious defenses to the allegations made in these lawsuits. Because the
matter is in its preliminary stages, our outside legal counsel is not able to
provide an opinion on the probable outcome of the claim and therefore, no
provision for loss has been recorded in our Condensed Consolidated Financial
Statements. Although we carry directors and officers liability insurance that we
believe is sufficient for such class action claims, we intend to vigorously
defend ourselves and we deny any wrongdoing. An unfavorable outcome of this
matter may have a material adverse impact on our business, results of
operations, financial position, or liquidity.
On November 6, 2001, a class action complaint alleging violations of the
federal securities laws was filed in the United States District Court for the
Southern District of New York naming TenFold, certain of its officers and
directors, and certain underwriters of TenFold's initial public offering as
defendants. The complaint alleges, among other things, that the underwriters of
our initial public offering violated the securities laws by failing to disclose
certain alleged compensation arrangements (such as undisclosed commissions or
stock stabilization practices) in
53
the offering's registration statement. TenFold and certain of its officers and
directors are named in the complaint pursuant to Sections 11 and 15 of the
Securities Act of 1933. Similar complaints have been filed against over 180
other issuers that have had initial public offerings since 1998. TenFold intends
to defend this action vigorously. Although no assurance can be given that this
matter will be resolved in TenFold's favor, we believe that the resolution of
this lawsuit will not have a material adverse effect on our financial position,
results of operations or cash flows. An unfavorable outcome of this matter may
have a material adverse impact on our business, results of operations, financial
position, or liquidity.
SEC Inquiry
On May 26, 2000, the United States Securities and Exchange Commission
("SEC") issued a Formal Order Directing Private Investigation. The Order
contains no specific factual allegations. We understand, however, that the SEC
is conducting a non-public fact-finding inquiry into our revenue recognition
decisions on approximately 15 contracts. We have received several document
subpoenas from the SEC and we have complied or are in the process of complying
with them. We have learned that the SEC has issued subpoenas to our independent
auditors and to several of our current and former customers. Since February
2001, the SEC has taken testimony from several of our current or former
executives and personnel, including former chief financial officers and sales
executives and personnel. The SEC has scheduled to take testimony from other of
our current and former executives and personnel during October and December
2001.
The inquiry is in its preliminary stages and we have retained outside legal
counsel to represent us concerning the investigation. The SEC has a number of
statutory remedies that it may use in both fraud and non-fraud (books and
records) enforcement proceedings. These remedies include various forms of
injunctive relief, monetary penalties, and orders barring individuals from
future employment in public companies. It is too early in the inquiry to say
which of these remedies, if any, the SEC might seek against us and our officers.
Management and outside legal counsel believe that we have meritorious defenses
to any allegations the SEC may make and intend to continue to cooperate fully
with the SEC. However, because the inquiry is in its preliminary stages, our
outside legal counsel is not able to provide an opinion on the probable outcome
of the inquiry. An unfavorable outcome of this matter may have a material
adverse impact on our business, results of operations, financial position, or
liquidity.
54
Item 3. Defaults Upon Senior Securities
See "Part I Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations - Liquidity and Capital Resources" which is
incorporated herein.
55
Item 4. Submission of Matters to a Vote of Security Holders
The Company's annual meeting of stockholders was held on July 19, 2001, in
Salt Lake City, Utah. A total of 29,915,824 shares (approximately 83% of all
shares entitled to vote at the meeting) were represented by proxy or ballot at
the meeting. The matters voted upon at the meeting, and the votes cast with
respect to each were:
(1) Election of three directors to hold office until the 2003 Annual
Meeting of Stockholders: Jeffrey L. Walker - 29,793,924 shares cast
for election and 121,900 shares withheld; H. Raymond Bingham. -
29,807,806 shares cast for election and 108,018 shares withheld; Kay
R. Whitmore - 29,815,703 shares cast for election and 100,121 shares
withheld. The terms of the following directors continued after the
meeting: Nancy M. Walker, Ralph W. Hardy, Jr., and Robert W. Felton.
(2) Ratification of the selection of KPMG LLP as independent auditors of
the Company for the fiscal year ended December 31, 2001 - 29,873,179
shares voted for ratification, 35,963 shares voted against
ratification, and 6,682 abstained.
There were no broker non-votes for the matters voted upon.
56
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Number Description
- ------ -----------
10.1# Resignation Agreement between TenFold Corporation and Gary D. Kennedy
10.2# Resignation Agreement between TenFold Corporation and Donald R.
Jefferis
10.3# Employment Agreement between TenFold Corporation and John M. Ames
10.4# Employment Agreement between TenFold Corporation and Michelle Moratti
10.5 First Amendment dated June 15, 2001 between EOP-150 California
Street, L.L.C. and TenFold Corporation
10.6 First Lease Amendment dated June 27, 2001 between 200 South Wacker
Drive, L.L.C. and TenFold Corporation
11* Computation of Shares used in Computing Basic and Diluted Net Income
Per Share
* Incorporated by reference to "Notes to Condensed Consolidated Financial
Statements" herein
# Indicates management contract or compensatory plan or arrangement
(b) Reports on Form 8-K
None
57
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TenFold Corporation
By: /s/ John M. Ames
------------------------------
John M. Ames
Chief Financial Officer
Date: November 19, 2001
58