<PAGE>
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 June 30, 2000
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 Identification No.)
incorporation or organization)
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 June 30, 2000, there were 35,523,430 shares of the registrant's
Common Stock outstanding.
<PAGE>
INDEX
-----
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets at June 30, 2000 and
December 31, 1999............................................. 3
Consolidated Statements of Operations for the three and six
months ended June 30, 2000 and June 30, 1999.................. 4
Consolidated Statements of Cash Flows for the six months
ended June 30, 2000 and June 30, 1999......................... 5
Notes to Consolidated Financial Statements.................... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................... 16
Item 3. Quantitative and Qualitative Disclosures About Market Risk.... 34
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................. 34
Item 2. Changes in Securities and Use of Proceeds..................... 35
Item 6. Exhibits and Reports on Form 8-K.............................. 36
SIGNATURES................................................................ 37
2
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
TENFOLD CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
<TABLE>
<CAPTION>
June 30, December 31,
---------------------- --------------------
2000 1999
---------------------- --------------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents......................................................... $ 42,370 $ 58,247
Accounts receivable (net of allowances for doubtful accounts
of $475 and $725, respectively).......................................... 12,734 10,713
Unbilled accounts receivable (net of allowance for doubtful accounts
of $3,980 and $0, respectively).......................................... 8,905 4,377
Prepaid expenses and other assets................................................. 1,401 889
Deferred income taxes............................................................. 3,013 2,650
Other assets...................................................................... 257 1,080
------------------ --------------------
Total current assets.......................................................... 68,680 77,956
Restricted cash................................................................... 2,951 111
Property and equipment, net....................................................... 17,021 9,810
Due from stockholders............................................................. 1,000 1,000
Long-term deferred income taxes................................................... 5,281 -
Other assets...................................................................... 501 216
Goodwill and acquired intangibles, net............................................ 21,237 23,539
------------------ --------------------
Total assets.................................................................. $116,671 $112,632
================== ====================
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable.................................................................. $ 5,089 $ 2,903
Income taxes payable.............................................................. 1,044 1,142
Accrued liabilities............................................................... 11,292 16,836
Deferred revenue.................................................................. 10,472 9,066
Current installments of obligations under capital leases.......................... 1,361 926
Current installments of notes payable............................................. 2,710 1,701
Promissory note................................................................... 9,000 12,000
------------------ --------------------
Total current liabilities..................................................... 40,968 44,574
------------------ --------------------
Long-term liabilities:
Deferred income taxes............................................................. - 2,754
Obligations under capital leases, excluding current installments.................. 1,510 1,175
Notes payable, excluding current installments..................................... 5,565 2,289
------------------ --------------------
Total long-term liabilities................................................... 7,075 6,218
------------------ --------------------
Contingencies (Note 8)
Minority interest.................................................................. - -
------------------ --------------------
Stockholders' equity:
Common stock, $0.001 par value:
Authorized: 120,000,000 shares
Issued and outstanding shares: 35,523,430 shares at June 30, 2000 and
34,806,602 shares at December 31, 1999....................................... 36 35
Additional paid-in capital........................................................ 73,275 62,672
Notes receivable from stockholders................................................ (2,115) (1,155)
Deferred compensation............................................................. (3,849) (5,611)
Retained earnings................................................................. 1,530 5,872
Accumulated other comprehensive income (loss)..................................... (249) 27
------------------ --------------------
Total stockholders' equity.................................................... 68,628 61,840
------------------ --------------------
Total liabilities and stockholders' equity.................................... $116,671 $112,632
================== ====================
</TABLE>
See accompanying notes to consolidated financial statements
3
<PAGE>
TENFOLD CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------- ----------------------------
2000 1999 2000 1999
----------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
Revenues:
License........................................................... $ 7,586 $ 7,511 $12,268 $13,167
Services.......................................................... 18,779 11,526 45,772 21,897
----------- ---------- ----------- ----------
Total revenues................................................ 26,365 19,037 58,040 35,064
----------- ---------- ----------- ----------
Operating expenses:
Cost of revenues (exclusive of non-cash compensation
of $114, $158, $248, and $296, respectively)................... 16,302 6,339 28,020 12,585
Sales and marketing (exclusive of non-cash compensation
of $54, $80, $115, and $139, respectively)..................... 6,453 5,843 13,297 10,579
Research and development (exclusive of non-cash
compensation of $92, $91, $190, and $161, respectively)........ 6,333 4,046 12,757 7,447
General and administrative (exclusive of non-cash
compensation of $56, $55, $114, and $93, respectively)......... 6,136 865 8,000 1,685
Amortization of deferred compensation............................. 316 384 667 689
Amortization of goodwill and acquired intangibles................. 1,151 - 2,302 -
----------- ---------- ----------- ----------
Total operating expenses...................................... 36,691 17,477 65,043 32,985
----------- ---------- ----------- ----------
Income (loss) from operations...................................... (10,326) 1,560 (7,003) 2,079
----------- ---------- ----------- ----------
Other income (expense):
Interest and other income......................................... 1,054 249 1,841 408
Interest expense.................................................. (349) (87) (628) (158)
----------- ---------- ----------- ----------
Total other income............................................ 705 162 1,213 250
----------- ---------- ----------- ----------
Income (loss) before income taxes and minority interest............ (9,621) 1,722 (5,790) 2,329
Provision (benefit) for income taxes............................... (3,134) 662 (1,448) 896
----------- ---------- ----------- ----------
Net income (loss) before minority interest......................... (6,487) 1,060 (4,342) 1,433
Minority interest.................................................. (8) - - -
----------- ---------- ----------- ----------
Net income (loss).................................................. $ (6,479) $ 1,060 $(4,342) $ 1,433
=========== ========== =========== ==========
Accretion of Series A and B preferred stock........................ - (143) - (391)
----------- ---------- ----------- ----------
Net income (loss) available to common stockholders................. $ (6,479) $ 917 $(4,342) $ 1,042
=========== ========== =========== ==========
Basic earnings (loss) per common share............................. $ (0.19) $ 0.03 $ (0.13) $ 0.04
=========== ========== =========== ==========
Diluted earnings (loss) per common share........................... $ (0.19) $ 0.03 $ (0.13) $ 0.04
=========== ========== =========== ==========
Weighted average common and common equivalent shares used to
calculate earnings (loss) per share:
Basic............................................................. 34,392 28,561 34,215 25,110
=========== ========== =========== ==========
Diluted........................................................... 34,392 32,547 34,215 28,954
=========== ========== =========== ==========
</TABLE>
See accompanying notes to consolidated financial statements
4
<PAGE>
TENFOLD CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
----------------------------------
2000 1999
------------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss)................................................ $ (4,342) $ 1,433
Adjustments to reconcile net income (loss) to net cash used
in operating activities:
Tax benefit from exercise of stock options.................... 6,820 556
Deferred income tax benefit................................... (8,398) -
Amortization of goodwill and acquired intangibles............. 2,302 -
Depreciation and amortization................................. 2,168 1,117
Allowances for doubtful accounts.............................. 4,129 -
Amortization of deferred compensation......................... 667 689
Changes in operating assets and liabilities:
Accounts receivable.......................................... (2,170) (3,432)
Unbilled accounts receivable................................. (8,508) (1,947)
Prepaid expenses and other assets............................ 26 (1,046)
Accounts payable............................................. 2,186 629
Income taxes payable......................................... (98) (876)
Accrued liabilities.......................................... (5,544) 3,655
Deferred revenues............................................ 1,406 (4,624)
------------- -----------
Net cash used in operating activities................. (9,356) (3,846)
------------- -----------
Cash flows from investing activities:
Additions to property and equipment........................... (8,129) (2,379)
Restricted cash............................................... (2,840) -
------------- -----------
Net cash used in investing activities................. (10,969) (2,379)
------------- -----------
Cash flows from financing activities:
Proceeds from employee stock purchase plan stock issuance..... 2,520 -
Proceeds from issuance of common stock........................ - 36,884
Exercise of common stock options.............................. 1,399 775
Proceeds from issuance of notes payable....................... 5,195 1,316
Principal payments on notes payable........................... (3,910) (443)
Notes receivable from stockholders............................ - (1,326)
Principal payments on obligations under capital leases........ (480) (211)
------------- -----------
Net cash provided by financing activities............... 4,724 36,995
------------- -----------
Effect of exchange rate changes..................................... (276) (20)
------------- -----------
Net (decrease) increase in cash and cash equivalents................ (15,877) 30,750
Cash and cash equivalents at beginning of period.................... 58,247 15,373
------------- -----------
Cash and cash equivalents at end of period.......................... $ 42,370 $46,123
============= ===========
Supplemental disclosure of cash flow information:
Cash paid for income taxes $ 212 $ 661
Cash paid for interest $ 747 $ 158
</TABLE>
See accompanying notes to consolidated financial statements
5
<PAGE>
TENFOLD CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The accompanying unaudited 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 fair presentation. All intercompany accounts and transactions have been
eliminated. 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 six
month periods ended June 30, 2000 are not necessarily indicative of the results
that may be expected for any future period or the year ended December 31, 2000.
This report should be read in conjunction with the Company's audited
consolidated financial statements for the year ended December 31, 1999 included
in the Annual Report on Form 10-K filed with the Securities and Exchange
Commission.
The preparation of the 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.
2. Revenue Recognition
The Company derives its revenues from license fees, application development
and implementation services, support, and training services. License revenues
consist of fees for licensing the Company's Universal Application and license
fees for the applications that the Company develops for its customers. The
Company also derives license revenues from the resale of 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.
SOP 97-2 generally requires revenue earned on software arrangements
involving multiple elements such as software products, enhancements, post-
contract customer support ("PCS"), installation and training to be allocated to
each 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. VSOE for
training is based on standard rates charged for each participant 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 to be charged in future periods. In arrangements where VSOE
exists for all but the delivered element, the fee is allocated to the delivered
element (generally the software product) using the residual method described in
SOP 98-9. The revenue allocated to software products is generally recognized
upon delivery of the products unless services provided are considered essential
to the functionality of the software.
6
<PAGE>
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 license 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 and six month periods ended June 30, 2000, were $4.3 million and $4.8
million, respectively. License fees recognized upon achieving these criteria,
for both the three and six month periods ended June 30, 1999 were $3.0 million.
For software arrangements that include a service element that is 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. The Company determines its 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 the Company's senior management team approve each fixed
price proposal. The Company makes monthly adjustments to the original estimates
used in the percentage-of-completion method of accounting as work progresses
under the contract and as the Company gains experience. Fixed price project
revenues are split between license and service based upon the relative fair
value of the various components. On a limited basis, the Company also provides
application development and implementation services on a time and materials
basis. The Company recognizes revenue on its time and material contracts as it
performs the services.
For the quarter ended June 30, 2000, the Company determined that for certain
highly complex projects, it should limit revenue recognition to the amount of
costs that it incurs in the period, and postpone recognition of profit until the
Company can more precisely estimate its project costs and its ability to
complete the projects in a timely manner. The Company is currently applying this
methodology to two projects with total project values of approximately $23.1
million.
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. The Company records billings and cash received in excess of revenue
earned as deferred revenue. The Company's deferred revenue balance at June 30,
2000 was $10.5 million. The Company expects to recognize most of this as revenue
within the next twelve months. 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. 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 for this revenue as payments
become due under the terms of the customer's contract. The Company's net
unbilled accounts receivable balance at June 30, 2000 was $8.9 million and the
Company expects to bill and collect this amount within twelve months. 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 all amounts due under the
terms of their existing contracts.
The Company's projects have, over time, grown in size thereby requiring
larger development and implementation teams. The growth in team size has mainly
been in employees with lower daily billing rates. As a result, the Company's
average daily service billing rate for a team has decreased over time.
Additionally, the Company determined that its current standard billing rates for
services were higher than some competitors' rates. The Company lowered these
standard billing rates effective July 1, 2000. The Company expects to offset
this decrease with higher license fees. In accordance with SOP 97-2, these two
factors, namely team composition changes and lower standard billing rates, will
require the allocation of contract revenues involving multiple elements to
change for contracts signed after June 30, 2000. The Company expects that
revenue from software arrangements that include a service element sold after
June 30,
7
<PAGE>
2000 will have lower service revenues as a percentage of total contract revenues
and higher license revenues as a percentage of total contract revenues. The
impact of these changes on the Company's overall revenues is anticipated to
result in a gradual mix change between license and services revenues over time,
with little or no impact on total revenues.
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):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------------------- ----------------------------------
2000 1999 2000 1999
------------------ ------------------- ----------------- ----------------
<S> <C> <C> <C> <C>
Numerator:
Numerator for basic earnings (loss) per share -
net income (loss) available to common
stockholders...................................... $(6,479) $ 917 $(4,342) $ 1,042
================== =================== ================= ================
Assumed dilution related to subsidiaries' earnings
applicable to minority stockholders............... (23) - (66) -
------------------ ------------------- ----------------- ----------------
Numerator for diluted earnings (loss) per share.... $(6,502) $ 917 $(4,408) $ 1,042
================== =================== ================= ================
Denominator:
Denominator for basic earnings (loss) per share -
weighted average shares.............................. 34,392 28,561 34,215 25,110
================== =================== ================= ================
Employee stock options................................ - 3,986 - 3,844
------------------ ------------------- ----------------- ----------------
Denominator for diluted earnings (loss) per share..... 34,392 32,547 34,215 28,954
================== =================== ================= ================
Earnings (loss) per common share:
Basic earnings (loss) per common share................ $ (0.19) $ 0.03 $ (0.13) $ 0.04
================== =================== ================= ================
Diluted earnings (loss) per common share.............. $ (0.19) $ 0.03 $ (0.13) $ 0.04
================== =================== ================= ================
</TABLE>
Employee stock options of 7,808,000 and 7,286,000 outstanding during the
three and six months ended June 30, 2000, respectively, that could potentially
dilute basic earnings (loss) per share in the future were not included in the
computation of diluted earnings (loss) per share because to do so would have
been anti-dilutive for the period.
The computation of diluted earnings per common share for the three and six
months ended June 30, 1999 excludes the assumed conversion of 6,261,000 shares
of Series A and B convertible preferred stock prior to its conversion to common
stock on May 21, 1999, because the impact of the conversion, including the
assumed elimination of the accretion on such preferred stock, would be anti-
dilutive.
4. Cash Equivalents
Cash equivalents include all highly liquid investments purchased with
remaining maturities of three or fewer months. Cash equivalents consist
primarily of investments in money market mutual funds, commercial paper, auction
rate, money market preferred stock investments, taxable and non-taxable
municipal bonds and notes, and are recorded at cost, which approximates fair
value.
5. Restricted Cash
Restricted cash relates to $2.5 million held in escrow to secure a lease on
office space in South Jordan, Utah; $111,000 held in the Company's accounts to
secure a lease on office space in Boston, Massachusetts; and $340,000 held in
the Company's accounts to secure letters of credit used to secure leases on
office space in Atlanta, Georgia and Irving, Texas.
8
<PAGE>
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 and its components in
financial statements. The Company incurred a foreign currency translation
adjustment loss of $(176,000), net of tax, for the three months ended June 30,
2000 compared to no foreign currency translation adjustment for the same period
in the prior year. This resulted in comprehensive loss of $(6.7) million for the
three months ended June 30, 2000 and comprehensive income of $1.1 million for
the three months ended June 30, 1999. The Company incurred a foreign currency
translation adjustment loss of $(276,000), net of tax, for the six months ended
June 30, 2000 compared to a foreign currency translation adjustment loss of
$(20,000), net of tax, for the same period in the prior year. This resulted in
comprehensive loss of $(4.6) million for the six months ended June 30, 2000 and
comprehensive income of $1.4 million for the six months ended June 30, 1999.
7. Commitments
We have commitments under long-term operating leases, principally for office
space and computer equipment. Our future minimum lease payments under non-
cancelable operating lease obligations, in excess of one year, at June 30, 2000
are as follows:
Year Amount
---- -----------------
Q3 - Q4, 2000 $ 4,986,857
2001 10,901,871
2002 12,621,886
2003 10,610,908
2004 10,265,834
Thereafter 47,855,693
-----------------
Total minimum lease commitments $97,243,049
=================
The future minimum lease payments noted above include amounts related to a
10-year lease for approximately 170,000 square feet of office space in South
Jordan, Utah. The lease will commence upon completion of construction and the
Company's subsequent occupancy of the office space, which is estimated to occur
in late 2001. It is expected that this lease will be an operating lease.
In addition to the above-noted operating leases, the Company also entered
into capital lease commitments totaling $1.3 million during the six months ended
June 30, 2000.
8. Legal Proceedings and Contingencies
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 alleges that the Company failed to deliver on contractual
commitments under a license agreement with Westfield and includes specific
claims of anticipatory breach of contract, breach of express warranty, and
negligent misrepresentation. The $5.8 million being sought from the Company by
Westfield was paid to the Company by Westfield in the first half of 1999 and
recognized as revenue by the Company during this period. On November 4, 1999,
the Company filed an Answer and Counterclaim denying these claims and seeking
recovery of $3.9 million that Westfield owes the Company under the license
agreement together with claims for additional damages. The case is in its
preliminary stages. Based on the information currently available, the Company
believes that it has valid defenses against Westfield's claims and the Company
intends to vigorously defend the case. The Company also intends to vigorously
enforce its rights under the license agreement, including recovery of the $3.9
million due and owing under the agreement.
The Company's outside legal counsel has commenced investigation of the facts
pertinent to the claims and counterclaims. Based on their analysis and current
assumptions, the Company's outside legal counsel has advised the Company that
there is a reasonable likelihood that the Company will successfully prosecute
the Company's claims and defenses. The Company's outside legal counsel has
advised the Company that, pending further investigation and discovery, the
prospect that the Company will incur a loss regarding
9
<PAGE>
monies already collected is remote, and that it is too early in the litigation
process to determine the probability of a recovery or loss with respect to the
remaining $3.9 million due under the agreement. The $3.9 million due and owing
under the agreement is included in accounts receivable in the consolidated
balance sheet at June 30, 2000. Due to the high degree of uncertainty associated
with litigation, it is possible that the Company will incur a loss with respect
to the $3.9 million currently due from Westfield. Such loss could range from
zero to $3.9 million. However, at the current time, the amount of any loss
cannot be reasonably estimated. An unfavorable outcome of this matter may have a
material adverse impact on the Company's financial position and results of
operations.
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
alleges that the Company failed to deliver on contractual commitments under a
license and services agreement with Nielsen and includes specific claims of
breach of contract and violation of the Illinois Consumer Fraud and Deceptive
Practices Act. The amount being sought from the Company by Nielsen is for fees
paid to the Company by Nielsen from the fourth quarter of 1997 through the first
quarter of 2000 and recognized as revenue by the Company during this period. In
addition, the Company has an unbilled accounts receivable recorded under the
terms of the contract totaling approximately $1.2 million, which is included in
unbilled accounts receivable in the consolidated balance sheet at June 30, 2000.
The case is in its preliminary stages and based on the information currently
available, the Company believes that it has valid defenses against Nielsen's
claims and the Company intends to vigorously defend the case and enforce its
rights under the agreement. The Company's legal counsel has commenced
investigation of the facts pertinent to the claims. As the case has just
recently been filed, the Company's legal counsel is not able to provide an
opinion on the likely or probable outcome of the case, including affirmative
claims and defenses that the Company may assert. An unfavorable outcome of this
matter may have a material adverse impact on the Company's financial position
and results of operations.
As a result of some customer correspondence that the Company received in
July 2000, the Company decided that it was appropriate to delay its scheduled
earnings release to conduct a review of this customer's and other significant
projects in process. As a result of these reviews, the Company became aware of
four potentially material customer disputes related to insurance applications
projects. In one case, a customer sent a letter to the Company in July 2000 in
which the customer purported to give notice of immediate termination of their
agreement, claiming default of the agreement, and requested a refund of all
amounts paid to date. The Company believes that it has not defaulted under the
agreement, and that the customer's attempted termination is not valid under the
terms of the agreement. In another case, a customer sent the Company letters in
July 2000 disputing the Company's performance under the contract and threatening
possible termination of the contract unless certain conditions are met. The
Company disputes these assertions about its performance. The Company has since
entered into active discussions with this customer and hopes to resolve these
differences. In the third case, the Company is in the latter stages of the
project but it is taking longer to complete than originally anticipated. This
customer has expressed a willingness to consider extending the deadline in the
contract based upon progress expected to be achieved during August and September
2000. However, if the Company is unable to demonstrate sufficient progress
during this time, it is possible that the customer may attempt to cancel the
contract and make a demand for refund of fees paid or other damages. In the
fourth case, the Company received a letter from the customer in June 2000
stating that the customer is terminating its contract with the Company effective
in the quarter ended September 30, 2000. In earlier periods, the Company
developed an application for this customer, and was paid in full for the
application following the customers' formal acceptance of the application.
During the quarter ended June 30, 2000 the Company provided some change order
and support services to this customer. The Company is actively working to
resolve these situations. However, if it is unable to do so, the Company will
defend itself vigorously and assert its rights as appropriate. An unfavorable
outcome of these matters may have a material adverse impact on the Company's
financial position and results of operations.
The total contract value of these four projects is approximately $38.1
million, of which $28.8 million has been received by the Company to date, and
$787,000 is included in accounts receivable and $3.9 million is included in
unbilled accounts receivable in the consolidated balance sheet at June 30, 2000.
Revenues recognized on these projects total $(2.6) million for the three months
ended June 30, 2000 and $2.0 million for the six months ended June 30, 2000.
10
<PAGE>
As a result of the above noted legal proceedings and contingencies, the
Company has provided an allowance for doubtful accounts related to unbilled
accounts receivable totaling approximately $4.0 million at June 30, 2000. In
addition, the Company maintains errors or omissions' and umbrella liability
insurance policies to protect itself in the event of claims for damages related
to the performance of or failure to perform computer related services. 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, as well as covering the costs of legal
defense; subject to the policies' total limit of $50 million and deductible of
$100,000 per occurrence, and the insurance carrier's standard reservation of
rights under which the carrier defers its final determination of the amount of
claims that it will cover until final disposition of a case.
9. 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 involves segmenting the Company's
business along industry lines, through the creation of separate subsidiaries,
and having these subsidiaries evolve into separate operating companies. The
Company is still in the process of establishing intercompany agreements between
the Company and these subsidiaries and between the subsidiaries themselves.
Currently, the CEO reviews 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. The consolidated financial information reviewed by the
CEO 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. Once the Company finalizes
intercompany agreements and these subsidiaries begin to provide meaningful
information for purposes of financial segment disclosure, the Company will
provide expanded segment information in accordance with SFAS No. 131.
Revenues from operations outside of North America were approximately 12
percent of revenues for the three months ended June 30, 2000 as compared to 11
percent of revenues for the same period in the prior year, while revenues from
operations outside of North America were approximately 11 percent of revenues
for the six months ended June 30, 2000 as compared to 8 percent of revenues for
the same period in the prior year. The Company's long-lived assets continue to
be deployed predominantly in the United States.
Three customers accounted for 15 percent, 12 percent, and 12 percent of the
Company's revenues for the three months ended June 30, 2000, compared to four
customers accounting for 20 percent, 19 percent, 11 percent, and 11 percent of
the Company's revenues for the same period in 1999. No other single customer
accounted for more than 10 percent of the Company's revenues for the three
months ended June 30, 2000 or the same period in 1999. Three customers accounted
for 19 percent, 11 percent, and 10 percent of the Company's revenues for the six
months ended June 30, 2000, compared to three customers accounting for 25
percent, 10 percent, and 10 percent of the Company's revenues for the same
period in 1999. No other single customer accounted for more than 10 percent of
the Company's revenues for the six months ended June 30, 2000 or the same period
in 1999.
11
<PAGE>
Revenue from our Vertical Business Groups is as follows (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------------- --------------------------------
2000 1999 2000 1999
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Banking:
License............................ $ 61 $ 618 $ 61 $ 818
Services........................... 2,529 1,429 5,105 1,977
--------- --------- --------- ---------
$ 2,590 $ 2,047 $ 5,166 $ 2,795
========= ========= ========= =========
Communications:
License............................ $ 423 $ - $ 762 $ 8
Services........................... 3,586 (37) 5,452 29
--------- --------- --------- ---------
$ 4,009 $ (37) $ 6,214 $ 37
========= ========= ========= =========
e-Business and Other:
License............................ $ 1,554 $ 434 $ 1,767 $ 510
Services........................... 895 1,372 2,158 1,757
--------- --------- --------- ---------
$ 2,449 $ 1,806 $ 3,925 $ 2,267
========= ========= ========= =========
Energy:
License............................ $ 618 $ 3,113 $ 1,530 $ 3,113
Services........................... 4,040 513 8,757 557
--------- --------- --------- ---------
$ 4,658 $ 3,626 $ 10,287 $ 3,670
========= ========= ========= =========
Healthcare:
License............................ $ 990 $ 310 $ 1,253 $ 337
Services........................... 1,230 864 2,564 1,457
--------- --------- --------- ---------
$ 2,220 $ 1,174 $ 3,817 $ 1,794
========= ========= ========= =========
Insurance:
License............................ $ (611) $ 2,712 $ 408 $ 7,374
Services........................... 4,089 6,184 17,503 13,590
--------- --------- --------- ---------
$ 3,478 $ 8,896 $ 17,911 $ 20,964
========= ========= ========= =========
Investment Management:
License............................ $ 4,551 $ 324 $ 6,487 $ 1,007
Services........................... 2,410 1,201 4,233 2,530
--------- --------- --------- ---------
$ 6,961 $ 1,525 $ 10,720 $ 3,537
========= ========= ========= =========
Total:
License............................ $ 7,586 $ 7,511 $ 12,268 $ 13,167
Services........................... 18,779 11,526 45,772 21,897
--------- --------- --------- ---------
$ 26,365 $ 19,037 $ 58,040 $ 35,064
========= ========= ========= =========
</TABLE>
10. Acquisition
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. Accordingly, the operations of LongView have been
included in the accompanying consolidated statements of operations for the
Company since the acquisition was closed. The acquisition was accounted for
under the purchase method of accounting.
Pursuant to the Agreement, the Company acquired from BarCal all of the
issued and outstanding capital stock of LongView for $22.0 million, comprised of
$10.0 million in cash and a $12.0 million note from the Company to BarCal. The
promissory note was due and payable in installments of $3.0 million on
12
<PAGE>
April 15, 2000 and $9.0 million on July 15, 2000 and bore interest at 6.5
percent. Both installment payments were made in accordance with the Agreement.
No further amounts remain outstanding on the $12.0 million note as of the date
of this filing.
BarCal has been a customer of LongView since 1998. BarCal has been a customer
of the Company since 1997 and, as such, has various software license and service
agreements with the Company. BarCal signed, on September 30, 1999, an additional
Master Software License and Services Agreement, purchasing from the Company a
multi-project license to the Universal Application and TenFold ComponentWare
products and related technical support services for $4.0 million. The Company
recorded approximately $3.7 million of license revenue in the fourth quarter of
1999 and is recording the remaining $330,000 as support revenue, ratably over
the support period.
At the acquisition date, LongView was in the process of researching and
developing two projects, 1) LongView 2000 and 2) TradeXpress. In connection with
the acquisition, the Company recorded a write-off of $2.0 million for acquired
in-process research and development related to these two projects in the fourth
quarter of 1999. The estimated costs to complete these acquired in-process
research and development projects as of the date of acquisition were $1.2
million. Management believed that the assumptions used in the LongView in-
process research and development analysis were reasonable at the time of the
acquisition. No assurance can be given, however, that the underlying assumptions
used to estimate expected revenues, development costs or profitability, or the
events associated with such projects, will transpire as estimated.
LongView 2000 is a trade order management software system for buy-side
financial institutions. The production version of this software was completed
and released during the first quarter of 2000. The Company has invested
approximately $1.3 million in research and development costs to date. Future
costs related to this product include only standard upgrades and maintenance
expense. Through June 30, 2000, $420,000 in revenues have been recognized from
LongView 2000.
TradeXpress is an e-business, large-scale trade order management software
solution for internet-based deployment. The primary risks and uncertainties
associated with this project at June 30, 2000 related to the dependency on new
features being added to the Universal Application, such as support for
hierarchical transactions and drag-and-drop technology. Remaining development
activities include application testing and various product enhancements. This
project is expected to be completed and released sometime during the fourth
quarter of 2000. The Company has invested approximately $500,000 in research and
development costs in TradeXpress to date. To date, no revenues have been
recognized on TradeXpress.
Expenses either incurred or anticipated which are associated with the
development and integration of the in-process research and development projects
are higher than previous estimates by $1.1 million. Additionally, other cash
outflows from maintenance and general and administrative activities are expected
to increase by $2.6 million. Management believes that projected revenues from
these projects will be higher than previous estimates by $6.9 million and that
revised estimates of net cash flows related to these projects are not materially
different than the original net cash flows used to calculate the in-process
research and development write-off.
The following unaudited pro forma financial information presents the combined
results of operations of the Company and LongView for the three and six months
ended June 30, 1999 as if the acquisition had occurred at the beginning of
calendar 1999, after giving effect to certain adjustments, including, but not
limited to, amortization of goodwill and other intangible assets, and decreased
interest expense. The $2.0 million write-off for acquired in-process research
and development has been excluded from the pro forma results as it is a non-
recurring charge. All amounts are in thousands except per share data.
13
<PAGE>
<TABLE>
<CAPTION>
Three Months Six Months
Ended Ended
June 30, 1999 June 30, 1999
------------------------ -----------------------
<S> <C> <C>
Total revenues............................. $ 20,425 $ 37,655
------------------------ -----------------------
Net income (loss).......................... 61 (753)
------------------------ -----------------------
Earnings (loss) per share:
Basic......................... $ 0.00 $ (0.03)
======================== =======================
Diluted....................... $ 0.00 $ (0.03)
======================== =======================
</TABLE>
The Company reviews its long-lived assets, including goodwill, for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets
held and used is measured by a comparison of the carrying amount of an asset to
future net cash flows expected to be generated by the asset. If such assets are
considered to be impaired, the impairment to be recognized is measured by the
amount by which the carrying amount of the assets exceeds the fair value of the
assets. Assets to be disposed of are reported at the lower of their carrying
amount or fair value less cost to sell.
Goodwill and other purchased intangibles represent the excess of the
purchase price over the fair value of the assets acquired in connection with the
acquisition of the LongView Group, Inc. on October 7, 1999. Goodwill and
substantially all other purchased intangibles are being amortized on a straight-
line basis over lives ranging from five to seven years. As of June 30, 2000
accumulated amortization of goodwill and other identifiable intangible assets
was $3.4 million.
11. 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. Each
subsidiary, 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. Outstanding stock options under the various stock option
plans as of June 30, 2000 range from 2.0 to 3.3 million common stock options.
One employee 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. 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, which is included in stockholder's equity in the consolidated balance
sheet under the caption Notes Receivable from Stockholders. This loan is full
recourse, secured by the related shares, and bears interest at 6.56 percent per
annum.
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. Prior to this transaction, the
Company owned 100 percent of its insurance subsidiary. Subsequent to this
transaction, the Company owns 99 percent of its insurance subsidiary. The
consolidated financial statements will not reflect minority interest
attributable to this exercise until this note is repaid. No other issuances of
subsidiary stock occurred during the three and six months ended June 30, 2000.
12. 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
14
<PAGE>
derivative are recognized in earnings in the period of change. The Company must
adopt SFAS No. 133 by January 1, 2001. Management does not believe the adoption
of SFAS No. 133 will have a material effect on the Company's results of
operations, financial position, or liquidity.
In December 1999, the Securities and Exchange Commission staff released
Staff Accounting Bulletin No. 101, Revenue Recognition ("SAB No. 101") to
provide guidance on the recognition, presentation, and disclosure of revenue in
financial statements; however, SAB No. 101 does not change existing literature
on revenue recognition. SAB No. 101 explains the staff's general framework for
revenue recognition, stating that four criteria need to be met in order to
recognize revenue. The four criteria, all of which must be met, are the
following:
. There must be persuasive evidence of an arrangement;
. Delivery must have occurred or services must have been rendered;
. The selling price must be fixed or determinable; and
. Collectibility must be reasonably assured.
Since releasing SAB No. 101, numerous implementation questions and concerns
have arisen in the financial reporting community. On June 26, 2000, the SEC
staff announced that they are delaying the required implementation date for SAB
No. 101. Accordingly, the Company is now required to adopt SAB No. 101 during
the fourth quarter of 2000. The Company continues to evaluate the impact, if
any, of SAB No. 101 and any possible, subsequent interpretations of SAB No. 101
on the Company's policies and procedures.
The FASB issued Interpretation No. 44, Accounting for Certain Transactions
Involving Stock Compensation--an Interpretation of APB Opinion No. 25 ("FIN No.
44") in March 2000. The interpretation clarifies the application of APB Opinion
No. 25 for certain issues such as the following: (a) the definition of employee
for purposes of applying APB Opinion No. 25, (b) the criteria for determining
whether a plan qualifies as a noncompensatory plan, (c) the accounting
consequence of various modifications to the terms of a previously fixed stock
option or award, and (d) the accounting for an exchange of stock compensation
awards in a business combination. The Company adopted FIN No. 44 on July 1,
2000. Management does not believe that the interpretation had or will have a
material effect on the Company's results of operations, financial position, or
liquidity.
13. Perot Systems Corporation Alliance
In June 2000, the Company amended its strategic alliance and related
agreements with Perot Systems Corporation, a systems integrator and less than
five percent shareholder of the Company. The Company also entered into a
reseller agreement under which Perot Systems may sublicense the Company's
current applications and technology products for five years. Perot Systems paid
the Company for initial sublicense fees and related support for these products.
The Company recognized these license fees upon shipment of these products to
Perot during the three months ended June 30, 2000, and is recognizing the
related support revenues ratably over the support period. After Perot Systems
has sublicensed copies of these products with sublicense fees equal to the
initial license payment, Perot Systems will pay the Company sublicense fees for
additional copies at rates specified in the reseller agreement.
The Company also amended two of its existing service agreements with Perot
Systems and its healthcare affiliate. The Company committed to use a minimum
number of Perot Systems staff on TenFold projects for a one-year period
beginning July 1, 2000. Perot Systems agreed to reduce the standard rate that it
charges the Company for Perot Systems staff working on TenFold projects during
this same one-year period. The Company has determined that its obligations to
use a minimum number of Perot System's staff is similar to a purchase commitment
which will be accounted for as those individuals provide services to the
Company. Although Perot Systems reduced the standard rate that it will charge
the Company for Perot Systems staff, the Company believes that these reduced
rates represent fair value given the volume of staff hours to be provided to the
Company. Additionally, as part of these changes, Perot Systems committed to
dedicate two salespeople to sell Company products and services through June
2001.
The Company also amended the existing alliance agreement such that it no
longer requires that if Perot Systems fails to provide the Company with
opportunities to contract for revenue of at least $15.0 million in
15
<PAGE>
the year following May 1, 2000, Perot Systems shall pay the Company 20 percent
of the shortfall. Management believes that these changes and the new reseller
agreement will provide the Company with more business opportunities than would
otherwise have been provided for under the original strategic alliance.
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: limited
operating history; recent customer complaints concerning our products and
services, and the possibility of future additional complaints; attraction and
retention of employees; variability of quarterly operating results; dependence
on a small number of customers; customer's fulfillment of various
responsibilities; fixed-time, fixed-price contracts; risks associated with the
functionality and timing of new product releases; project delays; longer than
expected sales cycles; ability to accurately estimate resources required for new
and existing projects; competitive factors; protection of intellectual property;
successful development of vertical businesses; maintaining strategic
partnerships; and risks associated with the integration of LongView into
TenFold's operations. These are representative of factors which could affect the
outcome of the forward-looking statements. 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. Please also refer to the
documents filed by us with the Securities and Exchange Commission, which
identify important risk factors that could cause actual results to differ from
those contained in forward-looking statements. Some of these factors are
described below under the section entitled "Factors That May Affect Future
Results and Market Price of Stock."
Overview
TenFold is a leading provider of large-scale e-business applications for
market-leading customers in banking, communications, energy, healthcare,
insurance, investment management, and other industries. From 1993 through 1995,
we engaged primarily in the development of our 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 large-scale, complex applications. In 1997 and
in subsequent years, we derived the majority of our license and service revenues
from fixed-price, fixed-time applications development projects. Starting in
1998, we also began reselling vertical applications products that we had
previously developed for other customers.
We derive our revenues from license fees, application development and
implementation services, support, and training services. License revenues
consist of fees for licensing our Universal 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.
SOP 97-2 generally requires revenue earned on software arrangements
involving multiple elements such as software products, enhancements, post-
contract customer support ("PCS"), installation
16
<PAGE>
and training to be allocated to each 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. VSOE for training is based 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 to be charged in future periods. In
arrangements where VSOE exists for all but the delivered element, the fee is
allocated to the delivered element (generally the software product) using the
residual method described in SOP 98-9. The revenue allocated to software
products is generally recognized upon delivery of the products unless services
provided are considered essential to the functionality of the software.
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 license 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 and six month
periods ended June 30, 2000 were $4.3 million and $4.8 million, respectively.
License fees recognized upon achieving these criteria, for both the three and
six month periods ended June 30, 1999 were $3.0 million.
For software arrangements that include a service element that is 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.
We determine 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 fixed price proposal. We make monthly adjustments
to the original estimates used in the percentage-of-completion method of
accounting as work progresses under the contract and as we gain experience.
Fixed price project revenues are split between license and service based upon
the relative fair value of the various components. On a limited basis, we also
provide application development and implementation services on a time and
materials basis. We recognize revenue on our time and material contracts as we
perform the services.
For the quarter ended June 30, 2000, as a result of the project reviews
described below, we determined that for certain highly complex projects, we
should limit revenue recognition to the amount of costs that we incur in the
period, and postpone recognition of profit until we can more precisely estimate
our project costs and our ability to complete the projects in a timely manner.
We are currently applying this methodology to two projects with total project
values of $23.1 million.
In mid-1998, we began offering the TenFold Guarantee, the industry's first
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
we guarantee 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
17
<PAGE>
recognize the refunds or losses in the period in which the refunds or losses
become probable and we can reasonably estimate them.
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 June 30,
2000 was $10.5 million. We expect to recognize most of this 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. Our unbilled accounts receivable represents revenue that we
have earned but which we have not yet billed. We bill customers for this revenue
as payments become due under the terms of the customer's contract. Our net
unbilled accounts receivable balance at June 30, 2000 was $8.9 million and we
expect to bill and collect this amount within twelve months. 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 all amounts due under the terms of their existing contracts.
Our projects have, over time, grown in size thereby requiring larger
development and implementation teams. The growth in team size has mainly been in
employees with lower daily billing rates. As a result, our average daily service
billing rate for a team has decreased over time. Additionally, we determined
that our current standard billing rates for services were higher than some
competitors' rates. We lowered these standard billing rates effective July 1,
2000. We expect to offset this decrease with higher license fees. In accordance
with SOP 97-2, these two factors, namely team composition changes and lower
standard billing rates, will require the allocation of contract revenues
involving multiple elements to change for contracts signed after June 30, 2000.
We expect that revenue from software arrangements that include a service element
sold after June 30, 2000 will have lower service revenues as a percentage of
total contract revenues and higher license revenues as a percentage of total
contract revenues. The impact of these changes on our overall revenues is
anticipated to result in a gradual mix change between license and services
revenues over time, with little or no impact on total revenues.
We are organized into discrete Vertical Business Groups, subsidiaries of
TenFold, to tailor marketing, selling, product development, and business
strategies for our target vertical industries. As each Vertical Business Group
grows in size, gains multiple customers, and develops multiple, resalable
applications products, it achieves increasing autonomy. We offer employee
incentives tied to the performance of these Vertical Business Groups. We have
granted to employees, and plan to continue to grant, options to acquire capital
stock of these subsidiaries. We expect these grants over time to total
approximately 15 percent to 20 percent of each subsidiary. We have offered and
may offer in the future, Vertical Business Group equity to strategic industry
partners. These subsidiaries may raise capital independently through an initial
public offering, private placement or other means, or be spun off from TenFold.
As of June 30, 2000, we had formed six subsidiaries from which we are
conducting or expect to conduct our vertical business operations in the banking,
communications, energy, healthcare, insurance, and investment management
industries. We are in the process of preparing intercompany agreements to cover
technology licensing and shared services between TenFold and these subsidiaries,
and between the subsidiaries themselves. We have transferred many of our
employees to these subsidiaries.
On September 30, 1999, we entered into a definitive agreement to acquire
The LongView Group, Inc. ("LongView"). The closing of the transaction occurred
on October 7, 1999. TenFold's acquisition of LongView was reported in a Form 8-K
filed on October 14, 1999, as amended.
On July 10, 2000, we issued a press release stating that we expected to
release final results for the second quarter and host a conference call on July
19, 2000. Subsequent to this press release, and prior to the expected release
date, we received correspondence from a customer that raised concerns about the
status of our project with this customer. As a result, we decided that it was
appropriate to delay our earnings release to conduct reviews of this and other
significant projects in process to reassess the status of each project and to
verify the related completion percentage. Upon completion of these reviews, we
reduced revenues on certain projects in process by approximately $4.8 million
and increased the allowance for doubtful accounts related to unbilled accounts
receivable from $0 at March 31, 2000 to approximately
18
<PAGE>
$4.0 million at June 30, 2000. Although we believe that we made all appropriate
adjustments to properly reflect the completion percentage and status of
contracts in process at June 30, 2000, we cannot be certain that similar future
adjustments will not be required. See Note 8 of Notes to Consolidated Financial
Statements for information about litigation and disputes related to some of our
projects.
Approximately $3.2 million of the $4.8 million revenue adjustment and the
majority of the customer disputes noted above, are related to projects within
our insurance vertical business group. Our insurance group has been one of our
fastest growing groups, and in a relatively short period of time has taken on
some particularly large and complex applications projects. We have asked
Jeffrey L. Walker, our Chairman, Executive Vice President and Chief Technology
Officer, to directly manage our insurance applications development and product
development areas until we are more confident of completion of our insurance
projects in process. We have also asked Nancy M. Harvey, our new Chief Operating
Officer, to spend the majority of her time helping to oversee our other vertical
groups' application development projects.
Results of Operations
The following table sets forth, for the periods indicated, the percentage
relationship of selected items from TenFold's statements of operations to total
net revenues.
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
------------------------ ------------------------
<S> <C> <C> <C> <C>
2000 1999 2000 1999
-------- -------- -------- --------
Revenues:
License.............................................. 29% 39% 21% 38%
Services............................................. 71% 61% 79% 62%
-------- -------- -------- --------
Total revenues..................................... 100% 100% 100% 100%
-------- -------- -------- --------
Operating expenses:
Cost of revenues..................................... 62% 33% 48% 36%
Sales and marketing.................................. 25% 31% 23% 30%
Research and development............................. 24% 21% 22% 21%
General and administrative........................... 23% 5% 14% 5%
Amortization of deferred compensation................ 1% 2% 1% 2%
Amortization of goodwill and acquired intangibles.... 4% - 4% -
-------- -------- -------- --------
Total operating expenses........................... 139% 92% 112% 94%
-------- -------- -------- --------
Income (loss) from operations......................... -39% 8% -12% 6%
-------- -------- -------- --------
Other income, net..................................... 3% 1% 2% 1%
-------- -------- -------- --------
Income (loss) before income taxes and minority
interest............................................ -36% 9% -10% 7%
Provision (benefit) for income taxes.................. -12% 3% -2% 3%
-------- -------- -------- --------
Net income (loss) before minority interest............ -24% 6% -8% 4%
Minority interest..................................... -0% - - -
-------- -------- -------- --------
Net income (loss)..................................... -24% 6% -8% 4%
======== ======== ======== ========
</TABLE>
Revenues
Total revenues increased $7.4 million, or 39 percent, to $26.4 million for
the three months ended June 30, 2000, as compared to $19.0 million for the same
period in 1999, while total revenues increased $22.9 million, or 66 percent, to
$58.0 million for the six months ended June 30, 2000, as compared to $35.1
million for the same period in 1999. Total revenues increased for the three and
six months ended June 30, 2000 compared to the same periods in 1999 due to an
increase in the number and size of our customer projects.
Revenues for the three and six months ended June 30, 2000 were lower than
we expected primarily due to longer than expected sales cycles as some of our
customer prospects moved more slowly than we anticipated to authorize and fund
new technology initiatives, delays encountered on some of our existing projects,
and reductions to revenue as a result of the project reviews that we did after
quarter-end as described in Overview above. We believe that some insurance
project delays and related revenue
19
<PAGE>
recognition adjustments occurred when we recently reorganized several similar
insurance application projects to avoid creating unnecessarily unique, and non-
product applications for each customer. By reorganizing and working on these
projects as a group, we believe that it keeps these customer applications
consistent with our overall product strategy and that in turn, these customers
benefit from enhanced functionality and ongoing product support. Despite the
additional short-term work, costs, and revenue adjustments required, we believe
that this approach will improve our customer relationships and our ability to
sell these products in the future, reduce our long-term costs of supporting
these customers, and improve the quality of our support.
License revenues increased $75,000, or 1 percent, to $7.6 million for the
three months ended June 30, 2000 as compared to $7.5 million for the same period
in 1999, while license revenues decreased $(899,000), or (7) percent, to $12.2
million for the six months ended June 30, 2000 as compared to $13.2 million for
the same period in 1999. License revenues represented 29 percent of total
revenues during the three months ended June 30, 2000 as compared to 39 percent
for the same period in 1999, and 21 percent of total revenues during the six
months ended June 30, 2000 as compared to 38 percent for the same period in
1999.
Service revenues increased $7.3 million, or 63 percent, to $18.8 million
for the three months ended June 30, 2000 as compared to $11.5 million for the
same period in 1999, while service revenues increased $23.9 million, or 109
percent, to $45.8 million for the six months ended June 30, 2000 as compared to
$21.9 million for the same period in 1999. Service revenues increased for the
three and six months ended June 30, 2000 compared to the same periods in 1999
due to an increase in the number and size of our customer projects.
Revenues from international customers were approximately 12 percent of
total revenues for the three months ended June 30, 2000 as compared to 11
percent for the same period in 1999. Revenues from international customers were
approximately 11 percent of total revenues for the six months ended June 30,
2000 as compared to 8 percent for the same period in 1999.
Three customers accounted for 15 percent, 12 percent, and 12 percent of our
revenues for the three months ended June 30, 2000, compared to four customers
accounting for 20 percent, 19 percent, 11 percent, and 11 percent of our
revenues for the same period in 1999. No other single customer accounted for
more than 10 percent of our revenues for the three months ended June 30, 2000 or
the same period in 1999. Three customers accounted for 19 percent, 11 percent,
and 10 percent of our revenues for the six months ended June 30, 2000, compared
to three customers accounting for 25 percent, 10 percent, and 10 percent of our
revenues for the same period in 1999. No other single customer accounted for
more than 10 percent of our revenues for the six months ended June 30, 2000 or
the same period in 1999.
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 and the relative emphasis we apply to
these offerings in any given quarter.
Operating Expenses
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 increased $10.0
million, or 157 percent, to $16.3 million for the three months ended June 30,
2000 compared to $6.3 million for the same period in 1999, while cost of
revenues increased $15.4 million, or 123 percent, to $28.0 million for the six
months ended June 30, 2000 compared to $12.6 million for the same period in
1999. Cost of revenues as a percentage of total revenues was 62 percent for the
three months ended June 30, 2000 as compared to 33 percent for the same period
in 1999, while cost of revenues as a percentage of total revenues was 48 percent
for the six months ended June 30, 2000 as compared to 36 percent for the same
period in 1999. The increase in absolute dollars between periods was mainly due
to an increase in compensation and other related costs associated with the
number of employees required for actual and anticipated customer projects. Cost
of revenues as a percentage of total revenues increased primarily because we
increased employment levels in anticipation of future sales. Additionally, cost
of revenues as a percentage of total revenues increased for the three and six
months ended June 30, 2000
20
<PAGE>
compared to the same periods in 1999 as service revenues comprised a higher
percentage of total revenues for the three and six months ended June 30, 2000
compared to the same periods in 1999.
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 increased $610,000, or 10 percent, to $6.4 million for the
three months ended June 30, 2000 as compared to $5.8 million for the same period
in 1999, while sales and marketing expenses increased $2.7 million, or 26
percent, to $13.3 million for the six months ended June 30, 2000 as compared to
$10.6 million for the same period in 1999. Sales and marketing expenses as a
percentage of total revenues were 25 percent for the three months ended June 30,
2000 as compared to 31 percent for the same period in 1999, while sales and
marketing expenses as a percentage of total revenues were 23 percent for the six
months ended June 30, 2000 as compared to 30 percent for the same period in
1999. The increase in sales and marketing expenses in absolute dollars was
primarily the result of hiring additional sales and marketing personnel and
expanding advertising and other marketing programs in connection with the growth
of our business. The decrease in expenses as a percentage of total revenues was
due to a decrease in sales commissions from lower than expected revenues as well
as the timing of advertising expenses.
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 increased
$2.3 million, or 57 percent, to $6.3 million for the three months ended June 30,
2000 as compared to $4.0 million for the same period in 1999, while research and
development expenses increased $5.3 million, or 71 percent, to $12.7 million for
the six months ended June 30, 2000 as compared to $7.4 million for the same
period in 1999. Research and development expenses as a percentage of total
revenues were 24 percent for the three months ended June 30, 2000 as compared to
21 percent for the same period in 1999, while research and development expenses
as a percentage of total revenues were 22 percent for the six months ended June
30, 2000 as compared to 21 percent for the same period in 1999. Research and
development expenses grew in absolute dollars due primarily to the addition of
personnel required to support expanded development efforts.
General and Administrative. General and administrative expenses consist
primarily of allowances for doubtful accounts, the costs of executive management
and finance and administrative staff, recruiting, business insurance, and
professional fees. General and administrative expenses increased $5.2 million,
or 609 percent, to $6.1 million for the three months ended June 30, 2000 as
compared to $865,000 for the same period in 1999, while general and
administrative expenses increased $6.3 million, or 375 percent, to $8.0 million
for the six months ended June 30, 2000 as compared to $1.7 million for the same
period in 1999. General and administrative expenses as a percentage of total
revenues were 23 percent for the three months ended June 30, 2000 as compared to
5 percent for the same period in 1999, while general and administrative expenses
as a percentage of total revenues were 14 percent for the six months ended June
30, 2000 as compared to 5 percent for the same period in 1999. The increase in
absolute dollars was primarily the result of an increase in the allowances for
doubtful accounts of approximately $4.0 million during the three months ended
June 30, 2000, as a result of the project reviews described under Overview
above. We also incurred additional general and administrative expenses as a
result of hiring additional finance and administrative personnel to manage and
support the increased complexity and scale of our operations.
Amortization of Deferred Compensation. Deferred compensation, along with
the associated amortization, results from the grant of stock options when there
is a difference between the exercise price of certain stock option grants and
the deemed fair value of the common stock at the time of such grants. Certain
grants during 1997, 1998, and 1999 were issued at a price that differed from 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
$316,000 for the three months ended June 30, 2000 as compared to $384,000 for
the same period in 1999, and amortization expense of $667,000 for the six months
ended June 30, 2000 as compared to $689,000 for the same period in 1999.
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 are
21
<PAGE>
being amortized over the expected lives of the goodwill and intangibles. These
lives range from five to seven years. We recorded amortization expense of
goodwill and acquired intangibles of $1.2 million for the three months ended
June 30, 2000, and amortization expense of goodwill and acquired intangibles of
$2.3 million for the six months ended June 30, 2000. We did not incur any
amortization of goodwill and acquired intangibles for the same periods in 1999
because the LongView acquisition did not occur until October 7, 1999.
Total Other Income, net. Net other income increased $543,000, or 335
percent, to $705,000 for the three months ended June 30, 2000 compared to
$162,000 for the same period in 1999, while net other income increased $963,000,
or 385 percent, to $1.2 million for the six months ended June 30, 2000 compared
to $250,000 for the same period in 1999. This increase primarily resulted from a
recognition of $540,000 of other income from a fee paid to us by Perot Systems.
Under their alliance agreement with TenFold, Perot Systems was obligated to
provide us with opportunities to contract for revenue of at least $15.0 million
for the fiscal year ended April 30, 2000 or pay us 20 percent of the shortfall.
This $540,000 payment fulfilled their remaining obligation to us for the year
ended April 30, 2000. This arrangement was amended such that the Company does
not expect to receive similar payments in the future. Additionally, we realized
an increase in interest and other income resulting from higher cash and cash
equivalent balances in the first six months of 2000 as compared to similar
periods in 1999. These balances mainly increased due to invested proceeds from
our initial public offering in May 1999. Interest income in both years was
partially offset by interest expense resulting from notes payable and capital
leases. Additionally, during the three months ended June 30, 2000, interest and
other income was negatively affected by a decrease in the British Pound to U.S.
dollar exchange rate. This resulted in a realized loss from foreign currency of
$(184,000).
Provision (Benefit) for Income Taxes. The benefit for income taxes was
$(3.1) million for the three months ended June 30, 2000 as compared to a
provision of $662,000 for the same period of 1999, while the benefit for income
taxes was $(1.4) million for the six months ended June 30, 2000 as compared to a
provision of $896,000 for the same period of 1999. The decrease in absolute
dollars was primarily due to decreased profitability during the three months
ended June 30, 2000. The effective tax rate of 32.6 percent during the three
months ended June 30, 2000 decreased from the 38.5 percent effective tax rate
during the same period in 1999 due to the non-tax deductibility of the
amortization of goodwill associated with the LongView acquisition, which reduces
the tax benefit of the operating losses. The effective tax rate of 25 percent
during the six months ended June 30, 2000 decreased from the 38.5 percent
effective tax rate during the same period in 1999 due to the non-tax
deductibility of goodwill associated with the LongView acquisition.
Minority Interest. Minority interest was $(8,000) for the three months
ended June 30, 2000 as compared to $0 in the same period in 1999, while minority
interest was $0 for the six months ended June 30, 2000 as compared to $0 in the
same period in 1999. This amount represents the minority stockholders'
proportionate interest in the net income (loss) of the Company's subsidiaries.
Minority interest decreased during the three months ended June 30, 2000
primarily due to decreased profitability. In future periods, as employees
exercise common stock options in the Company's subsidiaries, this amount is
anticipated to increase. We account for the sale of common stock in our
subsidiaries as an equity transaction.
Liquidity and Capital Resources
Prior to our initial public offering in May 1999, we financed our
operations primarily through cash flows from operations, private sales of
capital stock totaling $13.4 million, and, to a lesser extent, various types of
equipment loans and lease lines of credit. Effective May 20, 1999, we completed
an initial public offering of our common stock, resulting in net cash proceeds
to TenFold of $34.2 million.
On January 18, 1999, we entered into an unsecured Revolving Line of Credit
providing for borrowings of up to $5.0 million. On December 29, 1999 we modified
and extended the unsecured Revolving Line of Credit to provide for borrowings of
up to $15.0 million. On April 26, 2000, we further modified the agreement to
issue Letters of Credit against the Revolving Line of Credit. On April 28, 2000
and July 11, 2000, we obtained Letters of Credit in the amounts of $3.0 million
and $547,000 related to our San Francisco, California and Chicago, Illinois
office leases, respectively. These letters reduced the availability on the
Revolving Line of Credit by their face value to approximately $11.5 million as
of June
22
<PAGE>
30, 2000. The Revolving Line of Credit expires on November 15, 2000. We plan to
renew, renegotiate, or replace this facility, or seek other sources of
financing. Borrowings under the Revolving Line of Credit bear interest at rates
that vary from prime rate to prime rate less 1 percent or LIBOR plus 100 to 250
basis points. The actual interest rate is determined quarterly by certain
financial ratios. The Revolving Line of Credit includes covenants relating to
the maintenance of certain financial ratios and cash balances and limits the
payment of dividends. We had no outstanding borrowings on this Revolving Line of
Credit as of June 30, 2000.
Net cash used in operating activities was $9.4 million for the six months
ended June 30, 2000 as compared to $3.8 million in the same period of 1999. The
increase in cash flows used in operating activities was due to changes in
operating accounts, primarily a decrease in accrued liabilities and increases in
accounts receivable and unbilled accounts receivable. These changes were
partially offset by an increase in accounts payable. Additionally, a number of
employees exercised stock options during the six months ended June 30, 2000 as
the Company's stock price presented favorable conditions for employees to
exercise their options, creating a $6.8 million tax benefit from exercise of
stock options. This tax benefit was recorded as an increase in additional paid-
in capital. We expect to fully utilize the deferred tax assets associated with
these stock options in future periods. As future periods present favorable
conditions for employees to exercise their options, we expect to recognize
additional tax benefit associated with the exercise of stock options.
Net cash used in investing activities was $11.0 million for the six months
ended June 30, 2000 as compared to $2.4 million in the same period of 1999. The
increase in net cash used in investing activities was due primarily to purchases
made during the six months ended June 30, 2000 for additional office space,
including the purchase of two office buildings in San Rafael, California, as
well as equipment and furniture for additional office space in San Francisco,
California and Irving, Texas. The increase in restricted cash was due to $2.5
million held in escrow to secure a lease on office space in South Jordan, Utah;
and $340,000 held in the Company's accounts to secure letters of credit used to
secure leases on office space in Atlanta, Georgia and Irving, Texas.
Net cash provided by financing activities was $4.7 million for the six
months ended June 30, 2000 as compared to $37.0 million in the same period of
1999. Net cash provided by financing activities for the six months ended June
30, 2000 resulted from the issuance of a $2.4 million note payable related to
the purchase of two office buildings in San Rafael, California as well as an
additional $2.8 million in notes payable related to the purchase of new
equipment and furniture for new office space in San Francisco, California and
Irving, Texas. Additionally, we received $3.9 million in cash from the exercise
of employee stock options and the sale of Company stock through its Employee
Stock Purchase Plan. These proceeds were partially offset by principal payments
of $4.4 million on notes payable and obligations under capital leases. Net cash
provided by financing activities in 1999 resulted primarily from the proceeds of
the initial public offering.
Pursuant to the Agreement relating to the LongView acquisition, we entered
into a $12 million promissory note agreement with BarCal. Under the terms of
this agreement, we were required to pay installments of $3.0 million on April
15, 2000 and $9.0 million on July 15, 2000 plus interest at the rate of 6.5
percent per annum. We made both payments in accordance with the agreement.
We believe that our current cash and cash equivalent balances, anticipated
cash flows from operations, available credit facilities and future sources of
financing will be sufficient to meet our capital requirements for at least the
next twelve months. However, there can be no assurance that we will be
successful in generating anticipated levels of cash from operations or
borrowings. If we are unable to generate sufficient cash flow from operations,
or additional equipment loans or equipment and working capital lines of credit,
we may be required to scale down our operations and expansion plans, refinance
all or a portion of our existing indebtedness, or obtain other sources of
financing earlier than planned, any of which could have a material adverse
effect on our business, results of operations, and financial condition. There
can be no assurance that any such refinancing would be available on commercially
reasonable terms, or at all, or that any other financing could be obtained.
23
<PAGE>
In-Process Research and Development
In connection with the LongView acquisition, the Company recorded a write-
off of $2.0 million for in-process research and development in the fourth
quarter of 1999. The fair value assigned to purchased in-process research and
development was determined by estimating the costs to develop the purchased in-
process research and development into commercially viable products and
discounting the resulting net cash flows related to these projects. At the date
of the acquisition, the acquired in-process research and development had not yet
reached technological feasibility and had no alternative future uses.
In developing these cash flow projections, revenues were forecasted based
on estimates of relevant market sizes and growth factors, expected trends in
technology, and the nature and expected timing of new product introductions by
LongView and it competitors. LongView's projected revenues are dependent upon
successful introduction of the in-process research and development projects.
Operating expenses and resulting profit margins were forecasted based on the
characteristics and cash flow generating potential of the acquired in-process
research and development. Appropriate adjustments were made to operating income
to derive net cash flow.
In determining the operating cash flows related exclusively to in-process
research and development, management has considered the contribution of both
prior technologies (as demonstrated by prior products) and existing technology
or know-how that is generic among most or all products. Where appropriate, the
operating income estimates for each project have been apportioned between in-
process research and development and the appropriate intangible asset (i.e.,
existing technology). The operating income apportionment factor was determined
on the basis of an analysis of the specific contribution of each element of
existing technology to the subject in-process research and development, the
estimated effect of this contribution on the profitability of the subject in-
process project, and the relative importance of the existing technology to the
product's ultimate customer.
The discount rate for in-process research and development considers the
following risk elements (in addition to the baseline business and market risks
considered as part of the current product discount rate); risk of successfully
completing the in-process research and development project, risk that market
demand will exist in the future for the in-process research and development
product, risk that the forecasted cost structure will be possible, and the risk
that as yet unknown competitive products will emerge. An after-tax rate of 27.5
percent was applied to the in-process research and development projects.
The revenues earned by the in-process research and development products
represent the return on all of the assets acquired under the agreement. The cash
flows generated by the new products must provide a return on each asset
purchased that is consistent with the value and the relative risk of the asset.
To separately value in-process research and development, the value and required
rate of return for other identifiable assets must be determined. The required
return on these other assets is charged to (deducted from) the cash flows
generated by the projects shown in the in-process research and development model
to determine the incremental cash flows specifically attributable to the in-
process research and development project.
At the acquisition date, LongView was in the process of researching and
developing two projects, 1) LongView 2000 and 2) TradeXpress. In connection with
the acquisition, we recorded a write-off of $2.0 million for acquired in-process
research and development related to these two projects in the fourth quarter of
1999. The estimated costs to complete these acquired in-process research and
development projects as of the date of acquisition were $1.2 million. We
believed that the assumptions used in the LongView in-process research and
development analysis were reasonable at the time of the acquisition. No
assurance can be given, however, that the underlying assumptions used to
estimate expected revenues, development costs or profitability, or the events
associated with such projects, will occur as estimated.
LongView 2000 is a trade order management software system for buy-side
financial institutions. The production version of this software was completed
and released during the first quarter of 2000. We have invested approximately
$1.3 million in research and development costs to date. Future costs related to
this product include only standard upgrades and maintenance expense. Through
June 30, 2000, $420,000 in revenues have been recognized from LongView 2000.
24
<PAGE>
TradeXpress is an e-business, large-scale trade order management software
solution for internet-based deployment. The primary risks and uncertainties
associated with this project at June 30, 2000 related to the dependency on new
features being added to the Universal Application, such as support for
hierarchical transactions and drag-and-drop technology. Remaining development
activities include application testing and various product enhancements. This
project is expected to be completed and released sometime during the fourth
quarter of 2000. We have invested approximately $500,000 in research and
development costs in TradeXpress to date. To date, no revenues have been
recognized from TradeXpress.
Expenses either incurred or anticipated which are associated with the
development and integration of the in-process research and development projects
are higher than previous estimates by $1.1 million. Additionally, other cash
outflows from maintenance and general and administrative activities are expected
to increase by $2.6 million. We believe that projected revenues from these
projects will be higher than previous estimates by $6.9 million and that revised
estimates of net cash flows related to these projects are not materially
different than the original net cash flows used to calculate the in-process
research and development write-off.
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.
We must adopt SFAS No. 133 by January 1, 2001. We do not believe the adoption of
SFAS No. 133 will have a material effect on our results of operations, financial
position, or liquidity.
In December 1999, the Securities and Exchange Commission staff released
Staff Accounting Bulletin No. 101, Revenue Recognition ("SAB No. 101") to
provide guidance on the recognition, presentation, and disclosure of revenue in
financial statements; however, SAB No. 101 does not change existing literature
on revenue recognition. SAB No. 101 explains the staff's general framework for
revenue recognition, stating that four criteria need to be met in order to
recognize revenue. The four criteria, all of which must be met, are the
following:
. There must be persuasive evidence of an arrangement;
. Delivery must have occurred or services must have been rendered;
. The selling price must be fixed or determinable; and
. Collectibility must be reasonably assured.
Since releasing SAB No. 101, numerous implementation questions and concerns
have arisen in the financial reporting community. On June 26, 2000, the SEC
staff announced that they are delaying the required implementation date for SAB
No. 101. Accordingly, we are now required to adopt SAB No. 101 during the fourth
quarter of 2000. We continue to evaluate the impact, if any, of SAB No. 101 and
any possible, subsequent interpretations of SAB No. 101 on our policies and
procedures.
The FASB issued Interpretation No. 44, Accounting for Certain Transactions
Involving Stock Compensation--an Interpretation of APB Opinion No. 25 ("FIN No.
44") in March 2000. The interpretation clarifies the application of APB Opinion
No. 25 for certain issues such as the following: (a) the definition of employee
for purposes of applying APB Opinion No. 25, (b) the criteria for determining
whether a plan qualifies as a noncompensatory plan, (c) the accounting
consequence of various modifications to the terms of a previously fixed stock
option or award, and (d) the accounting for an
25
<PAGE>
exchange of stock compensation awards in a business combination. We adopted FIN
No. 44 on July 1, 2000. We do not believe that the interpretation had or will
have a material effect on our 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.
We have a limited operating history and consequently our future prospects are
difficult to evaluate.
We were founded in 1993 and have a limited operating history. As a result,
it is difficult to evaluate our future prospects. 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
recently 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.
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.
In the past, the software industry has experienced significant downturns,
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
. delays in introducing new applications.
Due to these factors, some of which are discussed in more detail below, 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.
26
<PAGE>
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 losses followed by profits
in a subsequent quarter and then returned again to a loss in a later quarter.
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.
If we fail to accurately estimate the resources required for a new project, or
the resources required to complete existing projects, quarterly operating
results could suffer and our stock price could fall.
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 would likely cause us to have lower margins or to suffer a loss
on the project, which would negatively impact our operating results. As a result
of recently receiving some correspondence from a customer that raised concerns
about the status of our project with this customer, we decided that it was
appropriate to conduct a review of this and other significant projects in
process to reassess the status of each project and to verify the related
completion percentage. Upon completion of these reviews, we reduced revenues on
certain projects in process by approximately $4.8 million and increased the
allowance for doubtful accounts related to unbilled accounts receivable from $0
at March 31, 2000 to approximately $4.0 million at June 30, 2000. Although we
believe that we made all appropriate adjustments to properly reflect the
completion percentage and status of contracts in process at June 30, 2000, we
cannot be certain that similar future adjustments will not be required.
If we fail to adequately anticipate employee and resource utilization rates,
quarterly operating results could suffer and our stock price could fall.
We plan to significantly increase our operating expenses to broaden our
service and customer support capabilities, expand sales and marketing
operations, develop new distribution channels, and fund greater levels of
research and development. 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 may
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 could result in under-utilized employees and could, therefore,
cause us to suffer quarterly losses or adverse results of operations.
If we experience project delays, quarterly operating results could suffer and
our stock price could fall.
Because we recognize service revenues over the period we develop an
application, project delays could have a significant negative impact on
operating results. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Overview" for a discussion of our revenue
recognition policies. These delays could be caused by a number of factors that
are outside of our control. For example, because our development methodology
requires significant involvement by customer personnel during several key phases
of the development cycle, delays could be caused by customers failing to meet
their contractual obligations, including reviewing and approving requirements,
providing timely feedback, and providing adequate staffing. Delays could also be
caused by customers being distracted by information technology issues they face,
by corporate reorganizations or business combinations in which they are
involved, or other factors. Furthermore, delays could be caused by
misinterpretations of, or changes in, customer requirements, or by a loss of
personnel or members of a particular project team. We have recently and in the
past experienced delays for these and other reasons. 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.
27
<PAGE>
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. 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.
We are dependent on a small number of large customers and the loss of one or
more of these customers may cause revenues to decline.
Although we plan to expand and diversify our customer base, 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, would have an adverse effect on our
revenues. 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, it 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.
If our current losses continue or increase, we may record a valuation
allowance against our deferred tax assets
While we believe our deferred tax assets are more likely than not
realizable, if our book losses continue or increase, we may record a valuation
allowance against our deferred tax assets, which could have an adverse effect on
earnings.
We have historically derived a significant portion of our revenues from
customers in the insurance industry.
Software applications we developed for companies in the insurance industry
represented 31 percent of our total revenues during the six months ended June
30, 2000. We have recently received customer complaints about a number of our
insurance projects. See Note 8 in the accompanying Notes to Consolidated
Financial Statements for more information concerning these matters. Our reliance
on customers from a particular industry subjects our business to the economic
conditions impacting that industry, including the industry's demand for
information technology resources. If we continue to rely on the insurance
industry, or any one industry as a major source of revenues, and that industry
suffers adverse economic conditions, there will likely be a significant
reduction in the demand for our products, causing revenues to suffer. Although
we intend to continue to diversify our customer base, there can be no assurance
that we will be able to completely do so in the near term or at all.
We are involved in litigation 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 could cause our operating results to suffer.
28
<PAGE>
We are currently involved in two significant litigation matters, and four
potential customer disputes. See Note 8 in the accompanying Notes to
Consolidated Financial Statements for more information concerning these matters.
We may in the future face other litigation or disputes with customers,
employees, partners, 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 financial position and results of operations.
We offer fixed-price, fixed-time contracts that we guarantee.
An important element of our strategy is to enter into fixed-price, fixed-
time contracts, rather than time and materials contracts. These contracts
involve risk because they require us to absorb possible cost overruns and, if we
fail to meet our performance obligations, may require us to satisfy our
performance guarantee. We guarantee that we will complete our projects within a
fixed time or the customer has the option to return the software and receive a
refund of any fees paid under the contract. For fixed-price contracts, 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. 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 would
likely cause us to have lower margins or to suffer a loss on the project, which
would negatively impact our operating results. In specific circumstances, we
have been required to commit unanticipated additional resources to complete
projects. We will likely experience similar situations in the future. In
addition, for specific projects, we may fix the price before the requirements
are finalized. This could result in a fixed price that turns out to be too low,
which would cause us to suffer a loss on the project and would negatively impact
our operating results.
If our software contains defects or other limitations, we could face product
liability exposure and our reputation could be damaged.
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.
Our products have not been extensively tested to determine the extent to
which they are scaleable - capable of being used effectively by large numbers of
users simultaneously. Because customers may require that our products be capable
of simultaneous use by large numbers of users, if it turns out that our products
are not scaleable to the required extent, our growth and market share would be
materially adversely affected.
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.
29
<PAGE>
Our failure to manage growth and organizational structure could impair our
business.
Our growth and new projects have placed significant demands on our
management and other resources. If we are unable to manage our growth and
projects effectively, this inability could have a material adverse effect on the
quality of our services and products, our ability to retain key personnel, and
our business, financial condition, and results of operations. Our revenues for
the six months ended June 30, 2000 increased approximately 66 percent when
compared with the same period in 1999. Our staff increased from 388 full-time
employees at June 30, 1999 to 668 full-time employees at June 30, 2000. Our
ability to manage this growth 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. In addition, our future success will depend in large part on our
ability to continue to set fixed-price fees accurately, maintain high rates of
employee utilization, and maintain project quality.
An element of our business strategy involves organizing our business along
industry lines, and evolving these business units into separate operating
companies. Our success in executing this strategy will depend to a large extent
on our ability to create and manage this complex organizational structure,
including our ability to establish and implement the appropriate management
structure, compensation programs, and financial reporting systems. Our
management has limited experience in managing an organization of this nature,
and our failure to meet the managerial challenges posed by the development and
operation of such an organization would harm our business.
A loss of Gary D. Kennedy, 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 Gary D.
Kennedy, 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,
Executive Vice President and Chief Technology Officer; Sameer Shalaby, Senior
Vice President of Architecture Development; and Adam Slovik, Senior Vice
President of Worldwide Applications Development. 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. None of our key employees, other than Mr. Kennedy, has signed an
employment agreement or an agreement not to compete with TenFold upon
termination of employment. Even in the case of Mr. Kennedy, his employment
agreement does not assure his 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. There can be no assurance that we will be successful in attracting a
sufficient number of highly-skilled employees in the future, or that we will be
successful in retaining, training, and motivating the employees we are able to
attract. If our employees are unable to achieve expected performance levels, our
business will be harmed.
30
<PAGE>
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.
The success of our business is dependent upon our ability to develop
software applications for customers that we can resell to other customers in the
same industry without significant modification. If we are unable to 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 resellable products in the near term. In addition, we have agreed with
Perot Systems Corporation, a systems integrator with whom we have a strategic
relationship, that in some cases Perot Systems or its customers will own
applications that we develop under our relationship with them.
We may not be able to successfully develop applications for new vertical
industries in which we have limited experience.
We intend to expand our business into new vertical industries. If we are
unsuccessful in developing applications that meet the needs of companies in
these markets or if our applications are not competitive, our operating results
will suffer. We have limited experience in developing software applications for
companies outside of the industries we have targeted to date and there can be no
assurance that we will be able to successfully develop these applications in the
future. In addition, we will face competition from companies that have
significantly greater experience in developing applications for the industries
we intend to target and that have greater name recognition than we do.
If we are unsuccessful in implementing our vertical business strategy, our
ability to grow our business will be impaired.
Our vertical business strategy involves segmenting our business along
industry lines, through the creation of separate subsidiaries, and having these
subsidiaries evolve into separate operating companies. We offer employee
incentives, including stock options in the subsidiaries, to attract, motivate,
and retain quality staff. We have offered and may offer in the future, equity in
the subsidiaries to strategic industry partners. These subsidiaries may raise
capital independently through an initial public offering, private placement or
other means, or be spun off from TenFold. We believe that the successful
implementation of this strategy will be important in order for us to achieve
significant growth. We may face significant challenges in implementing this
strategy, including the segmentation and valuation of the various subsidiaries,
the selection of strategic industry partners, issues relating to conflicts of
interest among the subsidiaries, their stockholders and TenFold, and potential
charges and expenses resulting from any repurchases of equity interests in the
subsidiaries. Our failure to successfully address these challenges could cause
this business strategy to fail, which would impair our ability to grow our
business.
Future events could affect previous valuations of subsidiaries.
Our subsidiaries grant options to certain employees. The exercise price for
all option grants is equal to the fair market value of the subsidiaries' common
stock. As none of the subsidiaries are publicly traded, the determination of
fair market value is made by the subsidiaries' boards of directors based upon
the board's knowledge of the subsidiaries' financial condition, prospects,
success in the marketplace, counsel from its professional advisors such as
outside counsel or independent appraisers, and other factors.
Before TenFold Corporation was publicly traded, we recognized deferred
compensation, along with the associated amortization, from the granting of
certain stock options when there was a difference between the exercise price of
certain stock option grants and the deemed fair value of the common stock at the
time of such grants. Future events could occur that could challenge the board of
directors previous
31
<PAGE>
determination of fair value. As a result, certain of the subsidiaries' stock
option grants could be deemed to have been granted at less than fair market
value. Such a determination would create deferred compensation and associated
amortization expense and change our reported financial results.
If we fail to generate substantial revenues from our relationship with Perot
Systems Corporation, our operating results may suffer.
We entered into a strategic relationship with Perot Systems Corporation, a
systems integrator, to develop and deliver applications, products, and services
to TenFold and Perot Systems customers. This relationship was modified in June
2000 when we entered into a reseller agreement with Perot Systems. We plan to
devote significant resources to the continued development of this relationship.
As a result, if we fail to generate substantial revenues from this relationship,
whether due to the failure of the relationship or our inability to staff the
opportunities presented, our operating results may suffer.
If we are unable to expand our international operations, our growth will
suffer.
Although we currently have limited international operations, our ability to
achieve revenue growth in the future will depend in part on our ability to
develop international sales. Although we may invest significant resources to
establish additional sales and service operations outside the United States and
to enter additional international markets, there can be no assurance that these
efforts will be successful. In order to successfully establish international
sales, we must establish foreign operations, add an international sales and
support organization, hire additional personnel, and recruit international
distributors. To the extent that we are unable to do so in a cost-effective
manner, our growth and operating results could be materially adversely affected.
In addition, our guarantee may not be appropriate in some international markets
for various reasons, including business practices in these markets. As a result,
we may not be able to derive value from the TenFold Guarantee in these markets.
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 two
patents and applied for one additional patent 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 foreign 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.
32
<PAGE>
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 consulting and
software integration firms, application software vendors, and internal
information systems groups. 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, 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 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.
We may fail to properly integrate our LongView acquisition, which could cause
our business to suffer.
While we analyzed carefully the LongView acquisition, we cannot ensure that
it will result in long-term benefits to us or our stockholders, or that our
management will be able to manage the acquired businesses effectively. In
addition, growth through acquisition involves a number of risks. If any of the
following events occur with the LongView acquisition, it could seriously harm
our business, operating results, and financial condition:
. we have difficulty combining previously separate businesses into a
single unit;
. we fail to realize anticipated benefits, such as cost savings and
revenue enhancements;
. we discover unknown liabilities after the acquisition;
. we do not properly train LongView employees on our technology and our
culture;
. we are unable to retain key personnel;
. we have difficulty assimilating LongView's products; and
. we fail to retain LongView's customers
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% of our outstanding common
stock. Furthermore, Jeffrey L. Walker, Chairman, Executive Vice President and
Chief Technology Officer, and the Walker Children's Trust, in the aggregate,
33
<PAGE>
currently beneficially own approximately 50% of our outstanding common stock.
Mr. Walker, acting alone or 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.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Interest Rate Risk. As of June 30, 2000, we had cash and cash
equivalents of $42.4 million. 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 June 30, 2000 rates
would cause the fair value of these cash 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.
Foreign Currency Exchange Rate 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, fixed assets, accounts payable, deferred revenue, 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 June
30, 2000 rate would cause the fair value of such monetary assets and liabilities
in the United Kingdom to change by approximately $750,000. We recognize the risk
related to this foreign currency exchange and we are currently evaluating
several foreign currency hedging strategies to mitigate this risk; however, we
are not currently engaged in any foreign currency hedging activities.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
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 alleges that we
failed to deliver on contractual commitments under a license and services
agreement with Nielsen and includes specific claims of breach of contract and
violation of the Illinois Consumer Fraud and Deceptive Practices Act. The amount
being sought from us by Nielsen is for fees paid to us by Nielsen from the
fourth quarter of 1997 through the first quarter of 2000 and recognized as
revenue by us during this period. In addition, we have an unbilled accounts
receivable recorded under the terms of the contract totaling approximately $1.2
million, which is included in unbilled accounts receivable in the consolidated
balance sheet at June 30, 2000.
The case is in its preliminary stages and based on the information
currently available, we believe that we have valid defenses against Nielsen's
claims and we intend to vigorously defend the case and
34
<PAGE>
enforce our rights under the agreement. Our legal counsel has commenced
investigation of the facts pertinent to the claims. As the case has just
recently been filed, our legal counsel is not able to provide an opinion on the
likely or probable outcome of the case, including affirmative claims and
defenses that we may assert. An unfavorable outcome of this matter may have a
material adverse impact on our financial position and results of operations.
We maintain errors or omissions' and umbrella liability insurance
policies to protect ourselves in the event of claims for damages related to the
performance of or failure to perform computer related services. We believe that
this insurance covers the types of alleged damages (but not unpaid or unbilled
accounts receivable) claimed in the case noted above, as well as covering the
costs of legal defense; subject to the policies' total limit of $50 million and
deductible of $100,000 per occurrence, and the insurance carrier's standard
reservation of rights under which the carrier defers its final determination of
the amount of claims that it will cover until final disposition of a case.
For information concerning our litigation with Ohio Farmers Insurance
Company, other contingencies, and related accounts receivable allowances that we
have provided, see Note 8 of the Notes to Consolidated Financial Statements in
Part I of this report.
Item 2. Changes in Securities and Use of Proceeds.
Our registration statement (Registration No. 333-74057) under the
Securities Act of 1933, for our initial public offering, became effective on May
20, 1999. Our offering proceeds, net of aggregate expenses of approximately $4.7
million, were $34.2 million. As of June 30, 2000, we used approximately $34.2
million of those proceeds as follows (in millions):
Construction of plant, building and facilities $ -
Purchase and installation of machinery and equipment -
Purchases of real estate -
Acquisition of The LongView Group, Inc. 13.0
Repayment of indebtedness -
Working capital -
Purchase of temporary investments 21.2
-----
$34.2
=====
See Note 10 of Notes to Consolidated Financial Statements for a more
detailed discussion of our acquisition of The LongView Group, Inc. and payments
made or to be made in connection with this acquisition. The foregoing amounts
represent our best estimate of our use of the proceeds for the period indicated.
We invested the net proceeds used for the purchase of temporary investments in
cash, cash equivalents, and short-term investments. None of our net offering
proceeds were paid directly or indirectly to our directors, officers, general
partners, holders of 10 percent or more of any class of equity securities, or
any of our affiliates.
35
<PAGE>
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Number Description
------ -----------
10.1 Office Lease at 200 South Wacker Drive, Chicago, Illinois between
200 South Wacker Drive, L.L.C. and TenFold Corporation
10.2+ Amended and Restated Strategic Alliance Agreement effective June 30,
2000 between Perot Systems Corporation and TenFold Corporation
11* Computation of Shares used in Computing Basic and Diluted Net Income
Per Share
27 Financial Data Schedule
* Incorporated by reference to "Notes to Consolidated Financial Statements"
herein
+ Confidential treatment requested as to certain portions of this agreement
(b) Reports on Form 8-K
None
36
<PAGE>
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/ Robert P. Hughes
--------------------------
Robert P. Hughes
Senior Vice President and
Chief Financial Officer
Date: August 14, 2000
37
