Item 1. Business
Business Overview
TenFold provides services and technology for building complex, Service Oriented Architecture (“SOA”)-compliant, enterprise-scale applications in significantly less time and cost than it would otherwise take using traditional development technologies. We believe that with TenFold’s technology, EnterpriseTenFold SOA, customers will also experience significantly reduced ongoing applications maintenance and enhancement costs compared to what they generally experience with legacy applications.
Our business model focuses on providing applications development services and our EnterpriseTenFold SOA product, along with product support and training, to customers who can use a TenFold team or their own business teams to build and maintain applications.
At the end of 2005, we replaced our former Chief Executive Officer, with long-time TenFold director and shareholder, Robert W. Felton. Under his leadership, we have changed our business model to focus on selling larger consulting projects, instead of the smaller prototype application projects that we primarily sold in 2005. We believe that providing larger consulting projects (that include the full breadth of applications consulting from applications design through production implementation) will be a more successful model for both our customers and us. We believe that some of our earlier customers would have been more successful with their projects with more consulting assistance than they chose to purchase under our prior business model. We made steady progress closing new sales and beginning new consulting projects in 2006, quarter by quarter, to both existing and new customers. We also improved our quarterly operating cash flow from $(1.9) million for Q2 2006, to $(864,000) for Q3 2006, and to $21,000 for Q4 2006. However, such sales have not been sufficient to generate sustained positive cash flow from operations, or profitability. As a result, increasing sales further remains a key goal, and until we do so, we are likely to continue to experience negative cash flow from operations and losses. If we do not close significant future sales, our existing cash resources will not be sufficient to fund our operations beyond Q2 of 2007.
EnterpriseTenFold SOA automates most of what applications programmers typically do, and empowers small teams of business people and information technology (“IT”) professionals to design, build, test, deploy, and maintain complex, transaction and database-intensive applications, with significantly reduced demand on scarce IT resources as compared to other applications development approaches and technologies. Using a small team of business people supplemented with IT professionals for rapid applications development is a significant change from the industry-standard approach that relies on large teams of IT professionals who expend significant numbers of person years of effort to design, program, test, change, and deploy enterprise applications. We believe that with EnterpriseTenFold SOA, customers get high-quality, complex enterprise applications into production faster and at significantly lower cost than with other applications development technologies.
We believe that in EnterpriseTenFold SOA, TenFold has developed the first, complete universal application - a complete applications server and development environment that enables corporations to custom-build and maintain complex, database, transactional, enterprise applications rapidly with high quality and functional richness.
We believe EnterpriseTenFold SOA has two unique attributes that make building complex, database-intensive and transaction-intensive applications substantially cheaper, easier, and faster than traditional applications development methodologies and tools. First, EnterpriseTenFold SOA uses a model-driven approach that renders modeled applications by combining TenFold’s already programmed universal application with metadata describing a specific application, which means that EnterpriseTenFold SOA already includes most of what applications programmers typically do and automatically provides advanced applications functionality. Because of its model-driven approach, we believe customers get more powerful, higher quality applications faster and at a fraction of the cost of traditional programming approaches. Second, TenFold’s development environment provides a tool and methodology that
Index to Financial Statements
business people can effectively use, which we believe enables organizations to directly leverage their business experience and insight, and to adapt applications easily to meet changing business requirements. Thus, we believe TenFold’s model-driven approach lets a TenFold-trained team do Extremely Rapid Applications Development. As a result, a TenFold-trained team can build applications so quickly that customers experience both trying the application and improving the application in very short turnaround cycles to help ensure what is built is what the business really needs.
We believe EnterpriseTenFold SOA offers three standout benefits:
1. Speed. EnterpriseTenFold SOA lets a small, trained team of business people and IT professionals build and enhance high-quality, high-performance, powerful applications much faster than other technology because building or enhancing a TenFold-powered application using EnterpriseTenFold SOA requires only describing applications features and functionality. Other applications development technologies also let you build and enhance applications, but most require large teams of programmers, take longer, and are risky for complex applications because those other technologies require detailed, complex, logic programming. The high failure rate of complex applications development projects suggests that other applications development technologies often lead to project cost and schedule overruns, applications quality problems, and sometimes project cancellations.
2. Quality. EnterpriseTenFold SOA includes the TenFold RenderingEngine, which renders an application from its description (or model). With EnterpriseTenFold SOA, there is no need to write or test new code in the building of an application. Thus, it is less likely for the application to have defects or quality problems. We believe that a TenFold-powered application works just as you describe it to work; it may not do what you want, but it does do what your description says for it to do. Because the code that every TenFold-powered application executes is the same well-tested code that TenFold provides before a project begins, we believe TenFold-powered applications are much higher quality than most other applications.
3. Power. The TenFold RenderingEngine contains thousands of features that make any TenFold-powered application more functionally-rich than the same application that a programmer-staffed applications development team could pragmatically afford to program. We believe TenFold-powered applications have clever, powerful features unavailable in most other applications.
Our business model focuses on providing applications development services and our EnterpriseTenFold SOA product, along with product support, and training, to customers who can use a TenFold team or their own business teams to build and maintain applications.
Business History
We founded TenFold in 1993. We spent the first several years primarily developing our patented EnterpriseTenFold SOA technology. In 1996, we began using EnterpriseTenFold SOA to build applications for customers.
In 1999, we completed our initial public offering. In 1999 and early 2000, we tested a new business model that caused us to face significant financial, legal, and operational issues. Starting in late 2000, we took steps to resolve the financial and legal liabilities that arose as a result of the interim business model and to restore TenFold to sound business health.
We raised capital twice during 2003. In February 2003, Robert W. Felton, a long-time TenFold director (and our current Chairman, President, and Chief Executive Officer), made an investment of $700,000 in TenFold, by acquiring restricted TenFold common stock. In December 2003, we closed a $10 million private placement of restricted TenFold common stock.
Index to Financial Statements During 2003 and 2004, we continued sales and marketing related initiatives including establishing alliance relationships with distributors such as VARs; prototyped a new sales model focusing on selling small, paid proof-of-concept projects; initiated internet access to TenFold technology; introduced TenFold Support SpeedPro, making expert consultants available for short-duration projects; and increased marketing and public relations efforts to seek to broaden awareness of and interest in TenFold technology.
During 2005, we focused new-customer sales primarily on selling small, proof-of-concept projects as part of our penetrate and radiate sales program. Once we completed an initial project, we attempted to radiate into the account by selling additional services and licenses. The financial impact of the new-account, or “penetrate”, transactions was immaterial to our overall financial performance. Some of these accounts radiated from proof-of-concept projects to purchase larger production licenses and additional services. However, they were not sufficiently large for us to achieve profitability or positive cash flow.
At the end of 2005, we replaced our former Chief Executive Officer, with long-time TenFold director and shareholder, Robert W. Felton. Under his leadership, we have changed our business model to focus on selling larger consulting projects, instead of the smaller prototype application projects that we primarily sold in 2005.
During 2006, our new CEO’s initial goals were to raise capital for TenFold to improve our financial condition, and to increase sales. In March 2006, we completed a capital raising transaction for gross proceeds of approximately $6.3 million (before expenses and repayment of $1.1 million of interim financing obligations). And in December 2006, we completed an additional capital raising transaction for gross proceeds of approximately $1.3 million (before expenses).
During 2006, our CEO spent significant time working with prior and existing customers to re-establish and improve relationships with these customers, and meeting with many new prospects. We made steady progress closing new sales and beginning new consulting projects in 2006, quarter by quarter, to both existing and new customers. We also improved our quarterly operating cash flow from $(1.9) million for Q2 2006, to $(864,000) for Q3 2006, and to $21,000 for Q4 2006. However, such sales have not been sufficient to generate sustained positive cash flow from operations, or profitability. As a result, increasing sales further remains a key goal.
During 2006, we released EnterpriseTenFold SOA Personal Edition, a version of our EnterpriseTenFold SOA product packaged with tutorials to teach potential customers how to build SOA-compliant applications and services without extensive programming, for download and installation on a personal computer and licensed for anyone to evaluate TenFold technology at no charge. We believe that making EnterpriseTenFold SOA Personal Edition readily available at no charge will accelerate the acceptance of our technology as people try it out and discover the capabilities that it brings to the development process.
During 2006, we also continued to enhance our product, EnterpriseTenFold SOA, adding new features and capabilities including:
•
Enhanced TenFoldTools to improve applications development experts productivity
•
Expanded Service-Oriented Architecture capabilities
•
Upgraded web services support to include new standards and provide compatibility with more third-party technologies
•
Extended authentication integration to add Windows single sign-on and Active Directory support
•
Ajax-enabled BrowserClient user interface to greater usability, performance, and customizability
•
Extended software platforms support to include EnterpriseDB database, latest version of the Internet Explorer and FireFox browsers, and recent versions of several RDBMS and operating systems
•
TenFoldServer enhancements that improve applications maintainability and health-monitoring
During 2006, we earned revenues from 39 customers. Some of our customers accounted for 10 percent or more of our annual revenues in 2006. DevonWay (a related person, see Note 17 of the Notes to Financial Statements for more information) accounted for 21 percent, JPMorgan Chase accounted for 16 percent, and Allstate accounted for 10 percent of our revenues for the year ended
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December 31, 2006. In December 2006, we recognized $1 million in license revenues from previously deferred revenue from a single large license transaction in 2005 from DevonWay. Without this revenue, DevonWay would have accounted for 1% of our revenues for the year ended December 31, 2006. See Management’s Discussion and Analysis of Financial Condition and Results of Operations - 2006 as Compared to 2005-Revenues for more information.
XanGo accounted for 20 percent, JPMorgan Chase accounted for 18 percent, and DevonWay accounted for 11 percent of our revenues for the year ended December 31, 2005. Cedars-Sinai Medical Center accounted for 50 percent, JPMorgan Chase accounted for 22 percent, and Sapient accounted for 15 percent of our revenues for the year ended December 31, 2004.
Revenues from customers outside of North America were approximately 8 percent of total revenues for 2006, 11 percent of total revenues for 2005, and 20 percent of total revenues for 2004. Revenues from customers in the United Kingdom were 7 percent of total revenues for 2006, 9 percent of total revenues for 2005, and 19 percent of total revenues for 2004. Revenues from operations in Argentina were 1 percent of total revenues for 2006, 2 percent of total revenues for 2005, and 0.9 percent of total revenues for 2004. Our long-lived assets are deployed in the United States.
Customers with TenFold-powered applications in production today include, among others, Abbey National Bank, Allstate Insurance, Barclays Global Investors, Boston Scientific, Cedars-Sinai Medical Center, Deutsche Bank, Franklin Templeton, Ingenix (a subsidiary of UnitedHealth Group), Intermountain Power, iplan networks, Isolagen, JPMorgan Chase, MedCath, Medical Group Insurance Services, Oppenheimer, Rand Technology, Trinity Health, University of Utah DIGIT Lab, and Vertex Data Science Limited.
Industry Challenge
Organizations worldwide face increasing pressure to replace their legacy enterprise applications and introduce new applications as they seek to increase productivity, cut costs, introduce new products and services, address changing regulatory and competitive demands, and access new technology. However, organizations face daunting odds of failure because traditional processes for building, integrating, and deploying complex applications are costly and risky. Consequently, many organizations continue to make substantial investments to maintain legacy applications that inadequately meet current needs and do not address new business requirements. To obtain new or replacement applications, companies choose between buying a packaged software application or building a custom software application.
Organizations generally turn to independent software vendors, such as Enterprise Resource Planning (“ERP”) vendors or vertical software vendors, when seeking packaged applications. In general, packaged applications promise predictable quality and relatively quick implementation. However, packaged applications frequently require that an organization adapt its business practices to the software. ERP systems generally fail to address specific industry problems, such as patient management or securities lending; often cost considerably more than planned to implement; and, once installed, are difficult to modify to adapt to changing business needs. In addition, when an organization chooses the costly and time-consuming path of customizing a packaged application, cost and risk rise rapidly and the organization is generally inhibited from future opportunities to upgrade the packaged application when subsequent new releases are available.
Alternatively, organizations can build custom applications, either internally or with third parties. This approach promises organizations the functionality, flexibility, and fit they seek, but custom applications development carries a high risk of failure, with projects often exceeding budgets and schedules, and with many projects being cancelled prior to implementation due to time delays, budget overruns, and functional or technical deficiencies. Companies often hire software integration or services firms to build and implement enterprise-scale applications. These firms generally engage a large number of consultants who may remain on the project for years, and may exceed budgets and schedules without producing significantly better results than internal development organizations. In addition, these firms typically do not offer ongoing product enhancements because they build custom solutions for a single customer.
Index to Financial Statements Applications development projects fail because the process of designing, programming, and testing complex applications with conventional tools and approaches is very complex and labor intensive. Designing, programming, testing, integrating, and deploying complex applications can be difficult, take a long time, be expensive, and tie up scarce IT resources. This high cost and high risk is in stark contrast to the business need for new applications that address current business practices and can be adapted quickly and easily to meet the evolving business requirements of a dynamic, highly competitive business environment.
Today, there is a relatively new emerging trend, called SOA (Service Oriented Architecture), which is an information systems architectural strategy for building applications by combining loosely-coupled and interoperable services to support business process requirements. TenFold technology is already compatible with this trend and, should help customers efficiently and productively move toward such an architectural strategy.
TenFold Technology and Products
We believe TenFold’s patented EnterpriseTenFold presents a significantly new approach to applications development. We believe that this approach reduces applications development and maintenance cost and time in two ways: first, by automating tedious, time-consuming, error-prone tasks that programmers would generally do; and, second, by providing an applications development tool and methodology that lets business people actively participate in applications development. We believe that EnterpriseTenFold enables organizations to directly leverage their business experience and insight and to adapt applications easily to meet changing business requirements.
EnterpriseTenFold SOA has three key innovations that make designing, building, testing, deploying, and maintaining an application completely different from traditional programming-oriented technologies:
Innovation
Description
TenFoldTools
• Can be used by non-technical business people with relatively little training and some help from an experienced TenFoldTools consultant.
• Provides a sophisticated applications developer environment that is convenient for describing applications requirements.
• Is itself a set of easy-to-use applications with security, concurrency control, audit trails, et cetera.
• Is a set of TenFold-powered applications, so an applications developer has the same intuitive user interface, benefits from the same Quality and Power as other applications end-users.
TenFold
Dictionary
• Saves the applications description in an RDBMS to make changing the description easy and fast.
• Secures and manages the applications description just as an RDBMS does for any applications database data such as invoices or insurance policies.
TenFold
Rendering-
Engine
• Reads the applications description and renders the application.
• Supports using and changing an application as you describe it.
• Scales to support tens of thousands of simultaneous end-users.
• A family of pre-programmed reusable, model-driven, and metadata-driven technologies that together are a universal application and an application engine.
Index to Financial Statements These EnterpriseTenFold SOA innovations work together to automate tedious, repetitive, and error-prone tasks like writing SQL, Java, C++, or VisualBasic code. We believe that automating tedious programming tasks lets applications developers focus their intellect and energy on solving the business problem instead of fighting technology problems.
We believe this revolutionary EnterpriseTenFold SOA approach has important implications:
Implication
Description
Requirements
are easier,
faster, and
more
rewarding
• Accelerates the difficult, time-consuming, resource intensive, traditional first step in applications development, Requirements.
• Lets applications developers describe and unambiguously record requirements with TenFoldTools.
• Lets applications developers see a running application as they describe requirements.
• Lets applications developers build and modify their application quickly, so they can evolve requirements in concert with developing and trying their application.
Power
features make
applications
functionally
richer
• Built-in TenFold RenderingEngine features make applications automatically powerful with a slick Windows user-interface, a slick browser interface that includes Ajax behavior, powerful database features like TimeRelation, AuditTrail, and more.
The meaning
and purpose
of Testing
changes to
everyone’s
benefit
• TenFold RenderingEngine renders a working application, so testing becomes ‘an exercise to verify the business solution,’ instead of ‘figure out where it blows up and fix it.’
• With portions of the application running almost at the very start of the project, users can demonstrate it to business people and get feedback throughout the project, not just at the end when the project should be complete.
• Automated regression testing tools let users capture what they want to automatically test and help them ensure that ongoing applications changes do not impact things that work as they wish.
Change is fast,
responsive,
and at
significantly
lower cost
• Since changing an application involves only changing its description, change is much faster and less costly than alternative reprogramming strategies that are prevalent with traditional technologies and inherent in legacy systems.
• Automated regression testing tools make it possible to fully test a new applications version quickly and verify that new features work and that existing features still work as before.
• Built-in change management tools automate most of the work in promoting new applications versions into production.
The EnterpriseTenFold SOA value proposition provides three major benefits - Speed, Quality, and Power - to its customers. Speed. EnterpriseTenFold SOA makes building complex applications faster than other technologies so projects can be finished in months, not years. Quality. EnterpriseTenFold SOA addresses eleven key attributes of quality applications. Since TenFold RenderingEngine renders an application from its description, tedious, error-prone, programming-like tasks are avoided in building or enhancing a TenFold-powered application. Thus, we believe the quality of the application is excellent.
Index to Financial Statements Power. EnterpriseTenFold SOA renders an application from its description and automatically includes considerable, rich built-in functionality in the application. Interestingly, complex feature requirements, which traditionally generate complexity and a high likelihood of project failure, add little incremental cost to TenFold applications development, just as a spreadsheet requiring more-complex formulas is not significantly more costly to build than one with only simple formulas.
EnterpriseTenFold SOA has been in development for more than 14 years, contains about 3.5 million lines of C, C++, and JavaScript code, and is covered by three issued United States patents. We believe that with EnterpriseTenFold SOA, business people or applications developers with little or no traditional programming skills can collaborate with IT professionals to build and maintain an application by describing the application without needing to program in C, C++, Java, HTML, Structured Query Language (“SQL”) or other programming languages and without the need to do other programming-like tasks such as designing screens and writing technical designs.
We believe EnterpriseTenFold SOA delivers these benefits:
•
Faster development of complex applications because EnterpriseTenFold SOA automates tasks that programmers would otherwise have to do, such as coding SQL, coding logic functions, managing computer-to-computer communications, and coding user interface screens;
•
Longer-lived applications that can survive changes in underlying technologies without requiring applications rewrites, because EnterpriseTenFold SOA insulates applications from many technical changes such as new operating system and database software releases;
•
Relatively easy development of web services as a customer can expose any part of a TenFold-powered application as an industry-standard web service;
•
Reduced maintenance costs because there is little or no code to maintain;
•
Improved quality because EnterpriseTenFold SOA replaces individually-coded logic with already-existing, thoroughly-tested algorithms that provide both basic and sophisticated applications behavior such as security, menus, transaction behavior, and powerful windows and browser user interface features;
•
Greater consistency to look, feel and operation across the entire application, by replacing individually-built screen designs and transactions with a systematic, optimal, standard design and by eliminating the details of screen layout and repetitive transaction behavior from the application developer’s task list;
•
Demonstrated scalability as customers add simultaneous end-users and computing capacity; and
•
Typically sub-second response-time on properly configured hardware for most applications actions, because EnterpriseTenFold SOA is carefully optimized to provide good performance.
In addition to the above benefits, EnterpriseTenFold SOA has many distinguishing advanced features. The following is a partial listing of these features:
•
Portability across popular databases such as Oracle, DB2, SQL Server, Sybase, EnterpriseDB, and MySQL;
•
Generation of all SQL statements for accessing and updating data, each highly optimized for each relational database;
•
Automatic screen layout to ensure consistency and quality in both web and desktop environments;
•
Automatic creation of both a Windows and web browser user interface;
•
Built-in support for query and update of time-varying data such as effective-dated employee or insurance policy records;
•
Real-time, server-supplied screen refresh of detail and summary information as underlying data changes;
•
Simplified business rule definition and optimized rule execution for workflow, posting, access control, and other sophisticated rule types;
•
Formal rule abstractions for validation, propagation, population, without requiring application developers to master complex event models;
•
Shared middle-tier caching, deferred query execution, and optimistic concurrency control to minimize database server load;
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•
Codeless integration with third-party applications via real-time messages, APIs, or files based on a simple interface description including support for many different messaging layers such as Tibco, TCP/IP, MQSeries, and Pipes; and
•
Application-level data synchronization between central servers and intermittently connected laptops.
EnterpriseTenFold SOA is composed of components for developing, executing, integrating, and configuring applications.
Developing an Application. TenFoldTools provides a sophisticated user interface that lets applications developers describe an application without traditional programming activities. Business people or other applications developers describe the database that the application uses and manages, transactions that business end-users use to do each end-user activity, and rules that control transaction behavior. TenFoldTools is itself a TenFold-powered application, that applications developers use to describe their application. TenFold AutoTest, a portion of TenFoldTools, uses patented techniques to simplify and automate functional and regression testing. TenFold Reporter and TenFoldAnalyzer, each a portion of TenFoldTools, let business people define their own reports and real-time data analysis. TenFoldTools store the description of their applications objects in a relational database called TenFold Dictionary.
Executing an Application. TenFold RenderingEngine is an executable program, generally deployed in various configurations on multiple client and server computers, that reads an applications description from TenFold Dictionary and runs as that application. TenFold RenderingEngine has these four major components:
Component
Description
TenFold
Client
The TenFoldClient part of the TenFold RenderingEngine typically runs on a client computer and interacts with you as you use a TenFold-powered application. TenFoldClient is a feature-rich, secure, portable, and graphical, transaction-execution environment that implements transaction requirements that applications developers describe in the TenFold Dictionary.
TenFold
Server
The TenFoldServer part of the TenFold Rendering Engine typically runs on a server computer and provides non-visible applications services. TenFoldServer provides an open-to-industry-standards messaging layer, applications server technologies, and standard business engines, and distributes data-intensive and computing-intensive processing across multiple server computers and multiple distributed databases.
LogicXpress
The LogicXpress part of the TenFold RenderingEngine includes TenFold Language for describing complex applications logic, reports, and processes, and technologies to compile, distribute, and efficiently run that logic portably across the various client and server computers on which you deploy an application.
TenFold
Kernel
The TenFoldKernel part of the TenFold RenderingEngine provides rich, portable, data-related functionality and powerful, standard, basic-applications functions to other TenFold RenderingEngine components. TenFoldKernel provides a dictionary-driven, read-write set interface to supported relational databases, and provides optimal performance, guaranteed portability, low development cost, low maintenance cost, and rich functionality to both applications and EnterpriseTenFold.
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Integrating an Application. TenFoldTools contains integration tools, called TenFoldConnect, that connect a TenFold-powered application to other applications, both within a company and at its customers and suppliers. Whether exchanging files, directly accessing another database, or using real-time messaging, applications developers codelessly describe the path that data follows to interface with typically-inflexible legacy or third party applications. Applications developers can convert and cleanse data during its passage to or from a TenFold-powered application.
Configuring an Application. EnterpriseTenFold supports leading relational databases, server operating systems, client operating systems, web servers and browsers, and communications systems. EnterpriseTenFold is highly configurable so that it can distribute components of the TenFold RenderingEngine across many computers to provide n-tier processing or run on a single computer. Configuration options let customers tune performance and scalability by configuring EnterpriseTenFold to match the underlying hardware and software environment. The EnterpriseTenFold architectural design simplifies adding support for additional technologies to respond to customer needs and emerging new technology market changes.
TenFold ComponentWare
TenFold ComponentWare is a family of pre-written applications components that easily plug into EnterpriseTenFold to extend its functionality without programming. For example, PowerBilling provides a robust suite of billing transactions, engines, and features. PowerAccounting makes it easy to include accounting-system integration to application descriptions.
TenFold Services
We offer consulting services that provide end-to-end custom applications development solutions and systems integration; basic and advanced applications development training; EnterpriseTenFold maintenance training; and customer support.
Training
TenFold University offers training so that customers can learn how to successfully build, implement, operate, maintain, and enhance their applications. Available training services include classroom instruction (with detailed courseware) offered at TenFold locations on a published schedule or at customer locations scheduled on demand, and on-site, on-the-job training working alongside TenFold expert consultants.
Index to Financial Statements Consulting Services
Our consulting services offer expertise in using EnterpriseTenFold SOA to provide end-to-end custom applications development solutions and systems integration. Our consultants help customers design, develop, test, integrate, deploy, operate and maintain their applications.
Implementation services include converting and cleansing legacy data, systems integration, running parallel application testing, and managing the implementation project. We use TenFold technology to leverage open standards, such as web services to build, connect, and streamline business processes.
Our consulting services provide technology transfer, which helps customer staff become self-sufficient with TenFold technology and tools.
Customer Support and SpeedPro Consulting
We provide customers who buy support services with new releases of EnterpriseTenFold SOA as new releases become available, telephone technical support for EnterpriseTenFold SOA, and, optionally, telephone applications support for their TenFold-powered application. We make SpeedPro consulting available to customers who maintain a support relationship with TenFold. SpeedPro offers customers a way to obtain the services of a TenFold expert at a moment's notice for immediate help or for short projects.
Competition
The competitive landscape for new and legacy-replacement enterprise applications is split among the options available to corporations today. These options are:
•
Status quo;
•
Buy a packaged application (with or without modification); and
•
Build a new application using internal IT resources or third-party consulting and software integration firms.
Status quo
TenFold’s largest competitor is “status quo.” Corporations continually wrestle with the issue of when to take on the challenge of building strategic new applications or attempting to retire and replace “legacy” applications. In recent years, most companies chose to invest large amounts of money to maintain legacy applications rather than replace them. Remaining with the status quo results in: continuously increasing costs as maintenance on top of maintenance gets harder; acceptance of barely adequate applications; limitations on lowering costs; limitations to embracing new technologies; and, difficulty in adding products or expanding markets. Status quo postpones the inevitable replacement of the application.
Buy a Packaged Application (with or without modification)
Many corporations prefer to obtain an off-the-shelf application from ERP or vertical packaged software vendors. Corporations license software packages to limit the risks associated with new software development projects. However, packaged applications force corporations to conform their business problems to the packaged solution, often with a poor fit. Corporations can modify a packaged application to solve their business problems, but such blended solutions are expensive, slow to implement, and suffer from poor integration.
We believe buying packaged applications is not a viable solution for replacing many legacy applications for most customers in most industries, as reasonable-fit packaged applications do not exist.
Index to Financial Statements Build New Applications
When companies contemplate building their own applications on their own or with help, TenFold competes primarily with suppliers of traditional programming technologies and development tools. Internal IT organizations and third party consulting firms frequently use tools from Oracle, IBM, Microsoft, BEA, Computer Associates, and others.
Programming languages such as COBOL, C++, and Java perform well and scale well, but require extraordinarily large project teams to spend multiple years to complete projects. Such projects generally run over budget in time and dollars and frequently fail. Visual Basic, SmallTalk, and other personal computer technologies support rapid applications development and improved productivity for smaller projects, but do not scale to support large numbers of end-users.
Today’s typical technologies include J2EE, .NET, and other component-enabling technologies intending to make programming languages viable for complex applications. Such technologies, all of which rely on programmers, have not significantly reduced the time and cost of large applications development at this time. Using such technologies for very large, complex applications development projects is likely to result in continued high failure rates for applications build projects since longer projects and large numbers of programmers on a project increase risk of failure exponentially according to most industry pundits.
Patents, Intellectual Property Rights and Licensing
We rely 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 received three separate patents in the United States. The first patent (US Patent # 6016394) relates to EnterpriseTenFold. The second (US Patent # 6061643) relates to TenFold AutoTest, our automated testing technology. The third patent (US Patent # 6301701) relates to our computer-assisted testing of software application components. We have these patents issued and pending in other countries. Our trademark portfolio contains a variety of U.S. and international trademark registrations and pending trademark applications.
In addition, as part of our confidentiality procedures, we enter into nondisclosure agreements with our employees, customers, consultants, and corporate partners, and limit access to and distribution of our software, documentation, and other proprietary information. We retain ownership of EnterpriseTenFold. Under our prior business model we generally retained ownership of the applications products that we developed for customers; however, we allowed a small number of customers to own rights to the applications we developed for them. In some cases, our contracts obligate us to pay royalties on future sales of specific applications, or prohibit us from licensing applications for specified periods of time or to specified third parties.
For information concerning risks associated with intellectual property rights, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Factors that May Affect Future Results and Market Price of Stock.”
Research and Development
Our technology development organization consists of teams of development engineers and product managers. These teams use a “documentation-centric” development process that includes planning and documenting deliverables in advance, adhering to coding standards, and performing nightly regression tests of all technology. We continuously monitor quality, analyze the root-cause of defects, report daily and weekly status, and regularly communicate individual and team performance and adherence to schedule and functionality requirements.
Our development infrastructure and processes produce documentation, quality assurance, platform certification, release management, and delivery capabilities (in addition to design and implementation functions) for our technology and products. Developers use TenFold AutoTest - our patented integrated testing technology - to perform nightly regression tests on all products, components, and technologies under development or modification. Developers use DocuManage, our web-based documentation management and reference system, to access and maintain product documentation.
Index to Financial Statements Our development organization regularly produces new versions and releases of our EnterpriseTenFold SOA technology. Our latest major release of EnterpriseTenFold SOA includes many new features that we believe, make building enterprise applications faster, production deployment more robust, and production management more cost-effective.
Research and development expenses were $4.1 million for the year ended December 31, 2006, $3.5 million for the year ended December 31, 2005, and $3.7 million in 2004. As of December 31, 2006, we had 18 staff engaged in research and development activities. We intend to continue to make investments in research and development to maintain and enhance our technology.
Employees
As of December 31, 2006, we had 46 employees, including 11 in consulting, training and support, 18 in research and development, 4 in sales and marketing, and 13 in finance, administrative, and information technology support functions. During the year ended December 31, 2006, our average headcount was 46. None of our employees is represented by a labor union or a collective bargaining agreement and all are at-will employees.
Executive Officers
The executive officers of TenFold are as follows:
Name
Age
Position(s)
Robert Felton
Chairman of the Board of Directors, Chief Executive
Officer, and President
Alexei Chadovich
Senior Vice President, Research and Development
Samer Diab
Senior Vice President, Customer Services
Robert Hughes
Chief Financial Officer, Chief of Staff
Robert Trounce
Vice President, Consulting
Jeffrey Walker
Executive Vice President, Chief Technology Officer
Sally White
Vice President, Business Development
Robert Felton joined TenFold as an executive officer in November 2005, and has served as Chairman of the Board of Directors, Chief Executive Officer, and President since that time. Mr. Felton has also served as a member of TenFold’s Board of Directors since March 1997. Mr. Felton is the founder and Chairman of DevonWay, a software applications company, which he founded in May 2005, and a customer of TenFold. Mr. Felton was the founder of Indus International, a software applications company, and served as Indus’s Chairman, President, and Chief Executive Officer from January 1988 to March 1999 at which point he retired. Mr. Felton also served as a member of the Board of Directors of Indus International since its inception in 1988 until 2002. Prior to that, Mr. Felton was the founder and CEO of Tera Corporation (later renamed Tenera Corporation) from 1974 to 1985. Mr. Felton served in the nuclear submarine force of the U.S Navy from 1962 to 1970. Mr. Felton holds a BS in mechanical engineering from Cornell University and an MS in nuclear engineering from the University of Washington.
Alexei Chadovich joined TenFold in October 1997, and has served as Senior Vice President of Research & Development since February 2002. Prior to that, Mr. Chadovich held various technical and development management roles at TenFold including Director, Development, Vice President of Universal Application Client, Director of Universal Application Core, Senior Developer, and Architect for Universal Application Client. Prior to joining TenFold, Mr. Chadovich served from 1996 to 1997 as software architect and developer with Corel Corporation, a business and graphics software development company. From 1990 to 1996, Mr. Chadovich served in various software development and architect positions with WordPerfect Corp., a business software development company, and after its merger with Novell Inc. in 1994, a business and networking software development company.
Index to Financial Statements
Prior to joining WordPerfect, Mr. Chadovich held various software development management positions with Kurchatov Atomic Energy Institute in Russia, a physics research institute. Mr. Chadovich holds MS in Computer Science from Moscow Institute of Electronic Technology, Russia.
Samer Diab joined TenFold in June 1994 and has served as Senior Vice President, Customer Services since August 2006 and as Vice President, Customer Services since April 2004. From September 2002 to April 2004, Mr. Diab served as TenFold's Operations Chief of Staff, and from October 1999 to September 2002, he served as a Vice President of Applications Development for TenFold and a prior wholly owned subsidiary. From June 1994 to October 1999, Mr. Diab served in various technical and management roles in TenFold's development and consulting organizations. Prior to joining TenFold, Mr. Diab served from 1989 to 1994 in various technical, architectural, and managerial roles in the Applications Division of Oracle Corporation, a large database and applications software company. Mr. Diab holds a BS in Electrical Engineering from the California Institute of Technology.
Robert Hughes joined TenFold in February 1995, and has served as Chief Financial Officer since January 2006 and as Chief of Staff since November 2005. Mr. Hughes has also served as Senior Vice President Finance since December 2000 and Chief Accounting Officer since May 2003. From September 2000 until December 2000, Mr. Hughes served as Chief Financial Officer of a TenFold subsidiary. From February 1995 until August 2000, Mr. Hughes served as TenFold’s Chief Financial Officer. Prior to joining TenFold, Mr. Hughes served in various finance and administrative capacities at Oracle Corporation, a large database and applications software company, from 1989 to 1995. Prior to joining Oracle, from 1982 to 1989, Mr. Hughes served in various audit positions for KPMG LLP, a public accounting firm. Mr. Hughes holds a BA in business administration from the Haas School of Business, University of California, Berkeley, and is a Certified Public Accountant.
Robert Trounce joined TenFold in February 1998 and has served as Vice President, Consulting since October 2005. From May 2005 to October 2005, Mr. Trounce served as Client Services Executive. From February 1998 to May 2005, Mr. Trounce served in various technical, account management and project management roles in TenFold's applications development and consulting organizations. Prior to joining TenFold, Mr. Trounce served as an Associate Systems Engineer at Electronic Data Systems, an information technology and business process outsourcing services company. Mr. Trounce holds a BS in Business Management with an emphasis in Management Information Systems from the Marriott School of Management, Brigham Young University.
Jeffrey Walker founded TenFold in February 1993 and has served as Executive Vice President, and Chief Technology Officer since October 1996. He served as its Chairman from TenFold’s inception to November 2005. From TenFold’s inception to October 1996, Mr. Walker served as TenFold’s President, Chief Executive Officer, and Chief Technology Officer. Prior to founding TenFold, from 1991 to 1993, Mr. Walker was an independent consultant. From 1985 to 1991, Mr. Walker held several management positions at Oracle Corporation, a large database and applications software company, including Executive Vice President from 1987 to 1991, General Manager Applications Division from 1985 to 1991, Chief Financial Officer from 1987 to 1991, and Senior Vice President of Marketing during 1986. Prior to joining Oracle, Mr. Walker founded and served as Chief Executive Officer of Walker Interactive Products, an application software company, from 1980 to 1985. Mr. Walker holds a BA in mathematics from Brown University.
Sally White joined TenFold in May 2000 and has served as Vice President, Business Development since February 2002. From May 2000 to February 2002, Ms. White served as TenFold's Training Sales Director. Prior to joining TenFold, Ms. White held several management positions with Provant, Inc., a performance improvement training services organization, including Director of Business Development from 1997 to 1999 and Vice President of Sales Strategies from 1999 to 2000. From 1988 to 1997, Ms. White was Vice President of Sales and Marketing for Innovations, a leadership seminar company. From 1982 to 1988, Ms. White served as the Director of Marketing, then Vice President of Sales and Marketing for Mrs. Fields Cookies, Inc. a global chain of premier cookie shops. Ms. White holds BS in communications from Westminster College and an MBA from Alameda College.
Index to Financial Statements Available Information
Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to reports filed or furnished pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended, are available free of charge from links on our website at www.tenfold.com as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the Securities and Exchange Commission. Registration statements and amendments thereto filed pursuant to the Securities Act of 1933, as amended, are similarly available from our website. The information posted on our web site is not incorporated into this Annual Report.
You may read and copy all or any portion of reports, statements or other information we file with the SEC at the public reference facility maintained by the SEC at 100 F Street, N.E., Washington, DC 20549.
Please call the SEC at 1-800-SEC-0330 for more information on the public reference room. You can also find our SEC filings at the SEC’s website at http://www.sec.gov.
Index to Financial Statements
Item 1A.
Item 1A. Risk Factors
We operate in a rapidly changing environment that involves numerous risks, some of which are beyond our control. The following discussion elaborates on some of these risks.
If we are unable to generate sufficient cash flow from operations, or secure additional sources of financing in the future, we will be unable to continue operations as a going concern
While our financial statements have been prepared under the assumption that we will continue as a going concern, the independent accounting firm’s report on our December 31, 2006 financial statements, prepared by Tanner LC, included an explanatory paragraph relating to their substantial doubt as to our ability to continue as a going concern. Our business model relies upon generating new sales to existing and new customers. We closed new sales in 2006 and improved our quarterly operating cash flow from $(1.9) million for Q2 2006, to $(864,000) for Q3 2006, and to $21,000 for Q4 2006. However, such sales have not been sufficient to generate sustained positive cash flow from operations, or profitability. As a result, it is unclear if or when we can expect to close significant sales to new or existing customers; and until we repeatedly do so, we are likely to continue to experience negative cash flow from operations and losses. If we do not close significant future sales, our existing cash resources will not be sufficient to fund our operations beyond Q2 2007. Under such circumstances, we would be required to pursue one or a combination of the following remedies: seek additional sources of financing, further reduce operating expenses, sell part or all of our assets, or terminate operations. There can be no assurance that we will be successful achieving sufficient cash flow.
We continue to experience difficulty in securing customer revenue
We have experienced difficulty closing substantial new sales, and it is unclear when or if we can expect to predictably close material sales to new or existing customers. Our prior strategy of selling small, proof-of-concept initial “penetrate” projects, and then seeking to “radiate” into the account by selling additional services and licenses was not successful in generating sufficient sales to achieve profitability or positive cash flow. Under the leadership of our Chief Executive Officer, Robert W. Felton, we changed our business model to focus on selling larger consulting projects. Although we expect to be more successful with this new model, our experience with the new model is limited to this year. Furthermore, our uncertain future may make it less likely for customers to want to do business with us. As a result, there is no assurance that we will be able to convince existing customers or future prospective customers to purchase products or services from us or that any customer revenue that is achieved can be sustained. If we are unable to obtain future customer revenue or outside financing, our operations, financial condition, liquidity, and prospects will be materially and adversely affected, and we would be required to pursue one or a combination of the following remedies: seek additional sources of financing, further reduce operating expenses, sell part or all of our assets, or terminate operations.
Our sales cycle can be lengthy and subject to delays and these delays could cause our operating results to suffer
We believe that a customer’s decision to purchase significant products or services from us can involve a significant commitment of resources and be influenced by customer budget cycles. To successfully sell our products and services, we generally must educate our potential customers regarding the use and benefit of our products and services. Getting new customers to purchase significant licenses or services can require significant time and resources. Consequently, the period between initial contact and the purchase of our products or services can be long and subject to delays associated with the lengthy budgeting, approval, and competitive evaluation processes that typically accompany significant capital expenditures. Sales delays could cause our operating results to vary widely. There can be no assurance that we will not experience sales delays in the future. In addition, we face a challenging sales environment and there can be no assurance that we will have sales in the future.
Index to Financial Statements We are substantially dependent on a small number of customers and the loss of one or more of these customers may cause revenues and cash flow to decline
We have derived, and over the near term we expect to continue to derive, a significant portion of our revenues and cash flow from a limited number of customers. For example, three customers accounted for a total of 47 percent of our total revenues for the year ended December 31, 2006 (individually 21 percent, 16 percent, and 10 percent, respectively). For the year ended December 31, 2005, three customers accounted for a total of 49 percent of total revenue (individually 20 percent, 18 percent and 11 percent, respectively). Significant reductions in the amount of business major customers conduct with us has previously and may in the future, materially and adversely affect our business, results of operations, financial position and liquidity. Replacing the loss of a major customer is unpredictable, and we have not been successful in doing so in the past. Revenues and cash flows from a single customer or a few major customers may constitute a significant portion of our total revenues and cash inflows in a particular period, then decline as the volume of work performed for specific customers decreases as they complete projects. A major customer in one period may not continue to purchase significant licenses or services from us in a subsequent period.
The customer accounting for 21 percent of our total revenues for the year ended December 31, 2006, DevonWay, is a related person. The revenue from DevonWay in 2006 was primarily from the recognition of previously deferred revenue from a single large license transaction in 2005. We do not expect DevonWay to account for a significant percentage of our revenues after December 31, 2006. See Note 17 of Notes to Financial Statements for more information.
Our growth and success depends on our ability to successfully implement our new business model; however, we have limited experience with the new model
Under the leadership of our new Chief Executive Officer, Robert W. Felton, we changed our business model to focus on selling larger consulting projects, instead of the smaller prototype application projects that we primarily sold in 2005. Although we hope to be more successful with this new model, our experience with the new model is limited to this year. Under this new model, we expect to take on larger, more difficult and complex consulting projects than we typically have in recent years. Under our original fixed-price project business model that we discontinued several years ago, we received customer complaints and lawsuits concerning some of our projects. Although we have substantially changed our business model, including no longer offering to do such large projects on a fixed-price basis or providing a money-back guarantee, we cannot be certain that we will not receive customer complaints in the future. Such complaints would likely adversely affect our ability to sell to other customers. If our new strategy for selling and delivering our services and products is unsuccessful, or if we are unable to close significant new business within the time frames anticipated, our revenues and operating results will continue to suffer.
Our historical quarterly operating results have varied significantly and our future operating results could vary
Historically, our quarterly operating results have varied significantly. For example, during some years, we have had quarterly profits followed by losses in subsequent quarters. Our future operating results may vary significantly in the future as well. Until we achieve and sustain material sales to new or existing customers, we expect to continue to experience negative cash flow from operations and losses.
Our future prospects are difficult to evaluate
In light of our operating results for recent periods and the continued difficult sales environment we face and in the technology sector in general, it is difficult to evaluate our future prospects. There can be no assurance that we will be able to successfully complete current or new projects. 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.
Index to Financial Statements Our failure to attract and retain highly skilled employees, particularly developers, consultants, project managers and other senior technical personnel, could impair our ability to complete projects and expand our business
Our Development organization and services business are labor intensive. We currently have only a small number of consultants in our consulting organization. We expect to supplement them on projects with members of our Development organization for projects in the near term. Longer term, our success will depend in large part upon our ability to attract, retain, train, and motivate highly skilled employees, particularly developers, consultants, project managers and other senior technical personnel. Any failure on our part to do so would impair our ability to develop new technology, 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 developers, consultants, project managers and senior technical staff are in great demand and are likely to remain a limited resource for the foreseeable future. Our current financial condition, and our prior restructurings and related headcount reductions, may make it more difficult for us to retain and compete for such employees. There can be no assurance that we will be successful in retaining, training, and motivating our employees or in attracting new, highly skilled employees. If we are unsuccessful in this effort or if our employees are unable to achieve expected performance levels, our business will be harmed.
A loss of Robert W. Felton, 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 Robert W. Felton, Chairman, 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, Executive Vice President, and Chief Technology Officer. 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 employees. We have not entered into employment agreements with our executives. 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.
If we fail to adequately anticipate employee and resource utilization rates, our operating results could suffer
A high percentage of our operating expenses, particularly personnel and rent, are relatively fixed in advance of any particular quarter. As a result, unanticipated variations in the number, or progress toward completion, of our projects or in employee utilization rates did and may continue to cause significant variations in operating results in any particular quarter and could result in quarterly losses. Time-and-materials consulting arrangements can typically be terminated by a customer on short notice. An unanticipated termination of a major project, the delay of a project, or the completion during a quarter of several projects has in the past and may continue to result in under-utilized employees and could, therefore, cause us to suffer quarterly losses or cause adverse results of operations.
Our errors and omissions coverage may not cover contractual disputes
While we maintain errors and omissions insurance coverage for claims related to customer contract disputes within the coverage scope and term, given the nature and complexity of the factors affecting the estimated liabilities, actual liabilities may exceed or be outside the scope of our current errors and omissions coverage. We can give no assurance that our insurance carrier will extend coverage to future claims. In addition, no assurance can be given that we will not be subject to material additional liabilities and significant additional litigation relating to errors and omissions arising from future claims.
Our errors and omissions insurance policy is in the form of an industry standard software errors and omissions policy. As such, it only covers software errors and omissions that occur after the delivery of software and excludes contractual disputes such as service commitments and cost and time related guarantees. We have previously had contractual disputes related to our guarantees.
Index to Financial Statements
While we have substantially changed our business model and no longer offer a money-back guarantee, no assurance can be given that we will not be subject to these types of claims in the future. In the event that liabilities from claims are not covered by or exceed our errors and omissions coverage, our business, results of operations, financial position, or liquidity could be materially and adversely affected.
If our software contains defects or other limitations, we could face product liability exposure
Because of our limited operating history and our small number of customers, we have completed a limited number of projects that are now in production. As a result, there may be undiscovered material defects in our products or technology. Furthermore, complex software products often contain errors or defects, particularly when first introduced or when new versions or enhancements are released. Despite internal testing and testing by current and potential customers, our current and future products may contain serious defects. Serious defects or errors could result in lost revenues or a delay in market acceptance, which would damage our reputation and business.
Because our customers may use our products for enterprise-scale 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 our being obligated to pay substantial damages, which would cause operating results to suffer. Although our license agreements typically contain provisions designed to limit our liability, existing or future laws or unfavorable judicial decisions could negate these limitations of liability provisions. A product liability claim brought against us, even if not successful, would likely be time consuming and costly.
We are involved in one litigation matter, and may in the future be involved in further litigation or disputes that may be costly and time-consuming, and if we suffer adverse outcomes, our operating results could suffer
We are involved in a class action suit against more than 300 issuers involving the underwriters of those issuers’ initial public offerings. Although we currently expect to resolve this matter without significant cost to TenFold, that outcome is not assured, and we may in the future face other litigation or disputes with customers, employees, business partners, stockholders, or other third parties. Such litigation or disputes could result in substantial costs and diversion of resources that would harm our business. An unfavorable outcome of this matter may have a material adverse impact on our business, results of operations, financial position, or liquidity.
See Note 9 “Legal Proceedings and Contingencies” of Notes to Financial Statements for more information concerning our litigation and disputes.
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 large part, upon our proprietary EnterpriseTenFold 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 issued three patents in the United States and intend to continue to seek patents on our technology when appropriate. There can be no assurance that the steps we have taken in this regard will be adequate to deter misappropriation of our proprietary information or that we will be able to detect unauthorized use and take appropriate steps to enforce our intellectual property rights. The laws of some countries may not protect our intellectual property rights to the same extent as do the laws of the United States. Furthermore, litigation may be necessary to enforce our intellectual property rights, to protect our trade secrets, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. This litigation could result in substantial costs and diversion of resources that would harm our business.
Index to Financial Statements 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 delivery delays, or require us to enter into royalty or licensing agreements. These royalty or licensing agreements, if required, may not be available on terms acceptable to us, or at all. A successful claim against us of product infringement and our failure or inability to license the infringed or similar technology on favorable terms would harm our business.
If we fail to successfully compete, our revenues 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 revenues and market share will suffer. Many of our 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.
International political and economic uncertainty could have an adverse impact on our business and on our operating results
Revenues from customers outside of North America were approximately 8 percent of total revenues for 2006, and approximately 11 percent of total revenues for 2005. The international political and economic uncertainty caused by the ongoing war on terrorism and other international political developments may adversely impact our ability to continue existing relationships with our foreign customers and to develop new business abroad.
Our stock price may continue to be volatile
Our stock price has fluctuated widely in the past and could continue to do so in the future. Your investment in our stock could lose value. Some of the factors that could significantly affect the market price of our stock, in addition to those mentioned in this section, include: further decreases in our cash resources, changes in our revenue; changes in our customer base including the loss of a major customer; changes in management; variations in our quarterly financial results; problems implementing our business model; reports or earnings estimates published by financial analysts; changes in political, economic and market conditions either generally or specifically to particular industries; and fluctuations in stock prices generally, particularly with respect to the stock prices for other technology companies. A significant drop in our stock price could expose us to the risk of securities class action lawsuits. Defending against such lawsuits could result in substantial costs and divert management’s attention and resources. An unfavorable outcome of such a matter may have a material adverse impact on our business, results of operations, financial position, or liquidity.
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 67 percent of our voting stock (as calculated using the SEC’s conventions). These stockholders acting together 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.
Index to Financial Statements The anti-takeover provisions in our charter documents and/or 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.
Index to Financial Statements
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
TenFold currently owns no real property. Below are descriptions of our leased property and the status of each facility at December 31, 2006:
Location
Sq. Feet
Lease expires
Use
South Jordan , UT
22,310
August 31, 2007
Corporate headquarters, research and development, consulting, support, education, sales, executive and administrative activities.
San Francisco, CA
3,518
April 30, 2007
Research and development, and consulting.
We conduct much of our operations from our corporate headquarters located near Salt Lake City, Utah. Our staff currently work at this office, at our San Francisco office, at customer sites, or from home offices. During 2007, we do not presently anticipate needing material additional office space.
Item 3.
Item 3. Legal Proceedings
See Part IV, Item 15, Note 9 of Notes to Financial Statements for a description of legal proceedings.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Index to Financial Statements
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock is quoted on the OTC Bulletin Board under the trading symbol "TENF.OB." Our high and low prices by quarter during 2006 and 2005 are presented below. These prices reflect inter-dealer quotations and may not represent actual transactions.
On December 31, 2006, we had approximately 243 stockholders of record of our common stock and 46,557,745 shares of our common stock were issued and outstanding.
We have never declared or paid dividends on our common stock. We expect to retain any earnings generated by our operations for the development and growth of our business, and we do not anticipate paying any dividends to our stockholders for the foreseeable future.
Equity Compensation Plan Information
The following table provides the information about our common stock that may be issued upon the exercise of options and rights under all of our existing equity compensation plans as of December 31, 2006, including the 1993 Flexible Stock Incentive Plan, the 1999 Stock Plan, the 1999 Employee Stock Purchase Plan, and the 2000 Employee Stock Option Plan.
Index to Financial Statements
(1) 5,115,535 to be issued under the 1993 Flexible Stock Incentive Plan, and 14,180,286 to be issued under the 1999 Stock Plan.
(2) 290,673 available for future issuance under the 1993 Flexible Stock Incentive Plan, 6,985,145 available for future issuance under the 1999 Stock Plan, and 1,500,072 available for future issuance under the 1999 Employee Stock Purchase Plan.
(3) Issued under the 2000 Employee Stock Option Plan.
(4) Shares available at December 31, 2006 under the 2000 Employee Stock Option Plan.
2000 Employee Stock Option Plan. The Board of Directors adopted our 2000 Employee Stock Option Plan in December 2000. A total of 7,000,000 shares of common stock have been reserved for issuance under the 2000 Stock Option Plan. The 2000 Stock Option Plan provides for the granting of nonstatutory options to purchase shares of our common stock to employees, excluding officers and members of our Board of Directors. Nonstatutory options do not qualify as an Incentive Stock Option within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended. The Board of Directors administers the 2000 Employee Stock Option Plan. The plan administrator determines the terms of options granted under the 2000 Stock Option Plan, including the number of shares subject to an option, the exercise price, the term and exercisability of options, and any vesting or other restrictions that apply to awards. The 2000 Stock Option Plan allows us to issue options with an exercise price equal to any price determined appropriate by the administrator. To date, all options issued under the 2000 Stock Option Plan have had exercise prices equal to the fair market value of the common stock on the date the option was granted. The plan allows for payment of the exercise price with cash, check, promissory note, or other shares of TenFold common stock, through a brokered cashless exercise program, or with any other form of consideration permitted by the administrator. Options issued under the 2000 Stock Option Plan generally vest over a four-year period and expire ten years from the date of grant.
The 2000 Stock Option Plan provides for automatic adjustment of shares remaining available for issuance as well as adjustment of outstanding awards in the event of any stock split, stock dividend, or similar change in our capital structure. In the event we were to be acquired by a third-party acquiror, we would expect that outstanding options would be assumed by our acquiror so that they would convert into awards to purchase acquiror stock (adjusted to reflect the terms of the transaction). If our acquiror did not agree to assume outstanding awards, then the vesting of such awards would accelerate in full prior to the closing of the acquisition and unexercised awards would terminate upon the closing. Unless terminated earlier, the 2000 Stock Plan will terminate in December 2010.
Index to Financial Statements Recent Sales of Unregistered Securities
On March 29, 2006, we entered into a Securities Purchase Agreement for the sale of 1,500,000 shares of unregistered convertible preferred stock and warrants. The preferred shares are convertible into 20,315,805 shares of common stock. The warrants are to purchase 10,157,899 shares of common stock at an exercise price of $0.62 per share, with a 5-year term. The transaction generated gross proceeds of approximately $6.3 million (before expenses of approximately $227,000, and repayment of $1.1 million of interim financing obligations). Several members of our Board of Directors (or investment entities associated with them) and an Executive Officer participated in the transaction, providing approximately $4.7 million of the gross proceeds raised:
•
Robert W. Felton Trust invested $2 million. We repaid $709,000 of interim financing to Mr. Felton, our Chairman, President, and Chief Executive Officer, from the proceeds of the capital raising.
•
First Media TF Holdings LLC, an investment entity associated with TenFold Director Ralph W. Hardy Jr., invested $2 million. We repaid $205,000 of interim financing to First Media TF Holdings LLC from the proceeds of the capital raising.
•
TenFold Director Steven H. Coltrin invested $500,000. We used $206,000 of the proceeds of the capital raising to pay accounts payable due to his firm, Coltrin & Associates, for marketing and public relations work provided to TenFold in earlier periods.
•
Samer Diab, Senior Vice President, Customer Services, invested $230,000.
The other purchasers under the Securities Purchase Agreement were GMS Family Investors LLC, Jon M. Huntsman, Ronald Mika and Rationalwave Onshore Equity Fund L.P.
We also repaid $205,000 of interim financing to Wasatch Investments LLC, an investment entity associated with TenFold Director Robert E. Parsons, Jr., from the proceeds of the capital raising.
On December 19, 2006, we completed a private placement and received gross proceeds of approximately $1.3 million (before expenses of approximately $90,000) from the sale to six private investors of (i) 312,009 shares of Preferred Stock convertible into 4,225,809 shares of common stock, and (ii) warrants to purchase 2,112,904 shares of common stock at an exercise price of $0.62 per share, with a 5 year term. The sale of preferred stock and warrants was pursuant to a Securities Purchase Agreement, dated December 18, 2006, by and between TenFold and the Daniel S. & Stephanie A. Martin Living Trust, Jonathan Andron, Rationalwave Onshore Equity Fund, L.P., David Kaplan, Lawrence Kaplan, and Stanley Kaplan.
We had no sales of unregistered stock during 2005 or 2004.
All sales of unregistered securities listed above were made to “accredited investors” pursuant to the exemption from registration provided in Rule 506, which is part of Regulation D under the Securities Act of 1933.
Other than as set forth above, the proceeds of the March and December preferred stock offerings have been used for general corporate purposes.
Index to Financial Statements
Item 6.
Item 6. Selected Financial Data
The selected statement of operations data for the years ended December 31, 2006, 2005, 2004, 2003, and 2002, and the selected balance sheet data as of December 31, 2006, 2005, 2004, 2003, and 2002, are derived from, and are qualified by reference to, our audited financial statements. The historical results are not necessarily indicative of future results.
(1) See Note 4 to the financial statements for an explanation of the determination of the method used to determine the number of shares used in computing net earnings (loss) per share.
Index to Financial Statements Supplementary Financial Information
The following tables set forth certain unaudited quarterly results of our operations for 2006 and 2005. In the opinion of management, this information has been prepared on the same basis as the audited financial statements and all necessary adjustments, consisting only of normal recurring adjustments, have been included in the amounts stated below to present fairly the quarterly information when read in conjunction with the audited financial statements and notes thereto included elsewhere in this Annual Report on Form 10-K. The quarterly operating results are not necessarily indicative of future results.
Index to Financial Statements
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Business Overview
TenFold provides services and technology for building complex, Service Oriented Architecture (“SOA”)-compliant, enterprise-scale applications in significantly less time and cost than it would otherwise take using traditional development technologies. We believe that with TenFold’s technology, EnterpriseTenFold SOA, customers will also experience significantly reduced ongoing applications maintenance and enhancement costs compared to what they generally experience with legacy applications.
Our business model focuses on providing applications development services and our EnterpriseTenFold SOA product, along with product support and training, to customers who can use a TenFold team or their own business teams to build and maintain applications.
Critical Accounting Policies
The fundamental objective of financial reporting is to provide useful information that allows a reader to comprehend our business activities. To aid in that understanding, management has identified the “critical accounting policies” below. These policies have the potential to have a more significant impact on our financial statements, either because of the significance of the financial statement item to which they relate, or because they require judgment and estimation due to the uncertainty involved in measuring, at a specific point in time, events which are continuous in nature.
Revenue Recognition and Project Profitability
We believe risks relating to revenue recognition include the judgment required to determine project profit or loss projections on time-and-material contracts. We recognize time-and-materials revenue at the lowest point in the range of estimated profit margin, which represents our best estimate of the profit to be achieved. Variances may occur if we are unable to collect time-and-materials billings or if we grant concessions to time-and-materials customers in order to sell additional business or collect cash under the contract. As we occasionally provide services on a fixed price basis, risks relating to revenue recognition also include the judgment and estimation required to determine fixed-price project completion percentages, and fixed-price project profit or loss projections. Variances between management’s estimates and actual results may result in significant adjustments to our results of operations and financial position.
Stock-Based Compensation
In accordance with SFAS 123(R), we measure compensation cost for stock awards at fair value and recognize compensation over the service period for awards expected to vest. The estimation of stock awards that will ultimately vest requires judgment, and to the extent actual results or updated estimates differ from our current estimates, such amounts will be recorded as a cumulative adjustment in the period estimates are revised. We consider many factors when estimating expected forfeitures, including types of awards, employee roles, and historical experience. Actual results, and future changes in estimates, may differ substantially from our current estimates. See Note 18 of Notes to Financial Statements for more information.
Litigation Reserves
We review asserted litigation claims each quarter to determine the likelihood that the claim will result in a loss. Significant management judgment is required to conclude on the likely outcome of outstanding litigation. If a loss is probable on a litigation claim, management estimates the loss and we accrue the estimated loss. If a loss is considered probable but cannot be reasonably estimated, we disclose the contingency in the notes to our financial statements. Losses may result on litigation claims that are not considered probable or are not estimable at the current time, potentially having a significant impact on future financial results.
Index to Financial Statements Results of Operations
The following table sets forth, for the periods indicated, the percentage relationship of selected items from our statements of operations to total revenues.
2006 as Compared to 2005
Revenues
Total revenues decreased $712,000 or 12 percent, to $5.0 million for the year ended December 31, 2006, as compared to $5.7 million for the year ended December 31, 2005.
Services and other revenues decreased $1.6 million, or 31 percent, to $3.6 million for the year ended December 31, 2006 as compared to $5.2 million for the year ended December 31, 2005. The decrease in services and other revenues is primarily due to decreases in revenues from certain customers who purchased less services from us over time as they completed their application development projects. Although we have sold and begun new consulting projects in 2006, they are not as large as these particular prior projects.
License revenues increased $909,000, or 177 percent, to $1.4 million for the year ended December 31, 2006 as compared to $515,000 for the year ended December 31, 2005. The 2006 license revenue includes $1 million from DevonWay, a related person, that was deferred from 2005, because the license agreement contained a discount that could not be determined at the inception of the agreement. We used the end of the estimated economic life to recognize the revenue because we did not have vendor specific objective evidence of fair value (“VSOE”) for the related post-contract customer support, due to the discount, and therefore we did not allocate the revenue until the discount was known at the end of the estimated economic life. Although we recognized the revenue in 2006, we received the cash from the transaction in 2005.
During 2005, we entered into agreements with a new customer, DevonWay, to provide licenses, consulting services, technical support services, and training. Our Chairman, CEO and President, Robert W. Felton, is the founder and owner of DevonWay. All disinterested members of our Board of Directors approved of these related person transactions and our general ongoing business relationship with DevonWay. Our revenues from DevonWay for the year ended December 31, 2006, and December 31, 2005, are license revenues of $1.0 million and $160,000, respectively, and services and other revenue of $55,000 and $439,000, respectively. See Note 17 of the Notes to Financial Statements for more information.
Index to Financial Statements Three customers accounted for 21 percent, 16 percent and 10 percent of our total revenues for the year ended December 31, 2006, compared to three customers accounting for 20 percent, 18 percent and 11 percent of our total revenues for the year ended December 31, 2005. No other single customer accounted for 10 percent or more of our total revenues for the year ended December 31, 2006 or 2005.
The revenue from the customer accounting for 21 percent of our total revenues for the year ended December 31, 2006, DevonWay, was primarily from the recognition of previously deferred license revenue from a single transaction in 2005. We do not expect DevonWay to account for a significant percentage of our revenues after December 31, 2006.
We continue to actively market to new and existing customers. We have sold and begun several new consulting projects recently in 2006. However, such sales have not been sufficient to generate sustained positive cash flow from operations or profitability. We continue to face a challenging sales environment. As a result, it is unclear if or when we can expect to close significant sales to new or existing customers, and until we repeatedly do so we are likely to continue to experience negative cash flow from operations and losses.
Operating Expenses
Cost of Revenues. Cost of revenues consists primarily of compensation and other related costs of personnel and contractors to provide applications development and implementation consulting, support, and training services. Cost of revenues decreased $162,000, or 6 percent, to $2.8 million for the year ended December 31, 2006 as compared to $2.9 million for the year ended December 31, 2005. The decrease in cost of revenues is primarily due to having fewer staff working on customer projects in 2006. The decrease was partially offset by an increase in stock-based compensation expense in 2006 as a result of SFAS 123(R). See Note 18 of Notes to Financial Statements for more information on stock-based compensation expenses.
Sales and Marketing. Sales and marketing expenses consist primarily of compensation, travel, and other related expenses for sales and marketing personnel; and marketing seminars, public relations, advertising and other marketing expenses. Sales and marketing expenses decreased $2.1 million, or 72 percent, to $812,000 for the year ended December 31, 2006 as compared to $2.9 million for the year ended December 31, 2005. The decreases in sales and marketing expenses are due to our discontinuing most discretionary marketing programs in late 2005 in connection with the change in sales focus under our new Chief Executive Officer, Robert W. Felton, and to conserve our financial resources; as well as from a decrease in sales and marketing headcount.
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 $569,000, or 16%, to $4.1 million for the year ended December 31, 2006, as compared to $3.5 million for the year ended December 31, 2005. The increase in research and development expenses is due to recognition of stock-based compensation expense in 2006 as a result of SFAS 123(R), which was partially offset by a decrease from having fewer staff working on research and development activities in 2006 compared to 2005. See Note 18 of Notes to Condensed Financial Statements for more information on stock-based compensation expenses.
General and Administrative. General and administrative expenses consist primarily of the costs of executive management, finance and administrative staff, business insurance, and professional fees. General and administrative expenses decreased $168,000, or 6 percent, to $2.8 million for the year ended December 31, 2006 as compared to $3.0 million for the year ended December 31, 2005. The decrease is due primarily to general and administrative expenses for 2005 including severance costs for our prior CEO, as well as from lower general and administrative staffing in 2006 compared to 2005. The decreases in general and administrative costs were partially offset by an increase in stock-based compensation expense in 2006 associated with SFAS 123(R). See Note 18 of Notes to Financial Statements for more information on stock-based compensation expenses.
Index to Financial Statements Total Other Income, net
Net total other income was $92,000 for the year ended December 31, 2006, as compared to $137,000 for the year ended December 31, 2005.
Provision for Income Taxes
The benefit for income taxes was $235,000 for the year ended December 31, 2006 as compared to a benefit of $1.1 million for the year ended December 31, 2005. The benefit for income taxes for the years ended December 31, 2006 and 2005 relate primarily to reversing accruals for state taxes that were no longer deemed necessary.
At December 31, 2006, we had established a valuation allowance of $40.1 million for the net deferred tax assets related to temporary differences, foreign tax credit carryforwards and projected net operating loss carryforwards. The valuation allowance was recorded in accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 109, Accounting for Income Taxes, which requires that a valuation allowance be established when there is significant uncertainty as to the realizability of the deferred tax assets. Based on a number of factors, including the size of the prior operating losses, the currently available, objective evidence indicates that it is more likely than not that the net deferred tax assets will not be realized.
Deemed dividend related to convertible preferred stock
As a result of the warrants sold with the convertible preferred stock and the beneficial conversion feature inherent in the conversion rights and preferences of the convertible preferred stock issued in March and December 2006, we recognized non-cash deemed dividends totaling $2,207,000 in 2006. The deemed dividends were calculated based on the conversion price compared to the market price on the date of issuance of the convertible preferred shares.
Balance Sheet Items
Notes payable. In December 2005, we executed promissory notes due to three members of our Board of Directors (or investment entities associated with those Directors), for a total of $600,000. During the quarter ended March 31, 2006, we executed additional similar notes totaling $500,000 to our Chief Executive Officer, Robert W. Felton. We repaid these notes in full in March 2006, upon completing the March equity financing transaction. See Notes 7 and 11 of the Notes to Financial Statements for more information.
Deferred revenues. We had deferred revenues of $1.4 million at December 31, 2006 compared to $2.2 million at December 31, 2005. The decrease results primarily from recognizing as revenue during the year ended December 31, 2006, a $1 million license payment we received from DevonWay in August 2005. For accounting purposes we deferred revenue recognition of this revenue until December 2006, the end of the estimated economic life of the release of EnterpriseTenFold provided to DevonWay, because the license agreement contained a discount that could not be determined at inception of the agreement, as discussed above. This decrease was partially offset by a prepayment of $344,000 we received during the three months ended December 31, 2006 for a consulting project starting in early 2007, in exchange for our continuing this customers’ existing discounted time-and-materials consulting rate for the new project.
Index to Financial Statements 2005 as Compared to 2004
Revenues
Total revenues decreased $11.9 million or 68 percent, to $5.7 million for the year ended December 31, 2005, as compared to $17.6 million for the year ended December 31, 2004.
Services and other revenues decreased $12 million, or 70 percent, to $5.2 million for the year ended December 31, 2005 as compared to $17.2 million for the year ended December 31, 2004. Services and other revenues for the year ended December 31, 2004 include $8.1 million in revenues, and $150,000 in operating costs, recognized during the quarter ended June 30, 2004, related to the completion of an earlier fixed-price applications development project with Cedars-Sinai Medical Center (“Cedars”). This completed the recognition of these revenues and related costs that were deferred in prior years pending confirmation of the completion of the applications development project and resolution of potential disputes between the parties. Excluding the effect of this Cedars transaction, we would have had total revenues of $9.5 million, and a net loss of $4.5 million for the year ended December 31, 2004.
In addition to the decrease related to the Cedars transaction, services and other revenues decreased due to decreases in revenues from certain customers who purchased less time-and-materials consulting from us over time as they completed their applications development projects. One customer completed its use of our time-and-materials consulting services for its applications development project during the quarter ended September 30, 2004. Another large customer’s time-and-materials consulting engagement was substantially completed during the quarter ended March 31, 2005. These decreases were partially offset by consulting revenues from new customers.
During 2005, we entered into agreements with a new customer, DevonWay, to provide licenses, consulting services, technical support services, and training, for approximately $1.6 million. A long-time member of our Board of Directors and our recently elected Chairman, CEO and President, Robert W. Felton, is the founder and owner of DevonWay. All disinterested members of our Board of Directors approved of these related person transactions and our general ongoing business relationship with DevonWay. Our revenues from DevonWay for the year ended December 31, 2005, were license revenues of $160,000, and services and other revenue of $439,000. See Note 17 of the Notes to Financial Statements for more information.
Although customers purchased licenses with contract values totaling $1.5 million (including a $1 million license sold to DevonWay) for the year ending December 31, 2005, we recorded license revenues for accounting purposes of $515,000, up from $359,000 for the year ending December 31, 2004. For accounting purposes, the amounts allocated to individual contract elements (such as licenses) may differ from the amounts stated in the contract for those individual elements, and the timing of their recognition as revenue may be later than the period in which they are sold. See Note 3 of the Notes to Financial Statements for more information.
Three customers accounted for 20 percent, 18 percent and 11 percent of our total revenues for the year ended December 31, 2005, compared to three customers accounting for 50 percent (Cedars), 22 percent and 15 percent of our total revenues for the year ended December 31, 2004. No other single customer accounted for 10 percent or more of our total revenues for the year ended December 31, 2005 or 2004.
The customer accounting for 20 percent of our total revenues for the year ended December 31, 2005, completed its use of our time-and-materials consulting services for its application development project during the quarter ended December 31, 2005. The customer accounting for 18 percent of our total revenues for the year ended December 31, 2005, substantially completed its application development project during the quarter ended March 31, 2005. The customer accounting for 11 percent of our total revenues for the year ended December 31, 2005, DevonWay, is a related person, as noted above.
Index to Financial Statements Operating Expenses
Cost of Revenues. Cost of revenues consists primarily of compensation and other related costs of personnel and contractors to provide applications development and implementation consulting, support, and training services. Cost of revenues decreased $2.9 million, or 50 percent, to $2.9 million for the year ended December 31, 2005 as compared to $5.9 million for the year ended December 31, 2004. The decrease in cost of revenues was primarily due to having a smaller staff (particularly subcontractors) working on customer projects as these customers completed their current application development projects. In particular, the UK project that ended during the quarter ended September 30, 2004 was staffed with subcontractors who we released upon completion of the services.
Sales and Marketing. Sales and marketing expenses consist primarily of compensation, travel, and other related expenses for sales and marketing personnel; and marketing seminars, public relations, advertising and other marketing expenses. Sales and marketing expenses increased $35,000, or 1 percent, to $2.9 million for the year ended December 31, 2005 as compared to $2.9 million for the year ended December 31, 2004. In connection with the change in sales focus under our new Chief Executive Officer, Robert W. Felton, and to conserve our financial resources, we discontinued most discretionary marketing spending in December 2005.
Research and Development. Research and development expenses consist primarily of compensation and other related costs of personnel dedicated to research and development activities. Research and development expenses decreased $203,000, or 5%, to $3.5 million for the year ended December 31, 2005, as compared to $3.7 million for the year ended December 31, 2004.
General and Administrative. General and administrative expenses consist primarily of the costs of executive management, finance and administrative staff, business insurance, and professional fees. General and administrative expenses increased $671,000, or 29 percent, to $3.0 million for the year ended December 31, 2005 as compared to $2.3 million for the year ended December 31, 2004. The increase in general and administrative expenses for the year ended December 31, 2005 was primarily due to the recognition of estimated severance related charges related to the departure of our prior CEO totaling $670,000, including an estimated option modification charge of $157,000.
During the quarter ended March 31, 2004, we reduced some variable compensation accrued during 2003, to lower levels that we believe better reflect our estimates. This reduced operating expenses for the first quarter of 2004 by $219,000.
Total Other Income, net
Net total other income was $137,000 for the year ended December 31, 2005, as compared to $240,000 for the year ended December 31, 2004.
Provision for Income Taxes
The benefit for income taxes was $1.1 million for the year ended December 31, 2005 as compared to a benefit of $376,000 for the year ended December 31, 2004. The benefit for income taxes for the years ended December 31, 2005 and 2004 relate primarily to reversing accruals for foreign and state taxes that were no longer deemed necessary.
At December 31, 2005, we had established a valuation allowance of $39.1 million for the net deferred tax assets related to temporary differences, foreign tax credit carryforwards and projected net operating loss carryforwards.
Liquidity and Capital Resources
Net cash used in operating activities was $4.4 million for the year ended December 31, 2006 as compared to $4.5 million for 2005. The decrease in cash flow used in operating activities results from decreases in cash outflows from reduced expenses, which was largely offset by decreases in cash inflows from certain large customers.
Index to Financial Statements Net cash used in investing activities was $31,000 for the year ended December 31, 2006 as compared to net cash used in investing activities of $17,000 for 2005.
Net cash provided by financing activities was $6.7 million for the year ended December 31, 2006 as compared to $604,000 for 2005. Net cash provided by financing for the year ended December 31, 2006, included $7.3 million of net proceeds from the sale of convertible preferred stock and warrants, $500,000 from issuance of notes payable, less $1.1 million in principal payments on notes payable which were repaid in full upon closing our capital raising transaction in March 2006. Net cash provided by financing activities for the year ended December 31, 2005 also included $600,000 from the issuance of notes payable to three members of our Board of Directors (or investment entities associated with those Directors). See Note 7 of the Notes to Financial Statements for more information.
Our deferred revenue balance generally results from contractual commitments made by customers to pay amounts to us in advance of revenues earned. We had deferred revenue balances of $1.4 million at December 31, 2006 and $2.2 million at December 31, 2005. When, over time, we recognize these deferred revenue balances as revenues in the statement of operations, we will not have corresponding increases in cash, as the related cash amounts have previously been received by us. Our unbilled accounts receivable represents revenue that we have earned but which we have not yet billed.
As of December 31, 2006, our principal source of liquidity was our cash and cash equivalents of $3.6 million. Although we made progress in 2006 closing new sales and improving our cash flow, such sales have not been sufficient to generate sustained positive cash flow from operations, or profitability. As a result, significant challenges and risks remain:
•
We have not been able to generate positive cash flow from operations for the four years ended December 31, 2006. Our net cash used in operating activities was $4.4 million for the year ended December 31, 2006, and $4.5 million for the year ended December 31, 2005.
•
During 2004 and 2005, we derived a significant portion of our cash inflows from time-and-materials consulting services performed for a limited number of large customers for whom we were completing enterprise applications development projects. As these customers completed their projects, they reduced their purchases of time-and-materials consulting services, which materially reduced our cash inflows. Although we have sold and begun new consulting projects in 2006, they are not as large as these particular prior projects.
•
We have experienced difficulty closing substantial new sales, and it is unclear when or if we can expect to predictably close material sales to new or existing customers, and to achieve and sustain positive cash flow from operations. Under the leadership of our new Chief Executive Officer, Robert W. Felton, we changed our business model to focus on selling larger consulting projects, instead of the smaller prototype application projects that we primarily sold in 2005. Although we expect to be more successful with this new model, our experience with the new model is limited to this year. We closed new sales in 2006 and improved our quarterly operating cash flow from $(1.9) million for Q2 2006, to $(864,000) for Q3 2006, and to $21,000 for Q4 2006. However, such sales have not been sufficient to generate sustained positive cash flow from operations, or profitability. If we do not close significant future sales, our existing cash resources will not be sufficient to fund our operations beyond Q2 2007.
There can be no assurance that we will be successful closing sufficient new sales and an inability to do so would have a materially adverse affect on our future cash flow and operations.
See “Risk Factors” for more information about risks facing TenFold.
Index to Financial Statements Disclosure about Contractual Obligations
The following table sets forth certain contractual obligations recorded in the audited financial statements as of December 31, 2006 and summary information is presented in the following table (in thousands):
Recent Accounting Pronouncements
On January 1, 2006, we adopted SFAS 123(R), Share-Based Payment, which requires the measurement and recognition of compensation expense for all share-based payment awards made to our employees and directors, including employee stock options and employee stock purchases related to the Employee Stock Purchase Plan, based on estimated fair values. See Note 18 of Notes to Financial Statements for more information.
On January 1, 2006, we adopted SFAS No. 154, Accounting Changes and Error Corrections. SFAS No. 154 is a replacement of APB No. 20, Accounting Changes, and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements. SFAS No. 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes retrospective application as the required method for reporting a change in accounting principle. SFAS No. 154 provides guidance for determining whether retrospective application of a change in accounting principle is impracticable and how to report a change in such circumstances. SFAS No. 154 also provides that a change in method of depreciating or amortizing a long-lived non-financial asset be accounted for as a change in estimate effected by a change in accounting principle, and also provides that correction of errors in previously issued financial statements should be termed a “restatement.” SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005
In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Instruments, which amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and SFAS No. 140 Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. SFAS No. 155 allows financial instruments that have embedded derivatives to be accounted for as a whole (eliminating the need to bifurcate the derivative from its host) if the holder elects to account for the whole instrument on a fair value basis. SFAS No. 155 also clarifies and amends certain other provisions of SFAS No. 133 and SFAS No. 140. This statement is effective for all financial instruments acquired or issued in financial years beginning after September 15, 2006. We do not expect our adoption of this new standard to have a material impact on our financial position, results of operations or cash flows.
In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets to simplify accounting for separately recognized servicing assets and servicing liabilities. SFAS No. 156 amends SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. Additionally, SFAS No. 156 applies to all separately recognized servicing assets and liabilities acquired or issued after the beginning of an entity’s fiscal year that begins after September 15, 2006, although early adoption is permitted. We do not expect our adoption of this new standard to have a material impact on our financial position, results of operations or cash flows.
Index to Financial Statements In June 2006, the FASB ratified Emerging Issues Task Force Issue, or EITF, No. 06-3, How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation). EITF No. 06-3 requires that, for interim and annual reporting periods beginning after December 15, 2006, we disclose our policy related to the presentation of sales taxes and similar assessments related to our revenue transactions. Early adoption is permitted. In our statements of operations, we present revenue net of sales taxes and any similar assessments. EITF No. 06-3 had no effect on our financial position and results of operations.
In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109 (“FIN 48”) which prescribes a recognition threshold and measurement attribute, as well as criteria for subsequently recognizing, de-recognizing and measuring uncertain tax positions for financial statement purposes. FIN 48 also requires expanded disclosure with respect to the uncertainty in income tax assets and liabilities. FIN 48 is effective for fiscal years beginning after December 15, 2006 and is required to be recognized as a change in accounting principle through a cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption. We do not expect our adoption of this new standard to have a material impact on our financial position, results of operations or cash flows.
On September 13, 2006, the Securities and Exchange Commission released Staff Accounting Bulletin 108, Considering the Effects of Prior Year Misstatements in Current Year Financial Statements ("SAB 108"), which provides guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. SAB 108 calls for the quantification of errors using both a balance sheet and income statement approach based on the effects of such errors on each of the company's financial statements and the related financial statement disclosures. SAB 108 is effective for financial statements issued for the fiscal year ending after November 15, 2006. Adoption of SAB 108 did not have a significant impact on our results of operations or financial condition.
In September 2006, the FASB issued SFAS No. 157 Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 is effective in fiscal years beginning after November 15, 2007. We are currently evaluating the impact of adopting the provisions of SFAS No. 157.
In September 2006, the FASB issued SFAS No. 158, Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans (an amendment of FASB Statements No. 87, 88, 106, and 132R). SFAS No. 158 requires an employer to recognize in its statement of financial position an asset for a plan’s over funded status or a liability for a plan’s under funded status, measure a plan’s assets and its obligations that determine its funded status as of the end of the employer’s fiscal year (with limited exceptions), and recognize changes in the funded status of a defined benefit postretirement plan in the year in which the changes occur. SFAS No. 158 is effective in fiscal years beginning after December 15, 2006. As we do not have any defined benefit postretirement plans, we do not expect our adoption of this new standard to have a material impact on our financial position, results of operations or cash flows.
On December 21, 2006, the FASB issued FASB Staff Position (FSP) Emerging Issues Task Force ("EITF") 00-19-2, "Accounting for Registration Payment Arrangements," which requires an issuer to account for a contingent obligation to transfer consideration under a registration payment arrangement in accordance with FASB Statement No. 5, Accounting for Contingencies and FASB Interpretation 14, Reasonable Estimation of the Amount of Loss. Registration payment arrangements are frequently entered into in connection with issuance of unregistered financial instruments, such as equity shares or warrants. A registration payment arrangement contingently obligates the issuer to make future payments or otherwise transfer consideration to another party if the issuer fails to file a registration statement with the SEC for the resale of specified financial instruments or fails to have the registration statement declared effective within a specific period. The FSP requires issuers to make certain disclosures for each registration payment arrangement or group of similar arrangements. The FSP is effective immediately for registration payment arrangements and financial instruments entered into or modified after the FSP's issuance date. For previously issued registration payment arrangements and financial instruments subject to those arrangements, the FSP is effective for financial statements issued for fiscal years beginning after December 15, 2006. We do not expect our adoption of this new standard to have a material impact on our financial position, results of operations or cash flows.
Index to Financial Statements
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Interest Rate Risk
As of December 31, 2006, we had cash and cash equivalents of $3.6 million, and restricted cash of $74,000. Substantially 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 December 31, 2006 rates would cause the fair value of these cash investments to change by an insignificant amount. We do not invest in any financial derivatives or any other complex financial instruments. TenFold does not own any equity investments. Therefore, we do not currently have any direct equity price risk.
Currency Risk
Our operations include some transactions with customers and partners in the United Kingdom. Some of these transactions are denominated in British pounds. For example, we have had projects in the United Kingdom for which we received payment from our customer in British pounds, and paid a contractor we used 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 receivables or payables denominated in British pounds decreases. When the U.S. dollar weakens against the British pound, the value of receivables or payables denominated in British pounds increases. The monetary activities which are impacted by foreign currency fluctuations are cash, accounts receivable, accounts payable, and certain accrued liabilities. A hypothetical 10 percent increase or decrease in the exchange rate between the U.S. dollar and the British pound from the December 31, 2006 rate would cause the fair value of such monetary assets and liabilities denominated in British pounds to change by an insignificant amount. We are not currently engaged in any foreign currency hedging activities.
Item 8.
Item 8. Financial Statements and Supplementary Data
The responses to this item are submitted in other sections of this Form 10-K. See Item 6 for Supplementary Data. See Item 15 for Financial Statements.
Item 9.
Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures. Our Chief Executive Officer and our Chief Financial Officer, after evaluating the effectiveness of our “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 (Exchange Act) Rules 13a-15(e) or 15d-15(e)) as of the end of the period covered by this annual report, have concluded that our disclosure controls and procedures are effective based on their evaluation of these controls and procedures required by paragraph (b) of Exchange Act Rules 13a-15 or 15d-15.
Changes in Internal Control over Financial Reporting. There were no changes in our internal control over financial reporting that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B. Other Information
None.
Index to Financial Statements
Part III
Certain information required by Part III is omitted from this Report on Form 10-K since we will file a definitive Proxy pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended (the “Proxy Statement”), not later than 120 days after the end of the fiscal year covered by this Report, and certain information included in the Proxy Statement is incorporated herein by reference.
Item 10.
Item 10. Directors and Executive Officers of the Registrant
(a) Executive Officers
The information required by this Item is incorporated by reference to the section entitled “Executive Officers” in Part I of this Form 10-K and by reference to the Section entitled “Code of Ethics” in the Proxy Statement.
(b) Directors
The information required by this Item is incorporated by reference to the sections entitled “Board of Directors” and “Nominations” in the Proxy Statement.
(c) Section 16
The information required by this Item is incorporated by reference to the section entitled “Section 16 (a) Beneficial Ownership Reporting Compliance” in the Proxy Statement.
Item 11.
Item 11. Executive Compensation
The information required by this Item is incorporated by reference to the section entitled “Executive Compensation” in the Proxy Statement.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this Item is incorporated by reference to the section entitled “Equity Compensation Plan Information” in Part II of this Form 10-K and by reference to the section entitled “Security Ownership of Certain Beneficial Owners and Management” in the Proxy Statement.
Item 13.
Item 13. Certain Relationships and Related Transactions
The information required by this Item is incorporated by reference to the section entitled “Certain Transactions” in the Proxy Statement.
Item 14.
Item 14. Principal Accountant Fees and Services
The information required by this Item is incorporated by reference to the section entitled “Independent Registered Public Accountants” in the Proxy Statement.
Index to Financial Statements
Part IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules.
1. Financial Statements and Notes to Financial Statements
The following financial statements are filed as part of this report:
TENFOLD CORPORATION
Page
Report of Independent Registered Public Accounting Firm
Balance Sheets as of December 31, 2006 and 2005
Statements of Operations for each of the years in the three year period ended December 31, 2006
Statements of Changes in Stockholders' Equity for each of the years in the three year period ended December 31, 2006
Statements of Cash Flows for each of the years in the three year period ended December 31, 2006
Notes to Financial Statements
2. Financial Statement Schedule
The following financial statement schedule is filed as a part of this report:
Schedule II - Valuation and Qualifying Accounts for the Years Ended December 31, 2006, 2005, and 2004
All other schedules are omitted because they are not required or the required information is shown in the financial statements or notes thereto.
Index to Financial Statements 3. Exhibits. The following is a list of exhibits required by Item 601 of Regulation S-K filed as part of this Form 10-K. Where so indicated by footnote, exhibits which were previously filed are incorporated by reference. For exhibits incorporated by reference, the location of the exhibit in the previous filing is indicated in parentheses.
Index to Financial Statements
* Incorporated by reference to “Notes to Financial Statements” herein
** Previously filed
# Indicates management contract or compensatory plan or arrangement
1) Filed on March 8, 1999 as an exhibit to the Company’s Registration Statement on Form S-1 and incorporated by reference.
2) Filed on April 20, 1999 as an exhibit to Amendment No. 1 to the Company’s Registration Statement on Form S-1 and incorporated by reference.
3) Filed on May 18, 1999 as an exhibit to Amendment No. 4 to the Company’s Registration Statement on Form S-1 and incorporated by reference.
4) Filed on May 5, 2000 as an exhibit to the Company’s Quarterly Report on Form 10-Q and incorporated by reference.
5) Filed on April 12, 2001 as an exhibit to the Company’s Annual Report on Form 10-K and incorporated by reference.
6) Filed on May 21, 2001 as an exhibit to the Company’s Quarterly Report on Form 10-Q and incorporated by reference.
7) Filed on July 27, 2001 as an exhibit to the Company’s Quarterly Report on Form 10-Q and incorporated by reference.
8) Filed on April 15, 2002 as an exhibit to the Company’s Annual Report on Form 10-K and incorporated by reference.
9) Filed on August 14, 2002 as an exhibit to the Company’s Quarterly Report on Form 10-Q and incorporated by reference.
10) Filed on November 19, 2002 as an exhibit to the Company’s Quarterly Report on Form 10-Q and incorporated by reference.
11) Filed on March 31, 2003 as an exhibit to the Company’s Annual Report on Form 10-K and incorporated by reference.
12) Filed on May 13, 2003 as an exhibit to the Company’s Quarterly Report on Form 10-Q and incorporated by reference.
13) Filed on December 23, 2003 as an exhibit to the Company’s Report on Form 8-K and incorporated by reference.
14) Filed on March 22, 2004 as an exhibit to the Company’s Report on Form 10-K and incorporated by reference.
15) Filed on August 15, 2005 as an exhibit to the Company’s Quarterly Report on Form 10-Q and incorporated by reference.
16) Filed on March 31, 2006 as an exhibit to the Company’s Report on Form 10-K and incorporated by reference.
17) Filed on May 25, 2006 as an exhibit to the Company’s Report on Form 8-K and incorporated by reference.
18) Filed on December 22, 2006 as an exhibit to the Company’s Report on Form 8-K and incorporated by reference.
Index to Financial Statements
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
TenFold Corporation:
We have audited the balance sheets of TenFold Corporation as of December 31, 2006 and 2005 and the related statements of operations, stockholders equity and cash flows for each of the three years in the period ended December 31, 2006. In connection with our audits of the financial statements, we also have audited the financial statement schedule as of December 31, 2006 and 2005 and for the three years then ended as listed in Item 15.2 of the accompanying index. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of TenFold Corporation as of December 31, 2006 and 2005, and the results of their operations and their cash flows for the three years ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule as of and for the three years ended December 31, 2006, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
The accompanying financial statements and schedule referred to above have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company has used significant balances of its cash in operating activities and at present levels of cash consumption will not have sufficient resources to meet operating needs. This raises substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 2. The financial statements and schedule do not include any adjustments that might result from the outcome of this uncertainty.
/s/ Tanner LC
Salt Lake City, Utah
February 20, 2007
Index to Financial Statements
TENFOLD CORPORATION
BALANCE SHEETS
(in thousands, except share data)
The accompanying notes to financial statements are an integral part of these financial statements
Index to Financial Statements
TENFOLD CORPORATION
STATEMENTS OF OPERATIONS
(in thousands, except per share data)
The accompanying notes to financial statements are an integral part of these financial statements
Index to Financial Statements
TENFOLD CORPORATION
STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(in thousands, except share data)
The accompanying notes to financial statements are an integral part of these financial statements
Index to Financial Statements
TENFOLD CORPORATION
STATEMENTS OF CASH FLOWS
(in thousands)
The accompanying notes to financial statements are an integral part of these financial statements
Index to Financial Statements
TENFOLD CORPORATION
NOTES TO FINANCIAL STATEMENTS
1. Nature of Operations
TenFold provides services and technology for building complex, Service Oriented Architecture (“SOA”)-compliant, enterprise-scale applications in significantly less time and cost than it would otherwise take using traditional development technologies. We believe that with TenFold’s technology, EnterpriseTenFold SOA, customers will also experience significantly reduced ongoing applications maintenance and enhancement costs compared to what they generally experience with legacy applications. Our business model focuses on providing applications development services and our EnterpriseTenFold SOA product, along with product support and training, to customers who can use a TenFold team or their own business teams to build and maintain applications.
TenFold sells its products and services primarily to customers in the United States, but it currently has a small number of customers outside the United States.
TenFold was incorporated in the state of Delaware in February 1993.
2. Going Concern and Liquidity
Our financial statements have been prepared under the assumption that TenFold will continue as a going concern. The independent auditors’ opinion on our December 31, 2006 financial statements includes an explanatory paragraph relating to our ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
As of December 31, 2006, our principal source of liquidity was our cash and cash equivalents of $3.6 million. Although we made progress in 2006 closing new sales and improving our cash flow, such sales have not been sufficient to generate sustained positive cash flow from operations, or profitability. As a result, significant challenges and risks remain:
•
We have not been able to generate positive cash flow from operations for the four years ended December 31, 2006. Our net cash used in operating activities was $4.4 million for the year ended December 31, 2006, and $4.5 million for the year ended December 31, 2005.
•
During 2004 and 2005, we derived a significant portion of our cash inflows from time-and-materials consulting services performed for a limited number of large customers for whom we were completing enterprise applications development projects. As these customers completed their projects, they reduced their purchases of time-and-materials consulting services, which materially reduced our cash inflows. Although we have sold and begun new consulting projects in 2006, they are not as large as these particular prior projects.
•
We have experienced difficulty closing substantial new sales, and it is unclear when or if we can expect to predictably close material sales to new or existing customers, and to achieve and sustain positive cash flow from operations. Under the leadership of our new Chief Executive Officer, Robert W. Felton, we changed our business model to focus on selling larger consulting projects, instead of the smaller prototype application projects that we primarily sold in 2005. Although we expect to be more successful with this new model, our experience with the new model is limited to this year. We closed new sales in 2006 and improved our quarterly operating cash flow from $(1.9) million for Q2 2006, to $(864,000) for Q3 2006, and to $21,000 for Q4 2006. However, such sales have not been sufficient to generate sustained positive cash flow from operations, or profitability. If we do not close significant future sales, our existing cash resources will not be sufficient to fund our operations beyond Q2 2007.
Index to Financial Statements TENFOLD CORPORATION
NOTES TO FINANCIAL STATEMENTS
There can be no assurance that we will be successful closing sufficient new sales and an inability to do so would have a materially adverse affect on our future cash flow and operations.
3. Significant Accounting Policies
Basis of Presentation
As used herein, “TenFold,” the “Company,” “we,” “our” and similar terms refer to TenFold Corporation, unless the context indicates otherwise.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions, including for example, estimated project costs and profitability and accounts receivable allowances. These assumptions 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.
We believe risks relating to revenue recognition include the judgment required to determine project profit or loss projections on time-and-material contracts. We recognize time-and-materials revenue at the lowest point in the range of estimated profit margin, which represents our best estimate of the profit to be achieved. Variances may occur if we are unable to collect time-and-materials billings or if we grant concessions to time-and-materials customers in order to sell additional business or collect cash under the contract. As we occasionally provide services on a fixed price basis, risks relating to revenue recognition also include the judgment and estimation required to determine fixed-price project completion percentages, and fixed-price project profit or loss projections. Variances between management’s estimates and actual results may result in significant adjustments to our results of operations and financial position.
For a license agreement that we executed in August 2005 that contained a discount that could not be determined at the inception of the agreement, we recognized the related license revenue in December 2006 the end of the estimated economic life of the release of EnterpriseTenFold provided to the customer. We used the end of the estimated economic life to recognize the revenue because we did not have vendor specific objective evidence of fair value (“VSOE”) for the related post-contract customer support, due to the discount, and therefore we could not allocate the revenue until the discount was known at the end of the estimated economic life. For accounting purposes, management estimated that the economic life was 16 months after considering factors such as the rapid pace of technological change in the software industry generally and particularly in TenFold’s market, the pace at which TenFold produces new releases of TenFold technology with substantial technological improvements, and the pace at which TenFold’s customers adopt new releases of TenFold technology.
We review asserted litigation claims each quarter to determine the likelihood that the claim will result in a loss. Significant management judgment is required to conclude on the likely outcome of outstanding litigation. If a loss is probable on a litigation claim, management estimates the loss and we accrue the estimated loss. If a loss is considered probable but cannot be reasonably estimated, we disclose the contingency in the notes to our financial statements. Losses may result on litigation claims that are not considered probable or are not estimable at the current time, potentially having a significant impact on future financial results.
Index to Financial Statements TENFOLD CORPORATION
NOTES TO FINANCIAL STATEMENTS
Revenue Recognition
We derive revenues from license fees, applications development and implementation consulting services, support, and training services. License revenues consist of fees for licensing EnterpriseTenFold (formerly known as Universal Application) as an applications development tool. Service revenues consist of fees for applications development and implementation consulting, support and training. Other revenues include fees for reimbursement of out of pocket expenses incurred for customer projects.
We follow the provisions of Statement of Position (“SOP”) 97-2, Software Revenue Recognition, as modified by SOP 98-9, Modification of SOP 97-2 with Respect to Certain Transactions, and SOP 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts, in recognizing revenue under each of our contracts.
We generally enter into contracts that involve multiple elements, such as software products, post-contract customer support (“PCS”), training, and time-and-material services. For accounting purposes, we allocate a portion of the contract fee to each undelivered element based on the relative fair values of the elements and allocate the fee for delivered software products using the residual method. The fair values of an element must be based on VSOE. We establish VSOE based on the price charged when the same element is sold separately. For consulting services, we base VSOE on the rates charged when the services are sold separately under time-and-materials contracts. We base VSOE for training on the rates charged when training is sold separately for supplemental training courses. For PCS, VSOE is determined by reference to the renewal rate we charge the customer in future periods.
As a result, the amounts allocated to individual contract elements (such as license, consulting, training and support) for accounting purposes may differ from the amounts stated in the contract for those individual elements, but not in total.
For time-and-materials contracts, we generally estimate a profit range and recognize the related revenue using the lowest probable level of profit estimated in the range. Billings in excess of revenue recognized under time-and-material contracts are deferred and recognized upon completion of the time-and-materials contract or when the results can be estimated more precisely.
For fixed-price contracts, we recognize revenue using the percentage-of-completion method of accounting and following the guidance in Statement of Position (“SOP”) 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts. We make adjustments, if necessary, to the estimates used in the percentage-of-completion method of accounting as work progresses under the contract and as we gain experience.
We recognize support revenue from contracts for ongoing technical support and unspecified product updates ratably over the support period.
We recognize training revenue as we perform the services.
We recognize license revenues from EnterpriseTenFold 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 delivered 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 licenses are sold separately or when an EnterpriseTenFold license is sold with an applications development project. Services relating to the licenses typically include post contract customer support services, general time-and-materials consulting, and training; and do not add significant functionality, features, or significantly alter the software. In addition, similar services are available from other vendors; there are no milestones or customer specific acceptance criteria which affect the realizability of the software license fee; and the software license fee is non-cancelable and non-refundable.
Index to Financial Statements TENFOLD CORPORATION
NOTES TO FINANCIAL STATEMENTS
For software arrangements that include a service element that is considered essential to the functionality of the software, we recognize license fees related to the application, and the applications development service fees, over time as we perform the services, using the percentage-of-completion method of accounting and following the guidance in Statement of Position (“SOP”) 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts. We make adjustments, if necessary, to the estimates used in the percentage-of-completion method of accounting as work progresses under the contract and as we gain experience. Fixed-price project revenues are split between license and service based upon the relative fair value of the components.
For certain projects, we limit revenue recognition in the period to the amount of project costs incurred in the same period, resulting in zero profit during the period, and postpone recognition of profits until results can be estimated more precisely.
For certain contracts for which reasonably dependable estimates cannot be made or for which inherent hazards make estimates doubtful, we recognize revenue under the completed-contract method of contract accounting.
For license agreements that contain a discount that cannot be determined at the inception of the agreement, we recognize the related license revenue at the end of the estimated economic life of the release of the software version provided to the customer. We use the end of the estimated economic life to recognize the revenue when we do not VSOE for the related post-contract customer support, due to the discount, and therefore we cannot allocate the revenue until the discount is known at the end of the estimated economic life.
We record billings and cash received in excess of revenue earned as deferred revenue. 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 as payments become due under the terms of the customer’s contract. We consider current information and events regarding our customers and their contracts and establish allowances for doubtful accounts when it is probable that we will be unable to collect amounts due under the terms of existing contracts.
The following table sets forth, for the periods indicated, the revenue recognized by type (in thousands):
Index to Financial Statements TENFOLD CORPORATION
NOTES TO FINANCIAL STATEMENTS
Cash Equivalents
Cash equivalents include all highly-liquid investments purchased with remaining maturities of three or fewer months. Cash equivalents are recorded at cost, which approximates fair value, and consist primarily of investments in money market mutual funds, which at times, exceed federally insured limits. We have not experienced any losses in such accounts. We believe that we are not exposed to any significant credit risk on cash equivalents.
Accounts Receivable (Billed and Unbilled)
Our billed accounts receivable are recorded when invoiced and represent claims against third parties that will be settled in cash. Our unbilled accounts receivable represents revenue that we have earned but which we have not yet billed. The carrying value of our receivables, net of the allowance for doubtful accounts, represents their estimated net realizable value. We estimate our allowances for doubtful accounts based on historical collection trends, the age of outstanding receivables, customers’ financial condition and creditworthiness, and existing economic conditions. If events or changes in circumstances indicate that specific receivable balances may be impaired, further consideration is given to the collectibility of those balances and the allowance is adjusted accordingly. We charge off accounts receivable against the allowance for doubtful accounts when an account is deemed to be uncollectible.
Financial Instruments
The carrying values of accounts receivable, unbilled accounts receivable, accounts payable, accrued liabilities, and income taxes payable, approximate their estimated fair values due to the relative short maturity of these instruments.
Restricted Cash
Restricted cash of $74,000 at December 31, 2006 and December 31, 2005 is maintained to support various accounts payable activities. We do not expect to require additional restricted cash in 2007.
Property and Equipment
Property and equipment, including leasehold improvements, are stated at cost, as adjusted for impairment charges. See Note 5 for more information. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, generally three to five years, or the life of the lease, whichever is shorter.
Expenditures for repairs and maintenance are charged to expense when incurred. Expenditures for major renewals and betterments that extend the useful lives of existing equipment are capitalized and depreciated. On retirement or disposition of property and equipment, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is recognized in the statement of operations.
Accounting for Impairment of Long-Lived Assets
We review our 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 un-discounted 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 estimated fair value of the assets. Fair value is determined utilizing cash flow analyses, and other market valuations.
Index to Financial Statements TENFOLD CORPORATION
NOTES TO FINANCIAL STATEMENTS
Cost of Revenues
Cost of revenues consists primarily of compensation and other related costs of services personnel, and contractor and distributor costs related to customer projects. Costs of license revenues, including product packaging, documentation, and reproduction have not been significant.
Advertising
Advertising costs are expensed as incurred. Advertising costs amounted to $0 in 2006, $14,000 in 2005, and $112,000 in 2004.
Research and Development Costs
Research and development expenses consist primarily of costs for development and enhancement of our EnterpriseTenFold technologies. In accordance with Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards No. 86, Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed (“SFAS 86”), development costs incurred in the research and development of new software products to be sold, leased or otherwise marketed are expensed as incurred until technological feasibility has been established. We achieve technological feasibility through a working model. We have charged our software development costs to research and development expense in the accompanying Statements of Operations.
Warranty
We provide reserves for warranty costs expected to be incurred. To date, we have not incurred significant warranty costs. As a result, we have not recorded a liability for warranty costs as of December 31, 2006.
Income Taxes
We record income taxes using the asset and liability method. Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement basis amounts of existing assets and liabilities and their respective income tax bases. Future tax benefits, such as net operating loss carryforwards and tax credits, are recognized to the extent that realization of such benefits is more likely than not.
Stock-Based Compensation
Effective January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment, (“SFAS 123(R)”) which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors including employee stock options and employee stock purchases related to the Employee Stock Purchase Plan (“ESPP”) based on estimated fair values. In accordance to this standard, we recognize the compensation cost of all share based awards on a straight-line basis over the vesting period of the award. Prior to January 1, 2006, we accounted for those plans under the recognition and measurement provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations, as permitted by FASB Statement No. 123, Accounting for Stock-Based Compensation (“Statement 123”).
Index to Financial Statements TENFOLD CORPORATION
NOTES TO FINANCIAL STATEMENTS
Recent Accounting Pronouncements
On January 1, 2006, we adopted SFAS 123(R), Share-Based Payment, which requires the measurement and recognition of compensation expense for all share-based payment awards made to our employees and directors, including employee stock options and employee stock purchases related to the Employee Stock Purchase Plan, based on estimated fair values. See Note 18 of Notes to Financial Statements for more information.
On January 1, 2006, we adopted SFAS No. 154, Accounting Changes and Error Corrections. SFAS No. 154 is a replacement of APB No. 20, Accounting Changes, and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements. SFAS No. 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes retrospective application as the required method for reporting a change in accounting principle. SFAS No. 154 provides guidance for determining whether retrospective application of a change in accounting principle is impracticable and how to report a change in such circumstances. SFAS No. 154 also provides that a change in method of depreciating or amortizing a long-lived non-financial asset be accounted for as a change in estimate effected by a change in accounting principle, and also provides that correction of errors in previously issued financial statements should be termed a “restatement.” SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005
In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Instruments, which amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and SFAS No. 140 Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. SFAS No. 155 allows financial instruments that have embedded derivatives to be accounted for as a whole (eliminating the need to bifurcate the derivative from its host) if the holder elects to account for the whole instrument on a fair value basis. SFAS No. 155 also clarifies and amends certain other provisions of SFAS No. 133 and SFAS No. 140. This statement is effective for all financial instruments acquired or issued in financial years beginning after September 15, 2006. We do not expect our adoption of this new standard to have a material impact on our financial position, results of operations or cash flows.
In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets to simplify accounting for separately recognized servicing assets and servicing liabilities. SFAS No. 156 amends SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. Additionally, SFAS No. 156 applies to all separately recognized servicing assets and liabilities acquired or issued after the beginning of an entity’s fiscal year that begins after September 15, 2006, although early adoption is permitted. We do not expect our adoption of this new standard to have a material impact on our financial position, results of operations or cash flows.
In June 2006, the FASB ratified Emerging Issues Task Force Issue, or EITF, No. 06-3, How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation). EITF No. 06-3 requires that, for interim and annual reporting periods beginning after December 15, 2006, we disclose our policy related to the presentation of sales taxes and similar assessments related to our revenue transactions. Early adoption is permitted. In our statement of operations, we present revenue net of sales taxes and any similar assessments. EITF No. 06-3 had no effect on our financial position and results of operations.
In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109 (“FIN 48”) which prescribes a recognition threshold and measurement attribute, as well as criteria for subsequently recognizing, de-recognizing and measuring uncertain tax positions for financial statement purposes. FIN 48 also requires expanded disclosure with respect to the uncertainty in income tax assets and liabilities. FIN 48 is effective for fiscal years beginning after December 15, 2006 and is required to be recognized as a change in accounting principle through a cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption. We do not expect our adoption of this new standard to have a material impact on our financial position, results of operations or cash flows.
Index to Financial Statements TENFOLD CORPORATION
NOTES TO FINANCIAL STATEMENTS
On September 13, 2006, the Securities and Exchange Commission released Staff Accounting Bulletin 108, Considering the Effects of Prior Year Misstatements in Current Year Financial Statements (“SAB 108”), which provides guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. SAB 108 calls for the quantification of errors using both a balance sheet and income statement approach based on the effects of such errors on each of the company’s financial statements and the related financial statement disclosures. SAB 108 is effective for financial statements issued for the fiscal year ending after November 15, 2006. Adoption of SAB 108 did not have a significant impact on our results of operations or financial condition.
In September 2006, the FASB issued SFAS No. 157 Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 is effective in fiscal years beginning after November 15, 2007. We are currently evaluating the impact of adopting the provisions of SFAS No. 157.
In September 2006, the FASB issued SFAS No. 158, Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans (an amendment of FASB Statements No. 87, 88, 106, and 132R). SFAS No. 158 requires an employer to recognize in its statement of financial position an asset for a plan’s over funded status or a liability for a plan’s under funded status, measure a plan’s assets and its obligations that determine its funded status as of the end of the employer’s fiscal year (with limited exceptions), and recognize changes in the funded status of a defined benefit postretirement plan in the year in which the changes occur. SFAS No. 158 is effective in fiscal years beginning after December 15, 2006. As we do not have any defined benefit postretirement plans, we do not expect our adoption of this new standard to have a material impact on our financial position, results of operations or cash flows.
On December 21, 2006, the FASB issued FASB Staff Position (FSP) Emerging Issues Task Force (“EITF”) 00-19-2, “Accounting for Registration Payment Arrangements,” which requires an issuer to account for a contingent obligation to transfer consideration under a registration payment arrangement in accordance with FASB Statement No. 5, Accounting for Contingencies and FASB Interpretation 14, Reasonable Estimation of the Amount of Loss. Registration payment arrangements are frequently entered into in connection with issuance of unregistered financial instruments, such as equity shares or warrants. A registration payment arrangement contingently obligates the issuer to make future payments or otherwise transfer consideration to another party if the issuer fails to file a registration statement with the SEC for the resale of specified financial instruments or fails to have the registration statement declared effective within a specific period. The FSP requires issuers to make certain disclosures for each registration payment arrangement or group of similar arrangements. The FSP is effective immediately for registration payment arrangements and financial instruments entered into or modified after the FSP’s issuance date. For previously issued registration payment arrangements and financial instruments subject to those arrangements, the FSP is effective for financial statements issued for fiscal years beginning after December 15, 2006. We do not expect our adoption of this new standard to have a material impact on our financial position, results of operations or cash flows.
Index to Financial Statements TENFOLD CORPORATION
NOTES TO FINANCIAL STATEMENTS
4. 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):
Employee stock options that could potentially dilute basic earnings (loss) per share in the future, of which there were 22,168,871, 23,450,459, and 4,962,685 outstanding on December 31, 2006, 2005, and 2004, respectively, that have a weighted average exercise price of $1.28, $1.80, and $6.21 per share, respectively, 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 loss per common share for the year ended December 31, 2006 excludes the assumed conversion of 1,812,009 shares of convertible preferred stock outstanding at December 31, 2006, from our March and December 2006 capital raising transactions, which are convertible into 24,541,614 shares of common stock, because the impact of the conversion would be anti-dilutive. No convertible preferred stock was outstanding in 2005 or 2004.
Warrants to purchase 12,270,803 shares of common stock outstanding at December 31, 2006, from our March and December 2006 capital raising transactions, were also excluded from the computation of diluted loss per common share because to do so would have been anti-dilutive for the period. The warrants have an exercise price of $0.62 per share. No warrants were outstanding in 2005 or 2004.
Index to Financial Statements TENFOLD CORPORATION
NOTES TO FINANCIAL STATEMENTS
5. Property and Equipment
Property and equipment consists of the following (in thousands):
Accumulated amortization under capital leases amounted to $73,000, $44,000, and $15,000 at December 31, 2006, 2005, and 2004, respectively.
6. Accrued Liabilities
Accrued liabilities consists of the following (in thousands):
Accrued liabilities at December 31, 2006, and 2005, included estimated severance and related benefits of approximately $326,000, and $492,000, respectively, accrued in connection with the departure of our prior Chief Executive Officer in late 2005.
7. Notes Payable - Related Parties
On December 23, 2005, we executed a Promissory Note due to Robert W. Felton, our Chairman, President, and Chief Executive Officer, in the amount of $200,000.
On December 23, 2005, we executed a Promissory Note due to Wasatch Investments LLC, an investment entity associated with TenFold Director Robert E. Parsons, Jr., in the amount of $200,000.
On December 28, 2005, we executed a Promissory Note due to First Media TF Holdings LLC, an investment entity associated with TenFold Director Ralph W. Hardy Jr., in the amount of $200,000.
On February 23, 2006, we executed a Promissory Note due to Mr. Felton, in the amount of $250,000.
On March 15, 2006, we executed a Promissory Note due to Mr. Felton, in the amount of $250,000.
Index to Financial Statements TENFOLD CORPORATION
NOTES TO FINANCIAL STATEMENTS
These identical Promissory Notes provided interim financing to TenFold while we sought to secure equity financing. The notes were senior to other TenFold indebtedness and equity, bore interest at 10% and were due upon the earlier to occur of March 31, 2006, the closing of equity financing of $2 million or more, or a liquidation event. We repaid these notes in full in March 2006, upon completing the March 2006 equity financing transaction described in Note 11.
The disinterested members of our Board of Directors approved these transactions.
8. Commitments
We lease office space and equipment under non-cancelable lease agreements, which expire at various dates through 2007. Future minimum lease payments under non-cancelable lease obligations, in excess of one year, as of December 31, 2006 are as follows (in thousands):
Total rental expense under operating leases was $564,000, $541,000, and $492,000, for the years ended December 31, 2006, 2005, and 2004, respectively.
9. Legal Proceedings and Contingencies
Unresolved Stockholder Matter
On November 6, 2001, a class action complaint alleging violations of the federal securities laws was filed in the United States District Court for the Southern District of New York naming as defendants TenFold, certain of our officers and directors, and certain underwriters of our initial public offering. An amended complaint was filed on April 24, 2002. TenFold and certain of our officers and directors are named in the suit pursuant to Section 11 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act 1934 on the basis of an alleged failure to disclose the underwriters’ alleged compensation and manipulative practices. Similar complaints have been filed against over 300 other issuers that have had initial public offerings since 1998. The individual officer and director defendants entered into tolling agreements and, pursuant to a Court Order dated October 9, 2002, were dismissed from the litigation without prejudice. On February 19, 2003, the Court granted a Motion to Dismiss the Rule 10b-5 claims against 116 defendants, including TenFold. On June 27, 2003, our Board of Directors approved a proposed partial settlement with the plaintiffs in this matter. The settlement would provide, among other things, a release of TenFold and of the individual defendants for the alleged wrongful conduct in the Amended Complaint. We agreed to undertake other responsibilities under the partial settlement, including agreeing to assign away, not assert, or release certain potential claims we may have against our underwriters. In June 2004, a motion for preliminary approval of the settlement was filed with the Court. The underwriters filed a memorandum with the Court opposing preliminary approval of the settlement. The Court granted preliminary approval of the settlement on February 15, 2005, subject to certain modifications. On August 31, 2005, the Court issued a preliminary order further approving the modifications to the settlement
Index to Financial Statements
and certifying the settlement classes. The Court also appointed the Notice Administrator for the settlement and ordered that notice of the settlement be distributed to all settlement class members beginning on November 15, 2005. A settlement fairness hearing was held on April 24, 2006, however no ruling has been issued yet by the Court. On December 5, 2006, the United States Court of Appeals for the Second Circuit (the “Second Circuit”) issued an opinion vacating the District Court’s certification of a litigation class in that portion of the case between the Plaintiffs and the underwriter defendants. Because the Second Circuit’s opinion was directed to the class certified by the District Court for the Plaintiffs’ litigation against the underwriter defendants, the opinion’s effect on the class certified by the District Court for the company’s settlement is unclear. On January 5, 2007, Plaintiffs filed a petition for rehearing en banc by the Second Circuit. There can be no assurance that the proposed settlement would be approved and implemented. Any direct financial impact of the proposed settlement is expected to be borne by our insurers. At this point, we do not believe that this lawsuit will have a material adverse impact on our business, results of operations, financial position, or liquidity. Accordingly, no related losses have been provided for in our accompanying financial statements.
Assessing litigation
We review litigation claims each quarter to determine the likelihood that the claim will result in a loss. Due to the inherent uncertainties of litigation, predicting the ultimate outcome of litigation is very difficult. Significant management judgment is required to conclude on the likely outcome of outstanding litigation. As part of that review, we consider our available insurance coverage. Such coverage is subject to the particular policy’s total limit, and typically subject to the insurer’s standard reservation of rights regarding conditions or findings that might exclude coverage for a particular matter.
If a loss is considered probable on a litigation claim, management estimates the loss and we accrue the estimated loss. If a loss is considered probable but cannot be reasonably estimated, we disclose the contingency in these notes to our financial statements. Losses may however result on litigation claims that are not considered probable or are not estimable at the current time, potentially having a material adverse impact on our future business, results of operations, financial position, or liquidity.
Indemnifications, Warranties, Complaints and Insurance
As permitted under Delaware law, and as provided in agreements with our officers and Directors, we have indemnified officers and Directors for certain claims asserted against them in connection with their service as an officer or Director of TenFold. The maximum potential amount of future payments that we could be required to make under these indemnification provisions is unlimited. However, we have purchased Directors’ and Officers’ insurance policies that reduce our monetary exposure and enable us to recover a portion of any future amounts paid. As a result of this insurance coverage, we believe the estimated fair value of these indemnification agreements is not material. Our agreements with customers generally require us to indemnify the customer against claims that our software infringes third party patent, copyright, or other proprietary rights. Such indemnification obligations are generally limited in a variety of industry-standard respects, including a right to replace an infringing product or cancel the software license and return the fees paid by the customer. To date, we have not incurred costs to defend lawsuits or settle claims related to these indemnification agreements, and no such claims were outstanding at December 31, 2006. As a result, we have not recorded a liability for infringement costs as of December 31, 2006.
Our agreements with customers also generally provide a warranty that for so long as the customer is paying for support services, our software will materially conform to the related documentation, and that our software has been developed in a workmanlike manner. To date, we have not incurred significant warranty costs. As a result, we have not recorded a liability for warranty costs as of December 31, 2006.
Index to Financial Statements TENFOLD CORPORATION
NOTES TO FINANCIAL STATEMENTS
We are subject to various customer complaints or disputes that arise in the ordinary course of business from time-to-time. We do not believe that the ultimate liability, if any, to resolve currently outstanding complaints or disputes will have a material impact on our future business, results of operations, financial position, or liquidity.
We have an industry-standard, errors and omissions insurance policy. This policy excludes contractual related disputes such as cost and time guarantees, and only covers software errors or omissions that occur after the delivery of software. We believe this policy provides adequate coverage for potential damages related to errors and omissions in our delivered software.
10. Income Taxes
The components of the provision (benefit) for income taxes are presented below (in thousands):
The table below reconciles the expected U.S. federal statutory income tax rate to the recorded income tax provision (benefit) (in thousands):
Index to Financial Statements TENFOLD CORPORATION
NOTES TO FINANCIAL STATEMENTS
Our deferred tax assets are comprised of the following (in thousands):
Domestic and foreign components of income (loss) before taxes are as follows (in thousands):
The benefit for income taxes for the year ended December 31, 2006 relates to reversing accruals for state taxes that were no longer deemed necessary. As of December 31, 2006, we had federal net operating loss carryforwards of approximately $87.0 million that begin to expire in 2020. As of December 31, 2006, we had state net operating loss carryforwards of approximately $65.1 million, which are subject to various state carryover provisions that generally provide shorter carryover periods than federal. In addition, as of December 31, 2006, we had federal credit carryforwards for increasing research activities of approximately $4.1 million that begin to expire in 2014. We also had $1.7 million of state credits for increasing research activities that are subject to various state carryover provisions. The net operating losses and credits carryforwards could be subject to annual use limitations under Code Sections 382 and 383 if we raise additional capital sufficient to cause an ownership change.
The ultimate realization of the deferred income tax assets is dependent, in part, upon the tax laws in effect, our future earnings, and other events. As of December 31, 2006, we had recorded a valuation allowance of $40.1 million. During the year ended December 31, 2006, the valuation allowance increased approximately $1.0 million, and for the year ended December 31, 2005, the valuation allowance increased approximately $2.2 million. The increases for the years ended December 31, 2006 and 2005, relate primarily to the operating losses. The general valuation allowance has been established under the provisions of SFAS No. 109, Accounting for Income Taxes, which requires that a valuation allowance be established when it is more likely than not that the net deferred tax assets will not be realized. The valuation allowance as of December 31, 2006 includes the benefit for stock option exercises that increased the size of the net operating loss carryovers. Future reductions to the valuation allowance will be allocated $30.7 million to operations and $9.4 million to paid-in capital.
Index to Financial Statements TENFOLD CORPORATION
NOTES TO FINANCIAL STATEMENTS
11. Capital Stock
On March 29, 2006, we entered into a Securities Purchase Agreement for the sale of 1,500,000 shares of unregistered convertible preferred stock and warrants. The preferred shares are convertible into 20,315,805 shares of common stock. The warrants are to purchase 10,157,899 shares of common stock at an exercise price of $0.62 per share, with a 5-year term. The transaction generated gross proceeds of approximately $6.3 million (before expenses of approximately $227,000, and repayment of $1.1 million of interim financing obligations). Several members of our Board of Directors (or investment entities associated with them) and an Executive Officer participated in the transaction, providing approximately $4.7 million of the gross proceeds raised:
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Robert W. Felton Trust invested $2 million. We repaid $709,000 of interim financing to Mr. Felton, our Chairman, President, and Chief Executive Officer, from the proceeds of the capital raising.
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First Media TF Holdings LLC, an investment entity associated with TenFold Director Ralph W. Hardy Jr., invested $2 million. We repaid $205,000 of interim financing to First Media TF Holdings LLC from the proceeds of the capital raising.
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TenFold Director Steven H. Coltrin invested $500,000. We used $206,000 of the proceeds of the capital raising to pay accounts payable due to his firm, Coltrin & Associates, for marketing and public relations work provided to TenFold in earlier periods.
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Samer Diab, Senior Vice President, Customer Services, invested $230,000.
We also repaid $205,000 of interim financing to Wasatch Investments LLC, an investment entity associated with TenFold Director Robert E. Parsons, Jr., from the proceeds of the capital raising.
On December 18, 2006, we entered into a Securities Purchase Agreement for the sale of 312,009 shares of unregistered convertible preferred stock and warrants. The preferred shares are convertible into 4,225,809 shares of common stock. The warrants are to purchase 2,112,904 shares of common stock at an exercise price of $0.62 per share, with a 5-year term. The transaction generated gross proceeds of approximately $1.3 million (before expenses of approximately $90,000).
As a result of the warrants sold with the convertible preferred stock and the beneficial conversion feature inherent in the conversion rights and preferences of the convertible preferred stock, we recognized non-cash deemed dividends totaling $2,207,000 for the year ended December 31, 2006. The deemed dividends were calculated based on the conversion price compared to the market price on the dates of issuance of the convertible preferred shares. Because we have an accumulated deficit, the deemed dividend was recorded as additional paid-in-capital and had no affect on that account.
Each holder of the convertible preferred stock has the right, at the option of the holder at any time, to convert shares of the preferred stock into shares of our common stock, at a conversion ratio of 13.54387, subject to adjustment for stock splits, stock dividends and the like. We have the right to require conversion if the closing price of our common stock has been above $5.00 for 30 consecutive trading days.
Each holder of the convertible preferred stock is entitled to that number of votes on all matters presented to stockholders equal to the number of shares of common stock then issuable upon conversion of their preferred stock.
In the event of any liquidation or winding up of TenFold, each holder of the convertible preferred stock is entitled to receive in preference to the holders of common stock, the price per share paid for the preferred stock.
Index to Financial Statements TENFOLD CORPORATION
NOTES TO FINANCIAL STATEMENTS
Each holder of the preferred stock has the right in the event TenFold seeks to close any equity offering that occurs prior to March 30, 2008 to participate pro-rata (based upon his or her percentage equity ownership of TenFold at that time) in such offering. This excludes the offering of employee stock options, restricted stock grants, shares offered pursuant to an underwritten public offering, and other customary exclusions.
The consent of the holders of a majority of the preferred stock voting together as one class is required for any action that:
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alters or changes the rights, preferences or privileges of this preferred stock so as to materially or adversely affect such stock;
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increases or decreases the authorized number of this preferred stock; or
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authorizes for issue, or obligates TenFold to issue any other equity security having a preference over or on a parity with this preferred stock with respect to voting, dividend or liquidation rights; but not TenFold’s right to issue additional shares of common stock.
Other than as set forth above, the proceeds of the March and December preferred stock offerings have been used for general corporate purposes.
12. Stock Option Plans
1993 Flexible Stock Incentive Plan. Our 1993 Flexible Stock Incentive Plan (the “1993 Stock Plan”) was adopted by the Board of Directors and approved by our stockholders in February 1993. A total of 10,000,000 shares of common stock are reserved for issuance under the 1993 Stock Plan. The 1993 Stock Plan is administered by the Board of Directors and the Board Compensation Committee, and with respect to option grants to purchase up to 10,000 shares to any one employee, option grants may be approved by a separate committee of the board. The 1993 Stock Plan provides for the issuance of incentive stock options to employees, including officers and employee directors, and of nonqualified stock options, stock purchase rights, stock bonus awards, and stock appreciation rights to employees, including officers and directors, consultants, and non-employee directors. The options generally vest over a four or five-year period and expire ten years from the date of grant. On January 1, 2003, the Plan terminated with respect to the grant of incentive stock options. To date, we have not issued any incentive stock options, stock purchase rights, stock bonus awards, or stock appreciation rights under the 1993 Stock Plan.
1999 Stock Plan. Our 1999 Stock Plan was adopted by the Board of Directors and approved by the stockholders in March 1999 and June 2002. A total of 6,500,000 shares of common stock were initially reserved for issuance under the 1999 Stock Plan, plus an automatic annual increase on the first day of 2000, 2001, 2002, 2003, and 2004. This automatic annual increase was equal to the lesser of 1,000,000 shares or 3 percent of our outstanding common stock on the last day of the immediately preceding year, or such lesser number of shares as the Board of Directors determined. Under this provision, on each of January 1, 2004, January 1, 2003, January 1, 2002, January 1, 2001 and January 1, 2000 the number of shares reserved for issuance under the plan increased by 1,000,000 shares. At the 2003 Annual Meeting our stockholders approved a plan amendment that increased the number of shares of common stock available for issuance by 5,000,000 shares, and increased the annual limit on the number of shares of common stock that may be granted to any one employee by 1,000,000 shares to an annual maximum of 2,000,000 shares. At the 2005 Annual Meeting our stockholders approved a plan amendment that increased the number of shares of common stock available for issuance by 5,000,000 shares. The 1999 Stock Plan provides for the granting to employees, including officers and directors, of incentive stock options within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended, and for the granting to employees and consultants, including non-employee directors, of nonqualified stock options and stock purchase rights. We have historically granted only nonqualified stock options. The 1999 Stock Plan is administered by the Board of Directors and the Board Compensation Committee, and with respect to option grants to purchase up to 10,000 shares to any one employee, option grants may be approved by
Index to Financial Statements TENFOLD CORPORATION
NOTES TO FINANCIAL STATEMENTS
a separate committee of the board. The plan administrator determines the terms of options and stock purchase rights granted under the 1999 Stock Plan, including the number of shares subject to an option or purchase right, the exercise or purchase price, and the term and exercisability of options. The options generally vest over a four or five year period and expire ten years from the date of grant. Unless terminated earlier, the 1999 Stock Plan will terminate in March 2009. Through December 31, 2006, we have not issued any stock purchase rights or stock appreciation rights under the 1999 stock plan; and have issued only one incentive stock option grant and one stock bonus award.
2000 Employee Stock Option Plan. The Board of Directors adopted our 2000 Stock Option Plan in December 2000. A total of 7,000,000 shares of common stock have been reserved for issuance under the 2000 Stock Option Plan. The 2000 Stock Option Plan provides for the granting of nonstatutory rights of purchase of our common stock to employees, excluding section 16 officers, directors, and non-employee directors. Nonstatutory options do not qualify as an Incentive Stock Option within the meaning of Section 422 of the Internal Revenue Code of 1996, as amended. The Board of Directors administers the 2000 Stock Option Plan. The plan administrator determines the terms of options and stock purchase rights granted under the 2000 Stock Option Plan, including the number of shares subject to an option or purchase right, the exercise or purchase price, and the term and exercisability of options. The options generally vest over a four-year period and expire ten years from the date of grant. Unless terminated earlier, the 2000 Stock Plan will terminate in December 2010.
Stock option activity under our 1993, 1999, and 2000 stock option plans is as follows:
At December 31, 2006, 17,827,277 options were vested and exercisable as compared to 20,450,740 in 2005 and 12,883,266 in 2004, under the stock option plans. Included in the table above are options granted to consultants that were recorded at their estimated fair value. To date, the number of options granted to consultants and the related fair value of such options has been insignificant.
Index to Financial Statements TENFOLD CORPORATION
NOTES TO FINANCIAL STATEMENTS
The following table summarizes information about stock options under the plans outstanding at December 31, 2006:
The number of remaining options available to grant under the 1993, 1999, and 2000 plans is 11,169,195 as of December 31, 2006.
The weighted-average fair value of the options granted under the plans in 2006 is $0.22 as compared to $0.36 in 2005 and $2.62 in 2004. The fair value of these options was estimated at the date of grant using the Black-Scholes model with the following weighted-average assumptions for 2006, 2005, and 2004: risk-free interest rate of 4.83 percent in 2006, 3.95 percent in 2005, and 2.54 percent in 2004; a dividend yield of 0 percent; a volatility factor of 158.1 percent for 2006, 170.2 percent for 2005 and 185.3 percent in 2004; and an expected life of 5.3 years in 2006, 3.5 years in 2005, and 3.9 years in 2004.
We recorded deferred compensation of $0 in 2006; $157,000 in 2005; and $0 in 2004; relating to modifications of stock options. We recognized compensation expense of $2.7 million in 2006, $171,000 in 2005, and $17,000 in 2004, related to the vesting of options with associated deferred compensation. Included in the $2.7 million for 2006 was a reduction of our stock-based compensation expense by $133,000, for an option modification charge related to the departure of our prior CEO. See Note 18 of Notes to Financial Statements for more information.
13. 1999 Employee Stock Purchase Plan
Our 1999 Employee Stock Purchase Plan was adopted by our Board of Directors and approved by our stockholders in March 1999. A total of 1,000,000 shares of common stock were initially reserved for issuance under the purchase plan. In addition, the number of shares reserved for issuance under the purchase plan automatically increased on the first day of each of our fiscal years beginning in 2000, 2001, 2002, 2003, and 2004 equal to the lesser of 300,000 shares, 0.75 percent of our outstanding common stock on the last day of the immediately preceding fiscal year, or such lesser number of shares as the Board of Directors determined. Under this provision, the number of shares reserved for issuance under the purchase plan increased by 1,385,490 shares. The purchase plan, which is intended to qualify under Section 423 of the Internal Revenue Code, has two six-month offering periods each year, with new offering periods (other than the first offering period) commencing on February 1 and August 1 of each year. The first offering period commenced on the date of the initial public offering and ended on January 31, 2000. We issued 105,996, 68,530, and 95,496, shares under this plan during the years ended December 31, 2006, 2005, and 2004, respectively.
Index to Financial Statements TENFOLD CORPORATION
NOTES TO FINANCIAL STATEMENTS
As of December 31, 2006, 1,500,072 shares were available for issuance under the 1999 Employee Stock Purchase Plan.
The purchase plan is administered by the Board of Directors or by a committee appointed by the Board. Employees (including officers and employee directors) of TenFold, or of any majority-owned subsidiary designated by the Board, are eligible to participate in the purchase plan if they are employed by TenFold or any such subsidiary for at least 20 hours per week and more than 5 months per year. The purchase plan permits eligible employees to purchase common stock through payroll deductions of up to 10 percent of an employee’s compensation, at a price equal to 85 percent of the lower of the fair market value of the common stock at the beginning of the offering period or at the end of such period. No employee may purchase more than 3,000 shares of common stock under the purchase plan in any single offering period. No employee may purchase shares in an offering period if the purchase would cause such employee to own stock or hold outstanding stock options equal to or in excess of 5 percent of the total voting power of all classes of our stock. In addition, no employee shall be granted an option under the purchase plan if the option would permit an employee to purchase stock under all our employee stock purchase plans at a rate that exceeds $25,000 of fair market value of the stock for each calendar year in which the option is outstanding. An employee has the option of increasing or decreasing the percentage of payroll deductions once or of discontinuing the deduction during the offering period. Under SFAS 123(R), the plan is considered compensatory.
The weighted-average fair value of employee stock purchase rights granted under the employee stock purchase plan in 2006 was $0.13 as compared to $0.32 in 2005 and $1.66 in 2004. The fair value of the employee stock purchase rights was estimated using the Black-Scholes model with the following assumptions for 2006: a weighted-average risk-free interest rate of 4.89 percent, dividend yield of 0 percent, an expected life of 6 months, and a volatility factor of 135.9 percent.
14. 401(k) Retirement Plan
We established a 401(k) retirement savings plan for employees in January 1996. All employees age 21 and over are eligible to participate. Each participant may elect to have amounts deducted from his or her compensation and contributed to the plan. Through January 15, 2002, we matched 20 percent of the first 6 percent of an employees’ contributions, up to a maximum of $2,000 per employee per year. On January 15, 2002, we discontinued matching of employee contributions.
15. Operating Segments
Our CEO reviews financial information on a consolidated basis, similar in format to the accompanying Statements of Operations. We consolidate revenue and expense information for all business groups for internal and external reporting and for decision-making purposes. We operate in a single operating segment, which is applications products and services.
Revenues from customers outside of North America were approximately 8 percent of total revenues for 2006, 11 percent of total revenues for 2005, and 20 percent of total revenues for 2004. Revenues from customers in the United Kingdom were 7 percent of total revenues for 2006, 9 percent of total revenues for 2005, and 19 percent of total revenues for 2004. The decrease in percent of total revenues from the United Kingdom from 2004 to 2005 is primarily the result of the completion during the quarter ended September 30, 2004, of a UK consulting project we commenced in 2002. Revenues from operations in Argentina were 1 percent of total revenues for 2006, 2 percent of total revenues for 2005, and 0.9 percent of total revenues for 2004. At December 31, 2006, our long-lived assets are deployed in the United States.
Index to Financial Statements TENFOLD CORPORATION
NOTES TO FINANCIAL STATEMENTS
16. Additional Significant Risks and Uncertainties
We have derived, and over the near term we expect to continue to derive, a significant portion of our revenues and cash flow from a limited number of customers. Replacing the loss of an important customer is unpredictable. Revenues and cash flows from a single customer or a few important customers may constitute a significant portion of our total revenues and cash inflows in a particular period, then decline as the volume of work performed for specific customers is likely to vary from period to period, and a major customer in one period may not continue to purchase licenses or services from us in a subsequent period. Although we plan to expand and diversify our customer base, currently the loss of any of our large customers, without their replacement by new customers, would likely have a material adverse effect on our revenue and cash flow. The following table provides customer revenue concentrations of 10% or more of annual revenues, for each of the three years ended December 31, 2006, 2005 and 2004. No other customer accounted for 10 percent or more of total annual revenues during any of these years.
The revenue from the customer accounting for 21 percent of our total revenues for the year ended December 31, 2006, DevonWay, was primarily from the recognition of deferred license revenue from a single transaction in 2005. We do not expect DevonWay to account for a significant percentage of our revenues after December 31, 2006.
17. Related Person Transactions
During 2005, we entered into agreements with a new customer, DevonWay, to provide licenses, consulting services, technical support services, and training. Our Chairman, CEO and President, Robert W. Felton, is the founder and owner of DevonWay. All disinterested members of our Board of Directors approved of these related person transactions and our general ongoing business relationship with DevonWay.
Our revenues from DevonWay for the years ended December 31, 2006, and 2005 were $1.1 million and $599,000, respectively. For the years ended December 31, 2006, and 2005, we received cash inflows from DevonWay of $72,000 and $1.6 million, respectively. As of December 31, 2006, and 2005, we had accounts receivable of $0 and $25,0000, respectively, due from DevonWay. During late 2005 and continuing into 2006, DevonWay provided some marketing services to us. For the years ended December 31, 2006 and 2005, we incurred fees to DevonWay of $2,000 and $35,000, respectively, for such services. During late 2006, DevonWay provided a consulting staff to us for use on one of our projects. For the year ended December 31, 2006, we incurred fees to DevonWay of $21,000, for such services. As of December 31, 2006, and 2005, we had accounts payable due to DevonWay of $21,000 and $0, respectively.
Although we received a $1 million license payment from DevonWay in August 2005, for accounting purposes we deferred recognition of this revenue until December 2006, the end of the estimated economic life of the release of EnterpriseTenFold provided to DevonWay, because the license agreement contained a discount that could not be determined at the inception of the agreement. We used the end of the estimated economic life to recognize the revenue because we did not have vendor specific objective evidence of fair value (“VSOE”) for the related post-contract customer support, due to the discount, and therefore we could not allocate the revenue until the discount was known at the end of the estimated economic life.
Index to Financial Statements TENFOLD CORPORATION
NOTES TO FINANCIAL STATEMENTS
See Note 7 for information about Notes Payable we previously entered into with members of our Board of Directors.
See Note 11 for information about our capital raising transaction completed in March 2006, that included the sale of stock to members of our Board of Directors and Executive Officers.
18. Stock-Based Compensation
Effective January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment, (“SFAS 123(R)”) which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors including employee stock options and employee stock purchases related to the Employee Stock Purchase Plan (“ESPP”) based on estimated fair values. In accordance to this standard, we recognize the compensation cost of all share based awards on a straight-line basis over the vesting period of the award. Prior to January 1, 2006, we accounted for those plans under the recognition and measurement provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations, as permitted by FASB Statement No. 123, Accounting for Stock-Based Compensation (“Statement 123”).
We adopted SFAS 123(R) using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006. Our Financial Statements as of and for the year ended December 31, 2006, reflect the impact of SFAS 123(R). Under that transition method, compensation cost recognized for the year ended December 31, 2006 includes: (a) amortization related to the compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of Statement 123, and (b) amortization related to compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123(R). Results for prior periods have not been restated.
TenFold has three stock-based employee option plans and an ESPP, which are described more fully in Note 12 and Note 13, respectively. No stock-based employee compensation cost was recognized in the Statement of Operations for the year ended December 31, 2005, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The ESPP was deemed noncompensatory under Opinion 25, and, therefore, resulted in no compensation cost. As of December 31, 2006, TenFold has approximately 12.7 million shares of common stock reserved for future issuance under the stock option plans and the ESPP.
The adoption of SFAS 123(R) had a significant impact on our results of operations. Our statement of operations for year ended December 31, 2006 includes the following stock-based compensation expense from stock options and ESPP:
Index to Financial Statements TENFOLD CORPORATION
NOTES TO FINANCIAL STATEMENTS
In August 2006, we granted 5,000,000 options to our CEO, with half vesting immediately and the other half vesting quarterly in 2007. This grant accounts for $620,000 of the stock-based compensation expense for the year ended December 31, 2006.
For the year ended December 31, 2005, we recognized estimated severance related charges related to the departure of our prior CEO, including an estimated option modification charge, based upon the anticipated terms at that time. Upon the execution of the Separation Agreement and Release on May 19, 2006, we calculated the actual option modification charge based upon the final terms, and recognized a resulting reduction in our stock-based compensation expense of $133,000, which reduced our general and administrative expenses for the year ended December 31, 2006. The option modification included canceling approximately 5.9 million vested options, re-pricing 1.3 million vested options to an exercise price of $0.33 per share, and extending the expiration date on approximately 1.6 million vested options to December 15, 2010.
Unrecognized stock-based compensation expense expected to be recognized over an estimated weighted-average amortization period of 0.7 year was $2.3 million at December 31, 2006.
Our deferred compensation cost at December 31, 2005 of $6,000, which was accounted for under APB 25, was reclassified into additional paid-in capital.
The following table illustrates the effect on net loss and loss per share if we had applied the fair value recognition provisions of Statement 123 to options granted under our stock option plans and the employee stock purchase plan in all periods presented. For purposes of this pro-forma disclosure, the value of the options is estimated using a Black-Scholes option-pricing formula and amortized to expense over the options’ vesting periods.
Share Option Plans
We currently have three stock option plans that allow us to grant nonqualified stock options, stock purchase rights, stock bonus awards, stock appreciation rights, and other equity based awards to employees, including officers and directors, consultants, and non-employee directors. We have historically generally granted only nonqualified stock options. The options generally vest over a four or five-year period and expire ten years from the date of grant.
Index to Financial Statements TENFOLD CORPORATION
NOTES TO FINANCIAL STATEMENTS
Our weighted-average assumptions used in the Black-Scholes valuation model for equity awards with time-based vesting provisions granted during the year ended December 31, 2006 are shown below:
The expected volatility rate was estimated based on the historical volatility of TenFold common stock. The expected term was calculated using the SEC “simplified” method as provided for in Staff Accounting Bulletin No. 107. The risk-free interest rates are the rates provided by the U.S Treasury for Daily Treasury Yield Curve Rates commonly referred to as “Constant Maturity Treasury” rates in effect at the time of grant with a remaining term equal to the expected option term.
The pre-vesting forfeiture rate used for the three and twelve months ended December 31, 2006 was based on historical rates and forward-looking factors. As required under SFAS 123(R), we adjust the estimated forfeiture rates to our actual experience. Prior to adoption of SFAS 123(R), we accounted for forfeitures as they occurred.
A summary of the time-based stock option awards as of December 31, 2006, and changes during the year, is as follows:
The weighted-average grant-date fair value of stock options granted during the year ended December 31, 2006 was $0.22. Stock-based compensation expense related to stock options recognized under SFAS 123(R) for the year ended December 31, 2006 was $2.7 million. At December 31, 2006, there was $2.3 million of unrecognized stock-based compensation expense related to non-vested options, which is expected to be recognized over a weighted-average period of 0.7 year.
Employee Stock Purchase Plan
Our 1999 Employee Stock Purchase Plan (“ESPP”) was adopted by our Board of Directors and approved by our stockholders in March 1999. The ESPP, which is intended to qualify under Section 423 of the Internal Revenue Code, has two six-month offering periods each year, with new offering periods commencing on February 1 and August 1 of each year. Eligible full-time employees, through payroll deductions, are allowed to purchase a limited number of shares of our common stock during each offering period at 85% of the fair market value at the lower of either the date of enrollment or the date of purchase. We account for the ESPP as a compensatory plan and recorded compensation expense for the year ended December 31, 2006 of $13,000, in accordance with SFAS 123(R).
Index to Financial Statements TENFOLD CORPORATION
NOTES TO FINANCIAL STATEMENTS
The fair value of issuances under the purchase plan is estimated on the issuance date by applying the principles of FASB Technical Bulletin 97-1, Accounting under Statement 123 for Certain Employee Stock Purchase plan with a Look Back Option, and using the Black-Scholes valuation model. Our weighted-average assumptions used in the Black-Scholes valuation model for our ESPP grants during the year ended December 31, 2006 are shown below:
The expected volatility rate was estimated based on the historical volatility of TenFold common stock over a six-month period. The expected term is the same as the requisite service period. The risk-free interest rates are the rates provided by the U.S Treasury for Daily Treasury Yield Curve Rates commonly referred to as “Constant Maturity Treasury” rates in effect at the time of grant with a remaining term equal to the expected term.
During the years ended December 31, 2006, 2005, and 2004, 105,996, 68,530, and 95,496 shares, respectively, of common stock were purchased under the ESPP at a weighted-average price of $0.19, $0.54, and $1.52 per share, respectively. As of December 31, 2006, there was $1,400 of total unrecognized compensation costs related to employee stock plan purchases. These costs are expected to be recognized over a weighted-average period of 1 month.
Index to Financial Statements
Schedule II
TENFOLD CORPORATION
Valuation and Qualifying Accounts
For the Years Ended December 31, 2006, 2005, and 2004
(in thousands)
* Represents write-offs of accounts receivable
Index to Financial Statements
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, on February 21, 2007.
Dated: February 21, 2007
/s/ Robert P. Hughes
Robert P. Hughes, Chief Financial Officer and Chief of Staff
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.