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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark one)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission File Number 0-15454
TANGRAM ENTERPRISE SOLUTIONS, INC.
(Exact Name of Registrant as Specified in Its Charter)
Pennsylvania 23-2214726
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
11000 Regency Parkway, Suite 401
Cary, NC 27511
(Address of Principal Executive Offices) (Zip Code)
(919) 653-6000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.01 par value
(Title of class)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes X No ___
The number of outstanding shares of Common Stock, $0.01 par value per
share, as of August 12, 2002 was 19,802,439.
TANGRAM ENTERPRISE SOLUTIONS, INC.
INDEX
PART I. FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS:
Balance Sheets--June 30, 2002 (Unaudited) and December 31, 2001.............3
Statements of Operations--Three Months Ended
June 30, 2002 and 2001 (Unaudited)......................................4
Statements of Operations--Six Months Ended
June 30, 2002 and 2001 (Unaudited)......................................5
Statements of Cash Flows--Six Months Ended
June 30, 2002 and 2001 (Unaudited)......................................6
Notes to the Financial Statements...........................................7
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS...........................................11
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK...........29
PART II. OTHER INFORMATION
ITEM 2 - CHANGES IN SECURITIES AND USE OF PROCEEDS............................30
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K.....................................30
SIGNATURES....................................................................31
2
TANGRAM ENTERPRISE SOLUTIONS, INC.
BALANCE SHEETS
(in thousands, except share amounts)
JUNE 30 DECEMBER 31
2002 2001
---------------------------
(UNAUDITED) (AUDITED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 818 $ 322
Accounts receivable, net of allowance of $257 and $309
in 2002 and 2001, respectively 1,510 4,516
Other 321 251
---------------------------
Total current assets 2,649 5,089
PROPERTY AND EQUIPMENT:
Computer equipment and software 902 885
Office equipment and furniture 218 220
Leasehold improvements 117 117
---------------------------
1,237 1,222
Less accumulated depreciation and amortization (1,049) (965)
---------------------------
Total property and equipment 188 257
OTHER ASSETS:
Acquired software technology, net accumulated amortization of $805 and $366
in 2002 and 2001, respectively 2,708 3,147
Deferred software costs, net accumulated amortization of $1,240 and $1,461
in 2002 and 2001, respectively 3,400 3,218
Cost in excess of net assets of business acquired 1,415 1,415
Other intangibles, net accumulated amortization of $242 and $149 in 2002
and 2001, respectively 131 224
Other 67 79
---------------------------
Total other assets 7,721 8,083
---------------------------
Total assets $ 10,558 $ 13,429
===========================
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt $ 447 $ 300
Accounts payable 311 210
Accrued expenses 969 2,069
Deferred revenue 3,199 4,096
---------------------------
Total current liabilities 4,926 6,675
Long-term debt--shareholders 1,126 1,020
Other liabilities 577 493
SHAREHOLDERS' EQUITY:
Convertible preferred stock--Series F, par value $0.01, $1,000 stated
value, 3,000 shares authorized, designated, issued and outstanding -- --
Common stock, par value $0.01, authorized 48,000,000 shares, 19,802,439 and
19,405,548 issued and outstanding in 2002 and 2001, respectively 198 194
Additional paid-in capital 50,525 50,164
Accumulated deficit (46,794) (45,117)
---------------------------
Total shareholders' equity 3,929 5,241
---------------------------
Total liabilities and shareholders' equity $ 10,558 $ 13,429
===========================
See accompanying notes.
3
TANGRAM ENTERPRISE SOLUTIONS, INC.
STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
THREE MONTHS ENDED JUNE 30
2002 2001
----------- ------------
(UNAUDITED)
REVENUE:
Licenses and products $ 827 $ 1,306
Services 1,744 2,096
--------------------------
Total revenue 2,571 3,402
COST OF REVENUE:
Cost of licenses and products 532 473
Cost of services 392 532
--------------------------
Total cost of revenue 924 1,005
--------------------------
Gross profit 1,647 2,397
OPERATING EXPENSES:
Sales and marketing 1,554 1,644
General and administrative 490 772
Research and development 701 747
--------------------------
Total operating expenses 2,745 3,163
--------------------------
Loss from operations (1,098) (766)
Other expense, net (29) (5)
--------------------------
Loss before income taxes (1,127) (771)
Provision for income taxes -- --
--------------------------
Net loss $ (1,127) $ (771)
==========================
PER SHARE CALCULATION:
Net loss $ (1,127) $ (771)
Preferred stock dividend (65) (61)
--------------------------
Net loss available to common shareholders $ (1,192) $ (832)
==========================
Loss per common share -
Basic and diluted $ (0.06) $ (0.04)
==========================
Weighted average number of common shares outstanding -
Basic and diluted 19,802 19,406
==========================
See accompanying notes.
4
TANGRAM ENTERPRISE SOLUTIONS, INC.
STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
SIX MONTHS ENDED JUNE 30
2002 2001
--------------------------
(UNAUDITED)
REVENUE:
Licenses and products $ 2,125 $ 2,928
Services 3,593 4,086
--------------------------
Total revenue 5,718 7,014
COST OF REVENUE:
Cost of licenses and products 1,127 959
Cost of services 842 961
--------------------------
Total cost of revenue 1,969 1,920
--------------------------
Gross profit 3,749 5,094
OPERATING EXPENSES:
Sales and marketing 2,855 3,258
General and administrative 1,135 1,464
Research and development 1,200 1,629
--------------------------
Total operating expenses 5,190 6,351
--------------------------
Loss from operations (1,441) (1,257)
Other expense, net (107) (83)
--------------------------
Loss before income taxes (1,548) (1,340)
Provision for income taxes -- --
--------------------------
Net loss $ (1,548) $ (1,340)
==========================
PER SHARE CALCULATION:
Net loss $ (1,548) $ (1,340)
Preferred stock dividend (129) (87)
--------------------------
Net loss available to common shareholders $ (1,677) $ (1,427)
==========================
Loss per common share -
Basic and diluted $ (0.09) $ (0.08)
==========================
Weighted average number of common shares outstanding -
Basic and diluted 19,674 18,411
==========================
See accompanying notes.
5
TANGRAM ENTERPRISE SOLUTIONS, INC.
STATEMENTS OF CASH FLOWS
(in thousands)
SIX MONTHS ENDED JUNE 30
2002 2001
---------------------------
(UNAUDITED)
OPERATING ACTIVITIES
Net loss $ (1,548) $ (1,340)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Depreciation 84 70
Amortization 1,241 1,390
Reserve for doubtful accounts (52) 389
Other 20 (54)
Cash provided by (used in) changes in working capital items:
Accounts receivable and other current assets 2,988 1,408
Accounts payable 101 (229)
Accrued expenses (1,100) (315)
Deferred revenue (897) 309
---------------------------
Net cash provided by operating activities 837 1,628
INVESTING ACTIVITIES
Deferred software costs (838) (1,075)
Expenditures for property and equipment (15) (35)
Cash received in connection with purchase of acquired software technology -- 68
Decrease in other assets 12 6
---------------------------
Net cash used in investing activities (841) (1,036)
FINANCING ACTIVITIES
Net borrowings from (repayments to) shareholders 500 (925)
---------------------------
Net cash provided by (used in) financing activities 500 (925)
---------------------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 496 (333)
Cash and cash equivalents, beginning of period 322 553
---------------------------
Cash and cash equivalents, end of period $ 818 $ 220
===========================
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS INFORMATION
Cash paid during the period for interest $ 3 $ 30
===========================
See accompanying notes.
6
TANGRAM ENTERPRISE SOLUTIONS, INC
NOTES TO THE FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
BASIS OF PRESENTATION
The accompanying unaudited interim financial statements have been prepared
in accordance with accounting principles generally accepted in the United States
for interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of management, all adjustments
(consisting solely of normal recurring accruals) considered necessary for a fair
presentation of the statements have been included. The interim operating results
are not necessarily indicative of the results that may be expected for a full
fiscal year. The balance sheet at December 31, 2001 has been derived from the
audited financial statements at that date but does not include all of the
information and footnotes required by accounting principles generally accepted
in the United States for complete financial statements. For further information,
refer to the financial statements and accompanying footnotes thereto included in
the Company's Annual Report on Form 10-K for the year ended December 31, 2001.
REVENUE RECOGNITION
In October 1997, the Accounting Standards Executive Committee (AcSEC)
issued Statement of Position (SOP) 97-2 Software Revenue Recognition, as amended
in March 1998 by SOP 98-4 and October 1998 by SOP 98-9. These SOPs provide
guidance on applying generally accepted accounting principles in recognizing
revenue on software transactions. The Company adopted SOP 97-2 for software
transactions entered into beginning January 1, 1998. Based on the current
requirements of the SOPs, application of these statements did not have a
material impact on the Company's revenue recognition policies. However, AcSEC is
currently reviewing further modifications to the SOP with the objective of
providing more definitive, detailed implementation guidelines. This guidance
could lead to unanticipated changes in the Company's operational and revenue
recognition practices.
In December 1999, the Securities Exchange Commission ("SEC") staff released
Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition," as amended by
SAB No. 101A and SAB No. 101B, to provide guidance on the recognition,
presentation and disclosure of revenue in financial statements. SAB No. 101
explains the SEC staff's general framework for revenue recognition, stating that
certain criteria be met in order to recognize revenue. SAB No. 101 also
addresses gross versus net revenue presentation and financial statement and
Management's Discussion and Analysis disclosures related to revenue recognition.
In response to SAB No. 101, the Company undertook a review of its revenue
recognition practices and determined its method of accounting for revenue to be
in accordance with the provisions of SAB No. 101.
The Company derives revenue from software licenses, postcontract customer
support (PCS), and consulting services. Licenses and products revenue include
software license fees under perpetual and period licensing agreements and
revenue from the sale of gateway and other products, which include both hardware
and software. Postcontract customer support includes telephone support, bug
fixes, and rights to upgrades on a when-and-if available basis. Consulting
services consist primarily of implementation services performed on a time and
material basis for the installation of the Company's software products, database
trigger services which create a mechanism for importing data from a third party
system into the Company's software products and on-site training services.
Revenue from software license agreements and product sales are recognized upon
delivery, provided that all of the following conditions are met: a
non-cancelable license agreement has been signed; the software has been
delivered; no significant production, modification or customization of the
software is required; the vendor's fee is fixed or determinable; and collection
of the resulting receivable is deemed probable. In software arrangements that
include rights to software products, specified upgrades or gateways, PCS, and/or
other services, the Company allocates the total arrangement fee among each
deliverable based on vendor-specific objective evidence. Revenue from
maintenance agreements are recognized ratably over the term of the maintenance
period, generally one year. Consulting and training services, which are not
considered essential to the functionality of the software products, are
recognized as the respective services are performed.
7
In November 2001, the staff of the FASB issued an announcement, "Income
Statement Characterization of Reimbursements Received for Out of Pocket Expenses
Incurred." This announcement requires companies to characterize reimbursements
received for out of pocket expenses incurred as revenue in the income statement.
This announcement is to be applied in financial reporting periods beginning
after December 15, 2001 and comparative financial statements for prior periods
are to be reclassified to comply with the guidance in this announcement. We
adopted the policies outlined in the announcement on January 1, 2002, as such,
reimbursements for out of pocket expenses of $82,000 and $129,000 has been
reclassified as services revenue and cost of services for the three and six
month periods ended June 30, 2001, respectively.
IMPAIRMENT OF LONG-LIVED ASSETS AND IDENTIFIABLE INTANGIBLE ASSETS
The Company accounts for long-lived assets pursuant to Financial Accounting
Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS")
No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets." The
Company evaluates its property and equipment, certain intangible assets and
other long-lived assets for impairment and assesses their recoverability based
upon anticipated future cash flows. If changes in circumstances lead Company
management to believe that any of its long-lived assets may be impaired, the
Company will (a) evaluate the extent to which the remaining book value of the
asset is recoverable by comparing the future undiscounted cash flows estimated
to be associated with the asset to the asset's carrying amount and (b)
write-down the carrying amount to market value or discounted cash flow value to
the extent necessary. As of June 30, 2002, management did not consider any of
the Company's long-lived assets to be impaired.
In July 2001, the FASB issued SFAS No. 141, "Business Combinations," and
SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 requires that
the purchase method of accounting be used for all business combinations
initiated after June 30, 2001 as well as all purchase method business
combinations completed after June 30, 2001. SFAS No. 141 also specifies criteria
that intangible assets acquired in a purchase method business combination must
meet to be recognized and reported apart from goodwill, noting that any purchase
price allocable to an assembled workforce may not be accounted for separately.
SFAS No. 142 requires that goodwill and intangible assets with indefinite useful
lives no longer be amortized, but instead tested for impairment at least
annually in accordance with the provisions of SFAS No. 142. SFAS No. 142 also
requires that intangible assets with definite useful lives be amortized over
their respective estimated useful lives to their estimated residual values, and
reviewed for impairment.
The Company adopted the provisions of SFAS No. 141 in July 2001, except
with regard to business combinations initiated prior to July 1, 2001, and SFAS
No. 142 was adopted on its effective date of January 1, 2002. The Company has
used the purchase method when accounting for past business combinations and the
adoption of the standard did not result in any change to the Company's financial
statements except for the nonamortization provisions of the standard. Upon
adoption of SFAS No. 142, the Company performed an initial test of potential
intangible asset impairment. This required initial benchmark evaluation was
performed as of January 1, 2002 resulting in no impairment in the value of the
Company's goodwill and any related intangibles. Application of the
non-amortization provision of the standard is expected to reduce operating
expenses in 2002 by approximately $748,000 as compared to operating results if
this standard had not been applied. If we were to adjust the 2001 comparative
amounts to exclude this amortization expense and conform to the 2002
presentation, general and administration expense, total operating expenses, loss
from operations and the net loss, as presented, would be reduced by
approximately $374,000 each.
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." Under SFAS No. 143, the fair value of a liability for
an asset retirement obligation must be recognized in the period in which it is
incurred if a reasonable estimate of fair value can be made. The associated
asset retirement costs are capitalized as part of the carrying amount of the
long-lived asset. SFAS No. 143 is effective for fiscal years beginning after
June 15, 2002. The adoption of SFAS No. 143 is not expected to have a material
impact on our financial position or results of operations.
EARNINGS PER SHARE
In accordance with SFAS No. 128, "Earnings Per Share," basic earnings per
common share calculations are based on net earnings (loss) after preferred stock
dividend requirements and the weighted-average number of common shares
outstanding during each period. Diluted earnings (loss) per common share also
reflects the potential dilution that would occur assuming the exercise of stock
options and other related effects. Weighted average number of common shares
outstanding on a diluted basis for the three and six month periods ended March
31, 2002 and 2001 do not include common stock equivalents because the effect of
inclusion of these would be to reduce the loss per common share. If the exercise
of stock options were included, the weighted average number of common shares
outstanding would have increased by 13,800 and 36,500 for the three-month
periods ended June 30, 2002 and 2001, respectively, and would have increased by
30,200 and 30,000 for the six-month periods ended June 30, 2002 and 2001,
respectively.
8
NOTE 2. RESEARCH AND DEVELOPMENT COSTS
The Company capitalizes certain software development costs incurred to
enhance the Company's existing software or to develop new software. Certain
software development costs incurred after technological feasibility of the
product has been established are capitalized. Such capitalized costs are
amortized on an individual product basis commencing when a product is available
for release. Costs incurred prior to the establishment of technological
feasibility are charged to research and development expense.
Research and development costs are comprised of the following (in
thousands):
THREE MONTHS ENDED JUNE 30 SIX MONTHS ENDED JUNE 30
2002 2001 2002 2001
-------------------------- ------------------------
Research and development costs incurred $ 1,079 $ 1,333 $ 2,038 $ 2,704
Less - capitalized software development costs (378) (586) (838) (1,075)
-------------------------- ------------------------
Research and development costs, net $ 701 $ 747 $ 1,200 $ 1,629
========================== ========================
Included in cost of revenues is amortization of software development costs
and acquired software technology of $516,000 and $451,000 for the three months
ended June 30, 2002 and 2001, respectively. Amortization of software development
costs for the six months ended June 30, 2002 and 2001 was $1,095,000 and
$917,000, respectively. In the three-month period ended March 31, 2002
approximately $876,400 of fully amortized software development costs were
removed from deferred software costs and accumulated amortization.
NOTE 3. LONG-TERM DEBT -- SHAREHOLDERS
The Company has a $3 million unsecured revolving line of credit with
Safeguard Scientifics, Inc. ("Safeguard"), a majority shareholder of the
Company, holding 100% of the Company's outstanding Series F preferred shares and
approximately 59% of the Company's outstanding common stock (assuming the
conversion of the Series F preferred stock). Terms of the line of credit require
monthly interest payments at the prime rate plus 1%. Principal is due 13 months
after date of demand by Safeguard or earlier in the case of a sale of
substantially all of the assets of the Company, a business combination or upon
the closing of a debt or equity offering. As of August 12, 2002, borrowings
under the line of credit with Safeguard are $500,000. During the six months
ended June 30, 2002, the Company incurred $7,600 of interest cost under the
revolving line of credit with Safeguard.
On March 1, 2001, pursuant to an Asset Purchase Agreement dated February
13, 2001, the Company issued 3,000,000 shares of its common stock and $1.5
million in non-interest bearing Promissory Notes ("Notes") to Axial Technology
Holding AG ("Axial") (See Note 4 below). The Notes require the payment of
$300,000, $500,000, and $700,000 on the first, second, and third anniversaries,
respectively, of the Asset Purchase Agreement. With respect to the first note
payment, the Company could elect to provide, in lieu of cash, a number of shares
of its common stock equivalent in aggregate value to the amount of such cash
payment, the value of each such share to be deemed equal to 80% of the average
NASDAQ closing price during the 20 trading days immediately prior to the
relevant note payment date. The carrying amount of the Company's notes due to
Axial was established by discounting the expected future cash payment
obligations using a current interest rate at which the Company could borrow for
debt of similar size and maturity. On March 1, 2002 we issued 381,098 shares of
our common stock in lieu of the first note payment due on March 1, 2002. Related
to this transaction, the Company recognized on March 1, 2002 an interest charge
of $46,800, reflecting the difference between the face amount of the note and
the fair value of the stock exchanged in settlement of the note obligation.
9
The following table presents the carrying amounts and fair values of the
Company's debt instruments at June 30, 2002 and December 31, 2001 (in
thousands):
JUNE 30, DECEMBER 31,
2002 2001
-------------- -------------
Borrowings under revolving credit facility $ 500 $ --
Notes payable due Axial (less unamortized discount of
$127 and $180, respectively - effective rate of 9.5%)
1,073 1,320
-------------- -------------
1,573 1,320
Less current portion (447) (300)
-------------- -------------
Long-term debt - shareholders $ 1,126 $ 1,020
============== =============
NOTE 4. EQUITY TRANSACTIONS
Pursuant to an Asset Purchase Agreement dated February 13, 2001, we issued
3,000,000 shares of our common stock and $1.5 million in non-interest bearing
Promissory Notes ("Notes") to Axial Technology Holding AG ("Axial") for all
rights of ownership to Axial's proprietary asset management technology. The
Notes require the payment of $300,000, $500,000, and $700,000 on the first,
second, and third anniversaries, respectively, of the Asset Purchase Agreement.
As more fully described in Note 3 above, on March 1, 2002 we issued 381,098
shares of our common stock in lieu of the first note payment due on March 1,
2002.
Under the terms of the Series F Convertible Preferred Stock ("Series F
Shares"), holders of the Series F Shares are entitled to a cumulative quarterly
dividend, when and if declared by the Board, at a rate per share equal to 2% of
the issuance price per quarter. At June 30, 2002, dividends in arrears on the
Series F Shares were approximately $340,000.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This Quarterly Report on Form 10-Q contains "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934, including, among others, statements
containing the words "believes," "anticipates," "estimates," "expects," and
words of similar import. Such statements are subject to certain risks and
uncertainties, which include but are not limited to those important factors
discussed in cautionary statements throughout the section below and those set
forth in the Company's Annual Report on Form 10-K filed with the Securities and
Exchange Commission on April 1, 2002, as amended, and are qualified in their
entirety by those cautionary statements.
OVERVIEW
Tangram develops and markets lifecycle asset management software for large
and midsize organizations across all industries, in both domestic and
international markets. Our core business strategy and operating philosophy focus
on delivering world-class customer care, providing phased asset management
solutions that are tailored to our customers' evolving business needs, and
maintaining a leading-edge technical position that results in long-term customer
loyalty and sustained shareholder value. We are a partner company of Safeguard
Scientifics, Inc. (NYSE:SFE) ("Safeguard"). Safeguard is an operating company
that creates long-term value by focusing on technology related companies that
are developed through superior operations and management support. Safeguard
acquires and operates companies in three principal areas: business and IT
services, software, and emerging technology companies. Safeguard is the majority
shareholder of the Company, holding approximately 59% of the Company's
outstanding common shares (assuming the conversion of the Series F Convertible
Preferred Stock).
In 1996, we began focusing our business on the asset tracking market and
the introduction and sale of our Asset Insight product. Asset Insight, an
information technology asset tracking product, allows businesses to track
changes in their information technology asset base (including hardware and
software), forward plan technology requirements, optimize end-user productivity,
and calculate the cost of software and hardware upgrades. In October 2000, we
announced a strategic move to become a leader in the asset management market.
This strategy allows us to build upon our core Asset Insight tracking technology
and expertise and expand into a steadily growing, multi-billion dollar market.
In support of this business strategy, we purchased the technology of Wyzdom
Solutions, Inc. from Axial Technology Holding AG in March 2001, providing the
technological foundation for Tangram's asset management offering, Enterprise
Insight. This lifecycle offering, which has been rebranded as a member of the
Tangram family of solutions, allows business leaders to manage their information
technology assets from initial planning and procurement through final
disposal--ensuring information technology assets are maximized to
cost-effectively support corporate objectives. We continue to enhance our
industry-leading asset tracking technology to ensure our customers can
effectively manage new and emerging technologies, such as wireless and handheld
personal digital assistant (PDA) devices. These asset tracking features remain
the foundation of every asset management initiative. Additionally, in support of
the commitment to make Asset Insight a fully web-enabled solution, all new
features will be web-based, allowing our customers to access and analyze their
diverse asset information directly from their web browsers. As part of our new
lifecycle asset management offering, we are expanding our services offerings
whereby we will work closely with our customers to prioritize their asset
management requirements, pinpointing the necessary process and technology
changes and executing a phased asset management implementation plan that
delivers significant value during each step of the deployment. This tailored
service will cover specific disciplines, such as (i) software license
management; (ii) enterprise moves, adds and changes; (iii) lease management, and
(iv) procurement.
Our financial results reflect our growing dependence on revenue generated
by sales of Asset Insight and our move into the asset management market with the
introduction of Enterprise Insight in July 2001. Our ability to achieve our
planned business objectives involves many risks and uncertainties. Actual
results may differ materially from those stated in any forward-looking
statements based on a number of factors, including our ability to integrate our
existing business and the Wyzdom assets as well as encountering any
unanticipated software errors or other technical problems that may arise in the
future that could impact market acceptance of Enterprise Insight. In addition,
there can be no assurance that the anticipated benefits relating to our purchase
of the Wyzdom lifecycle asset management technology will be realized and there
can be no assurance that we will be able to succeed or capitalize upon the
opportunities in the asset management market. Therefore, there can be no
assurance that these efforts will be successful or delivered to the market on a
timely basis.
As a result, various risks and uncertainties relating to the development of
the asset management business may cause our actual results to differ materially
from the results contemplated. Such uncertainties include (i) our ability to
sell Asset Insight and Enterprise Insight products to major accounts with full
enterprise-wide deployment; (ii) the possibility of the introduction of superior
competitive products; (iii) our ability to develop a sustainable stream of
revenue from the sale of the Asset Insight and
11
Enterprise Insight products; (iv) our ability to recruit and retain key
technical, sales, and marketing personnel; and (v) our ability to secure
adequate financing on reasonable terms or at all.
We have been and will continue to be dependent on closing large Asset
Insight product sales in a given quarter. Our revenues in a given quarter could
be adversely affected if we are unable to complete one or more large license
agreements, if the completion of a large license agreement is delayed, or if the
contract terms were to prevent us from recognizing revenue during that quarter.
In addition, when negotiating large software licenses, many customers time their
negotiations at our quarter-end in an effort to improve their ability to
negotiate more favorable pricing terms. As a result, we recognize a substantial
portion of our revenues in the last month or weeks of a quarter, and license
revenues in a given quarter depend substantially on orders booked during the
last month or weeks of a quarter. We expect our reliance on these large
transactions to continue for the foreseeable future.
The license of our software generally requires us to engage in a sales
cycle that typically takes approximately three to nine months to complete.
During the second quarter of 2002, we have begun to experience extension of the
normal sales cycles resulting from increased vendor disarray and confusion in
the IT asset management market as some of the major players in this space were
distracted by consolidations and financial and regulatory issues. As a result of
this vendor upheaval, industry analysts stalled the market by openly advising
organizations to temporarily postpone their decisions on IT asset repository
solutions. In turn, we believe many organizations have adopted a "wait and see"
mentality--deferring their asset management purchasing decisions until there is
more market stability and the final market impact can be determined. In
addition, the length of the sales cycle has varied depending on factors over
which we have little or no control, such as the size of the transaction, the
internal activities of potential customers, and the level of competition that we
encounter in selling the products. As such, we have historically experienced a
certain degree of variability in our quarterly revenue and earnings patterns.
This variability, in addition to the foregoing reason, is typically driven by
significant events that impact the recognition of licenses, product, and
consulting services revenue. Examples of such events include: (i) the timing of
major enterprise-wide sales of the Asset Insight and Enterprise Insight product;
(ii) "one-time" payments from existing customers for license expansion rights
(required to install on a larger or an additional computer base); (iii)
completion and customer acceptance of significant implementation rollouts and
the related revenue recognition; (iv) budgeting cycles of our potential
customers; (v) changes in the mix of software products and services sold; and
(vi) software defects and other product quality problems. Additionally,
maintenance renewals have accounted for a significant portion of our revenue;
however, there can be no assurance that we will be able to sustain current
renewal rates in the future. Cancellations of licenses, subscriptions, or
maintenance contracts could reduce our revenues and harm our operating results.
In particular, our maintenance contracts with customers terminate on an annual
basis. Substantial cancellations of maintenance agreements, or a substantial
failure to renew these contracts, would reduce our revenues and harm our
operating results.
CRITICAL ACCOUNTING POLICIES
The Securities and Exchange Commission (SEC) recently released Financial
Reporting Release No. 60, which requires all companies to include a discussion
of critical accounting policies or methods used in the preparation of financial
statements. In addition, Financial Reporting Release No. 61 was recently
released by the SEC to require all companies to include a discussion to address,
among other matters, liquidity, off-balance sheet arrangements and contractual
obligations and commercial commitments. The following is a listing of our
critical accounting policies and a brief discussion of each:
. Allowance for doubtful accounts
. Deferred software costs
. Recoverability of goodwill and other intangible assets
. Income taxes
. Revenue recognition
ALLOWANCE FOR DOUBTFUL ACCOUNTS
Our allowance for doubtful accounts relate to customer accounts receivable.
The allowance for doubtful accounts is an estimate prepared by management based
on identification of the collectibility of specific accounts and the overall
condition of the receivable portfolios. We specifically analyze customer
receivables, as well as analyze historical bad debts, customer credits, customer
concentrations, customer credit-worthiness, current economic trends, and changes
in customer payment terms, when evaluating the adequacy of the allowance for
doubtful accounts. If the financial condition of our customers were to
deteriorate, resulting in an impairment of their ability to make payments,
additional allowances may be required. Likewise, should we determine that we
would be able to realize more of our receivables in the future than previously
estimated, an adjustment to the
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allowance would increase income in the period such determination was made. The
allowance for doubtful accounts is reviewed on a quarterly basis and adjustments
are recorded as deemed necessary. As a result of our analysis in the second
quarter of 2002, we reduced our reserve by approximately $100,000.
DEFERRED SOFTWARE COSTS
We account for software development costs in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 86, "Accounting for the Costs of
Computer Software to be Sold, Leased, or Otherwise Marketed." Costs associated
with the planning and designing phase of software development, including coding
and testing activities necessary to establish technological feasibility, are
classified as product development and expensed as incurred. Once technological
feasibility has been determined, additional costs incurred in development,
including coding, testing, and product quality assurance, are capitalized. Such
capitalized costs are amortized on a product-by-product basis over the estimated
economic life of the software, not to exceed three years, using the
straight-line method. Amortization commences when a product is available for
general release to customers. The market for our products is intensely
competitive and diverse, and the technologies for our products can change
rapidly. New products are introduced frequently and existing products are
continually enhanced. As a result, the life cycles of our products are difficult
to estimate. We periodically assess the remaining economic life of the software
whenever events or changes in circumstances indicate that the product life has
been shortened. If we determine the remaining economic life of the software is
too long, we will adjust the amortization prospectively to reflect the reduction
in the remaining economic life of the software.
RECOVERABILITY OF GOODWILL AND OTHER INTANGIBLE ASSETS
We periodically assess the impairment of goodwill and other intangible
assets whenever events or changes in circumstances indicate that the carrying
value may not be recoverable. Factors that we consider important which could
trigger an impairment review include significant underperformance relative to
historical or expected future operating results, significant changes in the
manner or use of the acquired assets or the strategy for our overall business,
significant negative industry or economic trends or a decline in our stock price
for a sustained period.
If we determine that the carrying value of other intangible assets,
exclusive of identifiable goodwill, may not be recoverable based upon the
existence of one or more of the above indicators of impairment, we assess the
recoverability of the intangibles by determining whether the carrying value of
the other intangible assets can be recovered through undiscounted future
operating cash flows. The amount of other intangible assets impairment, if any,
is measured based on projected discounted future operating cash flows using a
discount rate commensurate with the risk inherent in our current business model.
In 2002, SFAS No. 142, "Goodwill and Other Intangible Assets" became
effective, and as a result, we ceased amortization of goodwill on January 1,
2002. In lieu of amortization, we were required to perform an initial impairment
review of goodwill in 2002 and an annual impairment review thereafter. SFAS No.
142 requires us to test goodwill for impairment at a level referred to as a
reporting unit. We operate in a single industry and are engaged in the design
and sale of a limited number of software products, as such, we believe we meet
the definition of a single reporting unit. SFAS No. 142 requires that if the
fair value of the reporting unit is less than its carrying amount, the goodwill
is considered potentially impaired and a loss is recognized if its carrying
value exceeds its implied fair value. To determine fair value, we used the
quoted market price of our stock. The required initial benchmark evaluation was
performed as of January 1, 2002 resulting in no impairment in the value of the
Company's goodwill and any related intangibles. Net goodwill and other
intangible assets amounted to approximately $1.5 million as of June 30, 2002.
INCOME TAXES
We are required to estimate income taxes in each of the jurisdictions in
which we operate. This process involves estimating our actual current tax
exposure together with assessing temporary differences resulting from differing
treatment of items for tax and accounting purposes. These differences result in
deferred tax assets and liabilities. We must assess the likelihood that the
deferred tax assets will be recovered from future taxable income and to the
extent that we believe recovery is not likely, we must establish a valuation
allowance. To the extent we establish a valuation allowance in a period, we must
include an expense within the tax provision in the Statements of Operations. We
have recorded a valuation allowance against our entire net deferred tax assets
given the losses we have incurred and the uncertainties regarding our future
operating profitability and taxable income.
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REVENUE RECOGNITION
Our revenues are derived from product licensing and services. Services are
comprised of maintenance, professional services, and training. License fees are
generally due upon the granting of the license. We also provide ongoing
maintenance services (postcontract customer support), which include technical
support and product enhancements, for an annual fee based upon the current price
of the product. As described below, significant management judgments and
estimates must be made and used in connection with the revenue recognized in any
accounting period. Material differences may result in the amount and timing of
our revenue for any period if management made different judgments or utilized
different estimates.
Revenues from license agreements are recognized currently, provided that all of
the following conditions are met: (i) a non cancelable license agreement has
been signed; (ii) the product has been delivered; (iii) the fee is fixed or
determinable; (iv) there are no material uncertainties regarding customer
acceptance; (v) collection of the resulting receivable is deemed probable and
the risk of concession is deemed remote; and (vi) no other significant vendor
obligations related to the software exist. Generally, these criteria are met at
the time of delivery. Provision is made at the time the related revenue is
recognized for estimated product returns, which historically have been
immaterial. We analyze historical returns, current economic trends, and changes
in reseller and customer demands when evaluating the adequacy of provisions for
sales returns. At the time of the transaction, we determine whether the fee is
fixed and determinable based on the terms of the agreement associated with the
transaction. If a significant portion of a fee is contingent on future events,
we will recognize revenue as the future events occur. We consider all
arrangements with payment terms longer than our normal business practice, which
do not extend beyond 12 months, not to be fixed or determinable and revenue is
recognized when the fee becomes due. We assess collectibility based on a number
of factors, including past transaction history with the customer and the
credit-worthiness of the customer. If we determine that collection of the fee is
not reasonably assured, we will defer the revenue and recognize revenue at the
time collection becomes reasonably assured, which is generally upon receipt of
cash. For all sales, we generally use a binding purchase order or signed license
agreement as evidence of an arrangement.
Revenues from postcontract support services are recognized ratably over the
term of the support period, generally one year. Maintenance revenues, when and
if bundled, with license agreements are unbundled using vendor-specific
objective evidence. Consulting revenues are primarily related to implementation
services performed on a time and material basis under separate service
agreements for the installation of our products. Revenues from consulting and
training services are recognized as the respective services are performed.
RESULTS OF OPERATIONS
REVENUE
Licenses and products revenue for the three-month period ended June 30, 2002
decreased 37% to $827,000 from $1.3 million in the comparable period in 2001.
For the six-month period ended June 30, 2002, licenses and products revenue
decreased 27% to $2.1 million from $2.9 million in the comparable period in
2001. Licenses and products revenue include the sales of our asset management
product line, which consist of Asset Insight and Enterprise Insight, and product
upgrades and add-ons of AM:PM and our traditional mainframe product, Arbiter.
Asset Insight licenses and products revenue contributed $672,000, or 81% of
total licenses and products revenue, in the second quarter of 2002 compared to
$1.1 million, or 87% of total licenses and products revenue, in the comparable
period in 2001. The 40% reduction in Asset Insight license revenue was directly
impacted by two primary factors: 1) extended sales cycles resulting from
increased vendor disarray and confusion in the IT asset management market
(mentioned above), and 2) the continued sluggish economy, coupled with shrinking
IT budgets. For the six-month period ended June 30, 2002 Asset Insight licenses
and products revenue decreased 30% to $1.8 million from $2.5 million in 2001.
Our business and operating results are subject to the effects of changes in
general economic conditions. There has been a rapid and severe downturn in the
worldwide economy during the past 18 months. We expect this downturn to
continue, and are uncertain as to its future severity and duration. We believe
that these conditions, as well as the decline in worldwide economic conditions,
have led our current and potential customers to reduce their IT spending. If
these conditions worsen, demand for our products and services may be reduced as
a result of even further reduced spending on IT products such as ours. Revenue
from upgrades of AM:PM and our traditional mainframe products decreased to
$100,000 in the second quarter of 2002 compared to $154,000 in the second
quarter in 2001 and was $312,000 for the six months ended June 30, 2002 compared
to $396,000 for the same period in 2001. As we have focused our efforts on our
core asset management offerings and away from automated software distribution
and the traditional mainframe product lines, we believe that this trend of
declining AM:PM and Arbiter license revenue will continue and any future revenue
to be unpredictable.
Services revenue for the three-month period ended June 30, 2002 decreased
to $1.7 million, or 17%, from $2.1 million for the second quarter of 2001.
Services revenue includes postcontract customer support (PCS) agreements, expert
asset management consulting services, and training and support services not
otherwise covered under maintenance agreements.
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Postcontract customer support includes telephone support, bug fixes, and rights
to upgrades on a when-and-if available basis. Consulting services consist
primarily of implementation services performed on a time and material basis for
the installation of the our software products, database trigger services which
create a mechanism for importing data from a third party system and on-site
training services. PCS revenue from the sale of the asset management product
line remained relatively level in the second quarter of 2002 when compared to
2001 at $1.2 million and up slightly to $2.5 million, or 10%, for the six-month
period ended June 30, 2002 from $2.2 million for the same period in 2001. AM:PM
and Arbiter PCS revenue and maintenance decreased 32% to $322,000 in the second
quarter of 2002 from $471,000 in the comparable period of 2001. For the six
months ended June 30, 2002, AM:PM and Arbiter PCS revenue and maintenance
decreased 22% to $697,000 from $892,000 in the comparable period in 2001. As
noted above, we expect the trend of declining AM:PM and Arbiter PCS revenue and
maintenance renewals to continue. Our consulting services revenue decreased from
$312,000 during the three-month period ended June 30, 2001 to $169,000 in the
second quarter of 2002. Consulting services revenue for the six-month period
ended June 30, 2002 decreased from $828,000 in 2001 to $375,000 during the same
period in 2002. The decline in 2002 in consulting services revenue reflects the
tight spending environment that exist for IT products and services as well as
the impact of a single Asset Insight deployment engagement of approximately
$373,000 that was awarded in late 2000 and delivered in the first quarter of
2001. The 2002 period did not have a similar engagement of that size. A key part
of our strategy is to expand our delivery of expert asset management services.
If we are unable to meet customers' service requests with internal resources
(due to limited capacity or business expertise), we will endeavor to partner
with our partners and other third-party service providers for additional
support. There can be no assurance that we will be able to grow our service
business. Our failure to implement solutions that address customers'
requirements and provide timely and cost-effective customer support and service
could have a material adverse effect on our future business, operating results,
and financial condition.
In order to grow our business, increase our revenues, and improve our
operating results, we believe we must continue to expand internationally.
International revenue (including PCS contracts) for the three-month period ended
June 30, 2002 was $337,000 compared to $186,000 during the same period in 2001,
and represented approximately 13% and 5% of our total revenue in the second
quarter of 2002 and 2001, respectively. During the six-month period ended June
30, 2002, international revenue (including PCS contracts) was $572,000 compared
to $728,000 during the same period in 2001, and represented approximately 10% of
our total revenue in each period of 2002 and 2001. We have expanded our European
sales initiatives by establishing agreements with five distributors that are
marketing our Asset Insight and Enterprise Insight solutions in the United
Kingdom, Germany, Ireland, Scandinavia, Switzerland, Italy, Portugal, and Spain.
We carefully select distributors that share our customer-centric philosophy and
are committed to selling Tangram's solutions as their exclusive asset tracking
and asset management offerings. We are currently evaluating expanding our
distributor network to the English-speaking regions of the Pacific Rim,
including Hong Kong, Singapore, and Australia. International expansion will
require significant management attention and financial resources, and we may not
be successful in expanding our international operations. We have limited
experience in developing local language versions of our products or in marketing
our products to international customers. To date, the majority of our
international revenue has been denominated in United States currency. If future
international sales are denominated in local currency, there is an additional
risk associated with fluctuating exchange rates.
COST OF REVENUE
Cost of licenses and products includes costs related to the distribution of
licensed software products and the amortization of acquired software technology
and capitalized software development costs. A significant component of cost of
licenses and products is attributable to the amortization of acquired software
technology and deferred development costs. Cost of licenses and products
increased 13% in the second quarter of 2002 to $532,000 from $473,000 in the
comparable period in 2001. For the six-month period ended June 30, 2002, cost of
licenses and products increased 18% to $1.1 million from $959,000 in the
comparable period in 2001. This increase reflects the amortization of
acquisition and related development costs associated with the purchase of the
Wyzdom Solutions technology, which we commenced amortizing in July 2001. Cost of
licenses and products as a percentage of licenses and products revenue increased
to 64% for the three-month period ending June 30, 2002, compared to 36% in the
comparable period in 2001, and increased to 53% for the six months ended June
30, 2002 from 33% in the same period of 2001.
Cost of services reflects the cost of the direct labor force, including the
associated personnel, travel, and subsistence, and occupancy costs incurred in
connection with providing consulting and maintenance services. Cost of services
in the three-month period ended June 30, 2002 decreased 26% to $392,000 from
$532,000 in the comparable period in 2001. The reduction in cost is primarily
the result of lower personnel related cost. Cost of services for the six months
ended June 30, 2002 decreased to $842,000 from $961,000 during the same period
in 2001. Cost of services as a percentage of services revenue in the second
quarter of 2002 and 2001 was at 22% and 25%, respectively, and remained
relatively constant at 23% for the six-month period ended June 30, 2002.
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SALES AND MARKETING
Sales and marketing expenses consist principally of salaries, commissions,
and benefits for sales, marketing, and channel support personnel, and the costs
associated with product promotions and related travel. Sales and marketing
expenses decreased to $1.5 million, or 6%, in the three-month period ended June
30, 2002 from $1.6 million in the comparable period in 2001. For the six months
ended June 30, 2002, sales and marketing expenses decreased 12% to $2.9 million
from $3.3 million during the same period in 2001. The reduction in costs for
both the three and six month periods is primarily the result of lower spending
associated with personnel cost, marketing and travel related cost. Sales and
marketing expenses increased as a percentage of revenue in the second quarter of
2002 to 60% from 48% in the same period in 2001. As a percentage of revenue,
sales and marketing expenses for the six-month period ended June 30, 2002,
increased to 50% from 46% in 2001. The increase in sales and marketing expenses
as a percentage of revenue in 2002 is directly attributable to lower sales
revenue during the three and six-month periods ending June 30, 2002 when
compared to the same period in the previous year. We are currently investing and
intend to continue to invest significant resources in developing the direct
sales organization in North America and our distributor channel in Europe. The
sales organization continues to follow a sales process that shifts from a point
solution to a business solution sale. This process requires the efforts of
experienced sales personnel, as well as specialized consulting professionals. In
addition, the complexity of our products, and issues associated with installing
and maintaining them, require highly trained customer service and support
personnel. Our direct sales force has limited experience selling and delivering
our phased asset management solutions. We have started a process to evaluate
every member of our direct sales force to determine whether they have the
necessary skills. We have and may be required to take further action where
necessary to upgrade or replace skill sets as well as invest in a large sales
force in order to drive higher levels of sales activity. If we are unable to
successfully direct our sales force or hire these personnel in the future and
train them in the use of our products, our business, operating results, and
financial conditions could be harmed.
GENERAL AND ADMINISTRATIVE
General and administrative expenses consist principally of salaries and
benefit costs for administrative personnel, general operating costs, legal,
accounting and other professional services. General and administrative expenses
decreased 37% for the second quarter of 2002 to $490,000 from $772,000 in the
comparable quarter of 2001. For the six months ended June 30, 2002, general and
administrative expenses decreased to $1.1 million, or 23%, from $1.5 million
during the same period in 2001. As a percentage of total revenue, general and
administrative expenses were 19% for the second quarter of 2002 compared to 23%
in the second quarter of 2001. For the six months ended June 30, 2002 and 2001,
general and administrative expenses as percentage of total revenue were
approximately 20%. The reduction in costs in 2002 for both the three and six
month periods is primarily the result of reducing the reserve for bad debts by
$100,000 and the elimination goodwill amortization in accordance with the
guidance of SFAS No. 142, "Goodwill and Other Intangible Assets." If we were to
adjust the 2001 comparative amounts to exclude this amortization expense and
conform to the 2002 presentation, general and administration expense of the
three and six month periods ending June 30, 2001, as presented, would be reduced
by approximately $187,000 and $374,000, respectively.
RESEARCH AND DEVELOPMENT
Research and development expenses consist primarily of salaries and
benefits for the software development and technical support staff and, to a
lesser extent, costs associated with independent contractors. We capitalize
certain software development costs incurred to develop new software or to
enhance our existing software. Such capitalized costs are amortized on an
individual product basis commencing when a product is generally available for
release. Costs incurred prior to the establishment of technological feasibility
are charged to research and development expense. Gross expenditures for research
and development decreased 19% in the second quarter of 2002 to $1.1 million from
$1.3 million in the comparable period in 2001. Comparing the six months ended
June 30, 2002 and 2001, gross research and development decreased 25% to $2.0
million from $2.7 million, respectively. As a percentage of revenue, gross
research and development costs increased to 42% in the second quarter of 2002
from 39% in the same period in 2001 and decreased to 36% for the six months
ended June 30, 2002 from 39% during the same period in 2001. The decrease in
cost in 2002 can be attributable to lower staffing levels and personnel related
costs when compared to the respective period in the previous year. This decrease
in cost was offset in part by a $160,000 charge in the second quarter of 2002
associated with our obligation under a severance and non-compete agreement with
the former senior vice president and chief technology officer who resigned on
May 28, 2002. We capitalized and deferred development costs of $378,000, or 35%
of gross research and development costs, in the second quarter of 2002, a
decrease from $586,000, or 44% of gross research and development costs, during
the same period in 2001. Deferred development costs for the six months ended
June 30, 2002 were $838,000 compared to $1.1 million for the six months ended
June 30, 2001. Net research and development costs for the three months ended
June 30, 2002 decreased to $701,000 from $747,000 in the comparable period of
2001. For the six months ended June 30, 2002 net research and development
expenses decreased to $1.2 million from $1.6 million during the
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same period in 2001 for the reasons noted above. As a result of rapid
technological change in the industry, our position in existing markets can be
eroded rapidly by product advances. The life cycles of our products are
difficult to estimate. Our growth and future financial performance depend in
part upon our ability to improve existing products and develop and introduce new
products that keep pace with technological advances, meet changing customer
needs, and respond to competitive products. If we cannot compete effectively in
our markets by offering products that are comparable in functionality, ease of
use, and price to those of our competitors, our revenues will decrease, and our
operating results will be adversely affected. Many of our current and potential
competitors have substantially greater financial, technical, marketing, and
other resources than we have. As a result, they may be able to devote greater
resources than we can to the development, promotion, and sale of their products
and may be able to respond more quickly to new or emerging technologies and
changes in customer needs. As such, we will continue to commit substantial
resources to research and development efforts in the future.
OTHER EXPENSE, NET
Other expense, net consists primarily of interest expense. Interest expense
during the second quarter of 2002 increased to $30,000 compared to $12,000 for
the same period in 2001 due principally to our higher borrowing level in 2002.
For the six months ended June 30, 2002 interest expense was $110,000 compared to
$105,000 during the six months ended June 30, 2001.
PROVISION FOR INCOME TAXES
There was no provision for income taxes for the three and six month periods
ending June 30, 2002 and 2001, respectively, due to the net losses incurred
during these periods. At December 31, 2001, the Company has net operating loss
carryforwards of approximately $32.6 million, which are available to offset
future federal taxable income and expire in various amounts from 2002 through
2020. The Internal Revenue Code of 1986, as amended (the "Code"), contains
provisions that limit the ability to utilize net operating loss carryforwards in
the case of certain events, including significant changes in ownership interests
(as defined in the Code) on June 29, 1989, the Company is limited in its ability
to utilize approximately $18.0 million of its net operating loss carryforwards.
The annual limitation for the utilization of these carryforwards is
approximately $1.3 million, and any unused amount can be utilized in subsequent
years within the carryforward period.
At December 31, 2001, the Company had available approximately $16,000 of
investment credit carryforwards, which expire in 2002.
NET LOSS
We have incurred substantial losses in recent years, and predicting our
future operating results is difficult. If we continue to incur losses, if our
revenues decline, or if our expenses increase without commensurate increases in
revenues, our operating results will suffer and the price of our common stock
may fall. The Company recorded a net loss of $1.1 million, or ($0.06) per share,
in the three-month period ended June 30, 2002 compared to a net loss of
$771,000, or ($0.04) per share, in the comparable period in 2001. For the six
month period ended June 30, 2002, we recorded a net loss of $1.5 million, or
($0.09) per share, compared to a net loss of $1.3 million, or ($0.08) per share
during the same period in 2001.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In October 1997, the Accounting Standards Executive Committee (AcSEC)
issued Statement of Position (SOP) 97-2 Software Revenue Recognition, as amended
in March 1998 by SOP 98-4 and October 1998 by SOP 98-9. These SOPs provide
guidance on applying generally accepted accounting principles in recognizing
revenue on software transactions. The Company adopted SOP 97-2 for software
transactions entered into beginning January 1, 1998. Based on the current
requirements of the SOPs, application of these statements did not have a
material impact on the Company's revenue recognition policies. However, AcSEC is
currently reviewing further modifications to the SOP with the objective of
providing more definitive, detailed implementation guidelines. This guidance
could lead to unanticipated changes in the Company's operational and revenue
recognition practices.
In July 2001, the FASB issued SFAS No. 141, "Business Combinations," and
SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 requires that
the purchase method of accounting be used for all business combinations
initiated after June 30, 2001 as well as all purchase method business
combinations completed after June 30, 2001. SFAS No. 141 also specifies criteria
that intangible assets acquired in a purchase method business combination must
meet to be recognized and reported apart from goodwill, noting that any purchase
price allocable to an assembled workforce may not be accounted for separately.
SFAS No. 142 requires that goodwill and intangible assets with indefinite useful
lives no longer be amortized, but instead tested for impairment at least
annually in accordance with the provisions of SFAS No. 142. SFAS No. 142 also
requires
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that intangible assets with definite useful lives be amortized over their
respective estimated useful lives to their estimated residual values, and
reviewed for impairment in accordance with SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of."
The Company adopted the provisions of SFAS No. 141 on July 1, 2001, except
with regard to business combinations initiated prior to July 1, 2001, and SFAS
No. 142 became effective January 1, 2002. The Company has always used the
purchase method when accounting for past business combinations and thus no
change in procedures is required going forward. Upon adoption of SFAS No. 142 an
initial testing of impairment is required. The required initial benchmark
evaluation was performed as of January 1, 2002 resulting in no impairment in the
value of the Company's goodwill. Application of the non-amortization provision
of the standard is expected to reduce operating cost in 2002 by approximately
$748,000 as compared to operating results if this standard had not been applied.
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." Under SFAS No. 143, the fair value of a liability for
an asset retirement obligation must be recognized in the period in which it is
incurred if a reasonable estimate of fair value can be made. The associated
asset retirement costs are capitalized as part of the carrying amount of the
long-lived asset. SFAS No. 143 is effective for fiscal years beginning after
June 15, 2002. The adoption of SFAS No. 143 is not expected to have a material
impact on our financial position or results of operations.
In August 2001, the FASB issued SFAS No. 144, "Accounting for Impairment or
Disposal of Long-Lived Assets." SFAS No. 144 supersedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of," and addresses financial accounting and reporting for the
impairment or disposal of long-lived assets. This statement is effective for
fiscal years beginning after December 15, 2001. We adopted SFAS No. 144 on
January 1, 2002, which did not have a material impact on our financial position
or results of operations.
In November 2001, the staff of the FASB issued an announcement, "Income
Statement Characterization of Reimbursements Received for Out of Pocket Expenses
Incurred." This announcement requires companies to characterize reimbursements
received for out of pocket expenses incurred as revenue in the income statement.
This announcement is to be applied in financial reporting periods beginning
after December 15, 2001 and comparative financial statements for prior periods
are to be reclassified to comply with the guidance in this announcement. We
adopted the policies outlined in the announcement on January 1, 2002, as such,
reimbursements for out of pocket expenses of $22,000 and $82,000 has been
recognized as revenue and cost of services for the three month period ended June
30, 2002 and 2001, respectively. For the six month periods ended June 30, 2002
and 2001, reimbursements for out of pocket expenses of $63,000 and $129,000 has
been recognized as revenue and cost of services, respectively.
We do not expect the adoption of other recently issued accounting
pronouncements to have a significant impact on our results of operations,
financial position, or cash flows.
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 2002, we have $818,000 of cash on hand, $1.5 million in
trade receivables and $2.5 million of borrowing capacity on our line of credit
with Safeguard. Terms of the line of credit require monthly interest payments at
the prime rate plus 1%. Principal is due 13 months after date of demand by
Safeguard or earlier in the case of a sale of substantially all of our assets, a
business combination, or upon the closing of a sale of a debt or equity
offering. As of August 12, 2002, there were borrowings under the line of credit
with Safeguard in the amount of $500,000. In the past we have funded our
operations through borrowings and cash generated from operations. However, the
recent trend of operating losses and inconsistent revenue trends may require us
to seek other sources of capital.
The net cash provided by operating activities for the six month period
ended June 30, 2002 was $837,000 compared to $1.6 million provided by operating
activities during the same period in 2001. The decrease in cash provided by
operating activities was principally due to the changes in accrued expenses, and
deferred revenue offset by the decrease in accounts receivable as a result of
improved collection efforts and lower sales volume in 2002.
Net cash used in investing activities for the six month periods ended June
30, 2002 and 2001 amounted to $841,000 and $1.0 million, respectively,
principally representing capitalized development costs. In accordance with SFAS
No. 86, we capitalized and deferred development costs of $838,000, or 41% of
gross research and development costs, during the six months ended June 30, 2002,
and $1.1 million, or 40% of gross research and development costs, during the six
months ended June 30, 2001. Net cash used in investing activities reflects our
continued and ongoing investment associated with our commitment to develop,
enhance, and improve our asset management line of products. Our business is not
capital asset intensive, and capital
18
expenditures in any year normally would not be significant in relation to our
overall financial position. Generally, our capital expenditures relate to
information technology hardware and software purchases. Capital expenditures
were approximately $15,000 during the six month period ended June 30, 2002 as
compared to approximately $35,000 in 2001. We currently expect our capital
expenditure requirements in 2002 to be in a range of $100,000 to $200,000.
Net cash provided by financing activities during the six months ending June
30, 2002 amounted to $500,000 compared to net cash used in financing activities
of $925,000 during the same period in 2001 reflecting our borrowings in 2002
under the Safeguard line of credit. In 2002 and 2001, due to our stock price
levels, there were no exercises of employee stock options.
CONTRACTUAL OBLIGATIONS
Our contractual obligations consist of noncancelable operating leases for
facilities and equipment, debt financing, and cumulative dividend requirements
on the Series F preferred stock. We lease our facilities, as well as sublease a
part of a facility to an outside party, and certain equipment under several
non-cancelable operating lease agreements that expire at various times through
2004. Certain of these leases contain fixed rental increases over the life of
the respective lease. Net rental expense was $513,000 and $558,000,
respectively, for the six-month periods ending June 30, 2002 and 2001.
Future minimum lease payments under non-cancelable operating leases and
subleases at December 31, 2001 are as follows (in thousands):
Commitments Sublease Rentals Net Commitments
----------- ---------------- ---------------
2002 $ 1,477 $ 289 $ 1,188
2003 1,314 298 1,016
2004 952 229 723
2005 3 -- 3
----------- ---------------- ---------------
$ 3,746 $ 816 $ 2,930
=========== ================ ===============
Pursuant to an Asset Purchase Agreement dated February 13, 2001, we issued
3,000,000 shares of our common stock and $1.5 million in non-interest bearing
Promissory Notes ("Notes") to Axial Technology Holding AG ("Axial") for all
rights of ownership to Axial's proprietary asset management technology. The
Notes require the payment of $300,000, $500,000, and $700,000 on the first,
second, and third anniversaries, respectively, of the Asset Purchase Agreement.
With respect to the first note payment, we could elect to provide, in lieu of
cash, a number of shares of common stock, equivalent in aggregate value to the
amount of such cash payment, the value of each such share to be deemed equal to
80% of the average Nasdaq closing price during the 20 trading days immediately
prior to the relevant note payment date. On March 1, 2002 we issued 381,098
shares of our common stock in lieu of the first note payment due on March 1,
2002.
We may continue to make other investments in complementary products,
technologies, or companies. We may not realize the anticipated benefits of any
other acquisition or investment. If we make an acquisition, it may be necessary
to integrate products of these companies with our technology, and it is
uncertain whether we may accomplish this easily or at all. These integration
difficulties could disrupt our ongoing business, distract management and
employees, or increase expenses. Acquisitions are inherently risky, and we may
also face unexpected costs, which may adversely affect operating results in any
quarter.
Under the terms of the Series F Convertible Preferred Stock ("Series F
Shares"), holders of the Series F Shares are entitled to a cumulative quarterly
dividend, when and if declared by the Board, at a rate per share equal to 2% of
the issuance price per quarter. At June 30, 2002, dividends in arrears on the
Series F Shares were approximately $340,000.
As stated above, Safeguard has agreed to assist in funding our projected
cash requirements by providing a $3.0 million line of credit, of which there is
$500,000 borrowed as of August 12, 2002. Although operating activities may
provide cash in certain periods, we anticipate that our operating and investing
activities may use additional cash. Consequently, operations may require us to
obtain additional equity or debt financing. However, we have no present
understanding, commitment, or agreement with respect to any such transaction.
Accordingly, there can be no assurance that we will have access to adequate debt
or equity financing or that, if available, it will be under terms and conditions
satisfactory to us or which may not be dilutive.
RECENT DEVELOPMENTS
On June 19, 2001, we announced a voluntary stock option exchange program
for our eligible employees (excluding executive officers and members of our
Board of Directors). Under the exchange program, our employees were given the
19
opportunity, subject to certain conditions, to elect to cancel certain
outstanding stock options with an exercise price higher than $2.00 per share
held by them under our 1988 Stock Option Plan and our 1997 Equity Compensation
Plan, in exchange for an equal number of replacement options to be granted at a
future date under our 1997 Equity Compensation Plan, at least six months and a
day from the cancellation date (we refer to this date as the replacement option
grant date). The elections by eligible employees to cancel options were
effective as of July 30, 2001. The exchange program resulted in the voluntary
cancellation of 217,657 stock options with varying exercise prices in exchange
for the same number of replacement options granted on February 4, 2002. The
exercise price of each new option was equal the last reported sale price of our
common stock on the replacement option grant date. Twenty-five percent of the
new options vest immediately and 25% will vest on each of the first, second, and
third anniversaries of the replacement option grant date. The exchange program
is not expected to result in any additional compensation charges or variable
plan accounting. Members of the Company's Board of Directors and its officers
and senior executives were not eligible to participate in this exchange program.
RISK FACTORS
In addition to other information in this Quarterly Report on Form 10-Q, the
following risk factors should be carefully considered in evaluating Tangram and
our business because such factors currently may have a significant impact on
Tangram's business, operating results and financial condition. As a result of
the risk factors set forth below and elsewhere in this Form 10-Q, and the risks
discussed in Tangram's other Securities and Exchange Commission filings
including our Annual Report on Form 10-K for our fiscal year ended December 31,
2001, actual results could differ materially from those projected in any
forward-looking statements. Moreover, the risks and uncertainties described
below are not the only ones facing us. Additional risks and uncertainties not
presently known to us or that we currently deem immaterial also may impair our
business operations. If any of the following risks actually occur, our business
could be materially harmed. In that event, the trading price of our common stock
could decline.
We have a history of losses and negative cash flow from operations and
cannot assure that we will be profitable in the future on an operating basis or
otherwise.
We have incurred substantial losses in recent years, and predicting our
future operating results is difficult. If we continue to incur losses and
consume cash, if our revenues decline, or if our expenses increase without
commensurate increases in revenues, our operating results will suffer and the
price of our common stock may fall. Although operating activities may provide
cash in certain periods, we anticipate that our operating and investing
activities may use additional cash. Consequently, operations may require us to
obtain additional equity or debt financing. However, we have no present
understanding, commitment, or agreement with respect to any such transaction.
Accordingly, there can be no assurance that we will have access to adequate debt
or equity financing or that, if available, it will be under terms and conditions
satisfactory to us or which may not be dilutive.
Our future operating expenses and capital expenditures will increase, which
may harm our operating results.
We will continue to incur significant operating expenses and capital
expenditures as we seek to:
. expand our worldwide sales and marketing operations;
. develop our software to address the e-infrastructure needs of new
markets such as the Internet business market; and
. pursue strategic opportunities, including acquisitions, alliances,
and relationships with other companies.
If these expenditures do not lead to improved results, we may not earn
profits.
Our revenues vary significantly from quarter to quarter for numerous
reasons beyond our control. Quarter-to-quarter variations could result in a
substantial decrease in our stock price if our revenues or operating results are
less than the expectations of our investors.
Our revenues or operating results in a given quarter could be substantially
less than anticipated by our investors, which could result in a substantial
decline in our stock price. In addition, quarter to quarter variations could
create uncertainty about the direction or progress of our business, which could
also result in a decline in the price of our common stock. Our revenues and
operating results will vary from quarter-to-quarter for many reasons, many of
which are beyond our control, including:
. changes in demand for our products;
. the size, timing and contractual terms of orders for our products;
. any downturn in our customers and potential customers' businesses,
the domestic economy or international economies where our customers
and potential customers do business;
. the timing of product releases or upgrades by us or by our
competitors; and
20
. changes in the mix of revenue attributable to higher-margin
software products as opposed to substantially lower-margin
services.
As a result, our quarterly revenues and operating results are not
predictable with any significant degree of accuracy.
If the market for IT asset management software does not continue to develop
as we anticipate, the demand for our products might be adversely affected.
As their needs have become more complex, many companies have been
addressing their IT asset management needs for systems and applications
internally and only recently have become aware of the benefits of third-party
software products such as ours. Our future financial performance will depend in
large part on the continued growth in the number of businesses adopting
third-party IT asset management software products and their deployment of these
products on an enterprise-wide basis.
Our quarterly revenue and revenue growth are increasingly dependent on a
small number of large license transactions.
Our revenues in a given quarter could be adversely affected if we are
unable to complete one or more large license agreements, if the completion of a
large license agreement is delayed, or if the contract terms were to prevent us
from recognizing revenue during that quarter.
Historically, we have been dependent on closing large Asset Insight product
sales in a given quarter. We expect our reliance on these large transactions to
continue for the foreseeable future. If we are unable to complete a large
license transaction by the end of a particular quarter, our revenues and
operating results could be materially below the expectations of our investors,
and our stock price could fall. In particular, our dependence on a few
relatively large license transactions could have a material adverse effect on
our quarterly revenues or revenue growth rates as prospects may reduce their
capital investments in technology in response to slowing economic growth, budget
constraints, or other factors.
In addition, when negotiating large software licenses, many customers
postpone their negotiations until quarter-end in an effort to improve their
ability to obtain more favorable pricing terms. As a result, we recognize a
substantial portion of our revenues in the last month or weeks of a quarter, and
license revenues in a given quarter depend substantially on orders booked during
the last month or weeks of a quarter.
Maintenance renewals have accounted for a significant portion of our
revenue; however, there can be no assurance that we will be able to sustain
current renewal rates in the future.
Cancellations of licenses, subscriptions, or maintenance contracts could
reduce our revenues and harm our operating results. In particular, our
maintenance contracts with customers terminate on an annual basis. Substantial
cancellations of maintenance agreements, or a failure of a substantial number of
customers to renew these contracts, would reduce our revenues and harm our
operating results.
Our revenue growth may be affected if our partners are unsuccessful in
selling our products or if we are unsuccessful in adding new partners.
Many of our transactions are sourced, developed, and closed through our
strategic and distribution partners, including resellers and system integrators.
If the number or size of these partner-influenced transactions were to decrease
for any reason, our revenue growth and operating results could be materially and
adversely affected. If our sales through these indirect channels, or to new
distributors, resellers, or strategic partners, were to decrease in a given
quarter, our total revenues and operating results could be harmed. Historically,
sales through indirect channels, including distributors, third-party resellers,
and system integrators represent a significant percentage of our total sales. If
sales through these channels were to decrease, we could experience a shortfall
in our revenues. We have less ability to manage sales through indirect channels,
relative to direct sales, and less visibility into our channel partners' success
in selling our products. As a result, we could experience unforeseen variability
in our revenues and operating results for a number of reasons, including the
following:
. the inability of our partners to sell our products;
. a decision by our partners to favor competing products; or
. the inability of our partners to manage the timing of their
purchases from us against their sales to end-users, resulting in
inventories of unsold licenses held by channel partners.
21
Many of our channel partners experienced internal management and financial
performance problems that impacted their ability to resell our product. In
response, we have shifted from an exclusively indirect sales channel to a
predominantly direct sales organization.
Our ability to sell our products into new markets and to increase our
penetration into existing markets will be impaired if we fail to expand our
distribution channels and sales force. Our products and services require a
sophisticated selling effort targeted at several key people within a prospective
customer's organization. This process requires the efforts of experienced sales
personnel, as well as specialized consulting professionals. In addition, the
complexity of our products, and issues associated with installing and
maintaining them, require highly-trained customer service and support personnel.
We are in the process of transitioning and expanding our direct sales force to
complement our marketing arrangements with our channel partners and
distributors. As we have only recently begun this process, our direct sales
force has limited experience selling and delivering our phased asset management
solutions. If we are unable to successfully train our direct sales force or hire
these personnel in the future and train them in the use of our products, our
business, operating results, and financial conditions could be harmed.
A key part of our solution will be the delivery of expert asset management
services. If we are unable to meet customers' service requests with internal
resources (due to limited capacity or business expertise), we will partner with
our resellers and other third-party service providers for additional support.
There can be no assurance that we will be able to effectively implement this new
sales process. Our failure to implement solutions that address customers'
requirements and provide timely and cost-effective customer support and service
could have a material adverse effect on our business, operating results, and
financial condition.
We may be unable to expand our business and increase our revenues if we are
unable to expand our distribution channels.
If we are unable to expand our distribution channels effectively, our
business, revenues, and operating results could be harmed. In particular, we
will need to expand our direct sales force and establish relationships with
additional system integrators, resellers and other third-party channel partners
who market and sell our products. If we cannot establish these relationships, or
if our channel partners are unable to market our products effectively or provide
cost-effective customer support and service, our business, revenues, and
operating results will be harmed. Even where we are successful in establishing a
new third-party relationship, our agreement with the third-party may not be
exclusive. As a result, our partners may carry competing product lines.
Recent unfavorable economic conditions and reductions in IT spending could
limit our ability to grow our business. Our business and operating results are
subject to the effects of changes in general economic conditions.
There has been a rapid and severe downturn in the worldwide economy during
the past 18 months. We expect this downturn to continue, but are uncertain as to
its future severity and duration. This uncertainty has increased because of the
potential long-term impact of terrorist attacks, such as the attacks on the
United States on September 11, 2001, and the resulting military actions against
terrorism. In the future, fears of global recession, war and additional acts of
terrorism in the aftermath of the September 11, 2001 attack may continue to
impact global economies negatively. We believe that these conditions, as well as
the decline in worldwide economic conditions, have led our current and potential
customers to reduce their IT spending. If these conditions worsen, demand for
our products and services may be reduced as a result of even further reduced
spending on IT products such as ours.
Seasonal trends in sales of our software products may result in periodic
reductions in our revenues and impairment of our operating results.
Seasonality in our business could result in our revenues in a given period
being inconsistent. Seasonality could also result in quarter to quarter
decreases in our revenues. In either of these events, seasonality could have an
adverse impact on our results of operations. Historically, our revenues and
operating results in our third and fourth quarters have tended to benefit,
relative to our first and second quarters, from purchase decisions made by the
large concentration of our customers with calendar year-end budgeting
requirements. Our first and second quarters tend to be our weakest.
Notwithstanding these seasonal factors, other factors, including those
identified in this section, could still result in reduced revenues or operating
results in our third and fourth quarters. Historical patterns may change over
time, in particular as our international operations expand we may experience
variability in demand associated with seasonal buying patterns in these foreign
markets different from those in the United States.
22
Our quarterly revenues and revenue growth rates could be affected by the
new products that we announce or that our competitors announce.
Announcements of new products or releases by us or our competitors could
cause customers to delay purchases pending the introduction of the new product
or release. In addition, announcements by us or our competitors concerning
pricing policies could have an adverse effect on our revenues in a given
quarter.
Our products and service offerings have different margins, and changes in
our revenue mix could have an adverse effect on our operating results.
Changes in our revenue mix could adversely affect our operating results
because some products and service offerings provide higher margins than others.
For example, margins on software licenses tend to be higher than margins on
maintenance and services. Additionally, we have utilized both inside and outside
professional services consultants trained in the deployment of Asset Insight to
deliver our implementation services. The outside consultants who are
subcontractors generally cost significantly more than the consultants employed
directly by us. Our gross profit can fluctuate based upon the mix of use of
consultants who are subcontractors versus consultants employed directly by us.
The long sales cycle for our products may cause substantial fluctuations in
our revenues and operating results.
Delays in customer orders could result in our revenues being substantially
below the expectations of our investors. The sales cycle for our products
typically takes six to nine months to complete, and we may experience delays
that further extend this period. The length of the sales cycle may vary
depending on factors over which we have little or no control, such as the size
of the transaction, the internal activities of potential customers, and the
level of competition that we encounter in selling the products. Our customers'
planning and purchasing decisions involve a significant commitment of resources
and a lengthy evaluation and product qualification process. As a result, we may
incur substantial sales and marketing expenses during a particular period in an
effort to obtain orders. If we are unsuccessful in generating offsetting
revenues during that period, our revenues and earnings could be substantially
reduced, or we could experience a large loss. During the sales cycle, we
typically provide a significant level of education to prospective customers
regarding the use and benefits of our products. Any delay in the sales cycle of
a large license or a number of smaller licenses could have an adverse effect on
our operating results and financial condition.
If we are unable to expand our business internationally, our business,
revenues, and operating results could be harmed.
In order to grow our business, increase our revenues, and improve our
operating results, we believe we must continue to expand internationally. We
have expanded our European sales initiatives by establishing agreements with
five distributors that are marketing our Asset Insight and Enterprise Insight
solutions in the United Kingdom, Germany, Ireland, Scandinavia, Switzerland,
Italy, Portugal, and Spain. We carefully select distributors that share our
customer-centric philosophy and are committed to selling Tangram's solutions as
their exclusive asset tracking and asset management offerings. We are currently
evaluating expanding our distributor network to the English speaking regions of
the Pacific Rim including Hong Kong, Singapore and Australia. If we expend
substantial resources while pursuing an international strategy and we are not
successful, our revenues will fall short of our expectations, and our operating
results will suffer. International expansion will require significant management
attention and financial resources, and we may not be successful in expanding our
international operations. Additionally, we have limited experience in developing
local language versions of our products or in marketing our products to
international customers. We may not be able to successfully translate, market,
sell, and deliver our products internationally.
Conducting business internationally poses risks that could affect our
financial results.
Even if we are successful in expanding our operations internationally,
conducting business outside North America poses many risks that could adversely
affect our operating results. In particular, we may experience gains and losses
resulting from fluctuations in currency exchange rates, for which hedging
activities may not adequately protect us. To date, the majority of our
international revenue has been denominated in United States currency; therefore,
we have not experienced any significant currency fluctuations. However, future
exchange rate risks can have an adverse effect on our ability to sell our
products in foreign markets. Since we sell our products in U.S. dollars, our
sales could be adversely affected by declines in foreign currencies relative to
the dollar, thereby making our products more expensive in local currencies. If
we are to sell our products in local currencies, we could be competitively
unable to change our prices to reflect exchange rate changes. Additional risks
we face in conducting business internationally include longer payment cycles,
difficulties in staffing and managing international operations, problems in
collecting accounts receivable, and the adverse effects of tariffs, duties,
price controls, or other restrictions that impair trade.
23
Our business and operating results will be harmed if we cannot compete
effectively against other companies in our markets.
The market for our products is intensely competitive and diverse, and the
technologies for our products can change rapidly. New products are introduced
frequently and existing products are continually enhanced. Historically, we have
encountered competition from a number of sources, including system management
and infrastructure management companies. By mid-1999, vendors of asset
management software and infrastructure management offerings had enhanced their
products to include functionality that was provided by asset tracking and
low-end discovery tool software. Even though the asset tracking functionality
provided as standard features of asset management and infrastructure management
software is more limited than that of our Asset Insight products, there can be
no assurance that a significant number of potential customers would not elect to
accept such functionality in lieu of purchasing additional software. While we
believe we maintain a strong competitive advantage in functionality and
features, this emergence of asset management software and infrastructure
management offerings is having the effect of extending our sales cycle, as well
as creating pressure on us to reduce prices for our Asset Insight product line.
Competitors vary in size and in the scope and breadth of software and
services offered. There are many vendors in the infrastructure management
market, which includes asset tracking and asset management. This has created
confusion and overlap among vendors, such as Peregrine, MainControl, Intraware,
and Tally. Additionally, systems management suites provide auto-discovery
features that overlap with our offerings. These vendors include Microsoft's SMS,
Hewlett-Packard's OpenView, and Computer Associates' Unicenter. In the mid sized
asset tracking market, Asset Insight express competes with low-end discovery
tools, such as Blue Ocean's TrackIT. We also face competition from numerous
start-up and other entrepreneurial companies offering products that compete with
the functionality offered by one or more of our asset management products and
the internal information technology departments of those companies with asset
management needs.
If we cannot compete effectively in our markets by offering products that
are comparable in functionality, ease of use, and price to those of our
competitors, our revenues will decrease, and our operating results will be
adversely affected. Many of our current and potential competitors have
substantially greater financial, technical, marketing, and other resources than
we have. As a result, they may be able to devote greater resources than we can
to the development, promotion, and sale of their products and may be able to
respond more quickly to new or emerging technologies and changes in customer
needs.
Additional competition from new entrepreneurial companies or established
companies entering our markets could have an adverse effect on our business,
revenues, and operating results. In addition, alliances among companies that are
not currently direct competitors could create new competitors with substantial
market presence. Because few barriers to entry exist in the software industry,
we anticipate additional competition from new and established companies, as well
as business alliances. We expect that the software industry will continue to
consolidate. In particular, we expect that large software companies will
continue to acquire or establish alliances with our smaller competitors, thereby
increasing the resources available to these competitors. These new competitors
or alliances could rapidly gain significant market share at our expense.
We face strong competitors that have greater market share than we do and
pre-existing relationships with our potential customers, and if we are unable to
compete effectively, we might not be able to achieve sufficient market
penetration to achieve or sustain profitability.
The market for IT asset management products and services is rapidly
evolving and highly competitive, and we expect competition in this market to
persist and intensify. We may not have the resources or expertise to compete
successfully in the future. Many of our competitors have substantially greater
financial, customer support, technical and marketing resources, larger customer
bases, longer operating histories, greater name recognition and more established
relationships in the industry than we do. If our competitors maintain
significant market share, we might not be able to achieve sufficient market
penetration to grow our business, and our operating results could be harmed.
Our future revenues and operating results may be adversely affected if the
software application market continues to evolve toward a subscription-based
model, which may prove less profitable for us.
We expect our revenue growth rates and operating results to be adversely
affected as customers move to a subscription-based application service provider
model. Historically, we have sold our asset management solutions on a perpetual
license basis in exchange for an up-front license fee. Businesses are
increasingly attempting to reduce their up-front capital expenditures by
purchasing software applications under a hosted subscription service model.
Under the hosted model, the customer subscribes to use an application from the
software provider. The application is generally hosted on a server managed by
the software provider or a third-party hosting service. Under the subscription
revenue model, revenue is recognized ratably over the term of a subscription. As
a result, our rate of revenue growth under a subscription model may be less than
our historical rate under a license model. In addition, the price of our
services will be fixed at the time of entering into the subscription agreement.
If we are unable to adequately predict the costs associated with maintaining and
servicing a customer's subscription, then the periodic
24
expenses associated with a subscription may exceed the revenues we recognize for
the subscription in the same period, which would adversely affect our operating
results.
If the asset management market evolves toward a subscription-based model
and if an increasing number of our future customers demand a subscription-based
solution, or if we are not successful in implementing a subscription revenue
model, or if market analysts or investors do not believe that the model is
attractive relative to our traditional license model, our business could be
impaired, and our stock price could decline.
If we do not respond adequately to our industry's evolving technology
standards, or do not continually develop products that meet the complex and
evolving needs of our customers, sales of our products may decrease.
As a result of rapid technological change in our industry, our competitive
position in existing markets, or in markets we may enter in the future, can be
eroded rapidly by product advances and technological changes. As the market
evolves and competitive pressures increase, we believe that we will need to
further expand our product offerings and improve the integration between our
asset tracking and asset management solutions. We may be unable to improve the
performance and features of our products as necessary to respond to these
developments. In addition, the lifecycles of our products are difficult to
estimate. Our growth and future financial performance depend in part on our
ability to improve existing products and develop and introduce new products that
keep pace with technological advances, meet changing customer needs, and respond
to competitive products. Our product development efforts will continue to
require substantial investments. In addition, competitive or technological
developments may require us to make substantial, unanticipated investments in
new products and technologies, and we may not have sufficient resources to make
these investments.
Product development delays could harm our competitive position and reduce
our revenues.
If we experience significant product development delays, our position in
the market would be harmed, and our revenues could be substantially reduced,
which would adversely affect our operating results. We have experienced product
development delays in the past and may experience delays in the future. In
particular, we may experience product development delays associated with the
integration of recently acquired products and technologies. Delays may occur for
many reasons, including an inability to hire a sufficient number of developers,
discovery of software bugs and errors, or a failure of our current or future
products to conform to industry requirements.
Errors or other software bugs in our products could result in significant
expenditures to correct the errors or bugs, could result in our inability to
deliver product, and could result in product liability claims.
Software products as complex as those we offer may contain errors that may
be detected at any point in a product's lifecycle. While we continually test our
products for errors and work with customers through our customer support
services to identify and correct bugs, errors in our products may be found in
the future even after our products have been commercially introduced. Testing
for errors is complicated in part because it is difficult to simulate the
complex, distributed computing environments in which our customers use our
products, as well as because of the increased functionality of our product
offerings. We have experienced errors in the past that resulted in delays in
product shipment and increased costs. There can be no assurance that, despite
our testing, errors will not be found. If we were required to expend significant
amounts to correct software bugs or errors, our revenues could be harmed as a
result of an inability to deliver the product, and our operating results could
be impaired as we incur additional costs without offsetting revenues. Such
errors may result in loss of, or delay in, market acceptance and sales,
diversion of development resources, injury to our reputation, or increased
service and warranty costs, any of which could have a material adverse effect on
our business, results of operations, and financial condition.
If we were held liable for damages incurred as a result of our products,
our operating results could be significantly impaired. Our license agreements
with our customers typically contain provisions designed to limit exposure to
potential product liability claims. These limitations, however, may not be
effective under the laws of some jurisdictions. Although we have not experienced
any product liability losses to date, the sale and support of our products
entails the risks of these claims.
We may experience problems integrating the technologies of Tangram and
Wyzdom. Any integration problems could cause us to incur substantial
unanticipated costs and expenses, which would harm our operating results.
If we are unable to integrate our business with the acquired Wyzdom
Solutions assets, if we encounter unanticipated bugs or other technical
problems, or if we are unable to succeed or capitalize upon the opportunities in
the asset management market, we will incur substantial costs, which will
increase our expenses and our losses, and we will fail to achieve the expected
synergies of the acquisition. In addition, integration problems could divert
management's attention from other business opportunities, which could result in
slower revenue growth than anticipated or in declines in revenue. If we are
unable to realize the strategic and financial benefits currently anticipated
from the purchase of the lifecycle asset management software of Wyzdom
Solutions, Inc.,
25
our shareholders will have experienced substantial dilution of their ownership
interest without receiving any commensurate benefit.
We may experience integration or other problems with future acquisitions,
which could have an adverse effect on our business or results of operations. New
acquisitions could dilute the interests of existing shareholders, and the
announcement of new acquisitions could result in a decline in the price of our
common stock.
As part of our business strategy, we may find it desirable in the future to
make acquisitions of, or significant investments in, businesses that offer
complementary products, services and technologies. We may also make acquisitions
of, or investments in, businesses that we believe could expand our distribution
channels. If we identify an appropriate acquisition candidate, we may not be
able to negotiate the terms of the acquisition successfully or finance the
acquisition. If we consummate one or more significant acquisitions in which the
consideration consists of stock or other securities, your ownership percentage
in Tangram could be significantly diluted. In addition, we may be required to
write off or amortize significant amounts of goodwill and other intangible
assets in connection with future acquisitions, which could materially impair our
operating results and financial condition. Any future acquisition or substantial
investment would present numerous risks. The following are examples of these
risks:
. difficulties in assimilating the technology, operations, or
personnel of the acquired businesses into ours;
. potential disruption of our ongoing business;
. difficulty in realizing the potential financial or strategic
benefits of the transaction;
. problems in maintaining uniform standards, controls, procedures,
and policies;
. impairment of our relationships with our employees and clients as a
result of any integration of new businesses and management
personnel; and
. the diversion of our management's attention.
If we cannot attract and retain qualified sales personnel, software
developers, and customer service personnel, we will not be able to sell and
support our products.
Competition for qualified employees has been intense, particularly in the
technology industry, and we have in the past experienced difficulty recruiting
qualified employees. If we are not successful in attracting and retaining
qualified sales personnel, software developers, and customer service personnel,
our revenue growth rates could decrease, or our revenues could decline, and our
operating results could be materially harmed. Our products and services require
a sophisticated selling effort targeted at several key people within a
prospective customer's organization. This process requires the efforts of
experienced sales personnel, as well as specialized consulting professionals. In
addition, the complexity of our products, and issues associated with installing
and maintaining them, require highly-trained customer service and support
personnel. We intend to hire a significant number of these personnel in the
future and train them in the use of our products. We believe our success will
depend in large part on our ability to attract and retain these key employees.
Our business could be harmed if we lose the services of one or more members
of our senior management team.
The loss of the services of one or more of our executive officers or key
employees, or the decision of one or more of these individuals to join a
competitor, could adversely affect our business and harm our operating results
and financial condition. Our success depends to a significant extent on the
continued service of our senior management and other key sales, consulting,
technical, and marketing personnel.
We could be competitively disadvantaged if we are unable to protect our
intellectual property.
If we fail to adequately protect our proprietary rights, competitors could
offer similar products relying on technologies we developed, potentially harming
our competitive position and decreasing our revenues. We attempt to protect our
intellectual property rights by limiting access to the distribution of our
software, documentation, and other proprietary information and by relying on a
combination of copyright, trademark, and trade secret laws. In addition, we
enter into confidentiality agreements with our employees and certain customers,
vendors, and strategic partners.
Despite precautions that we take, it may be possible for unauthorized third
parties to copy aspects of our current or future products or to obtain and use
information that we regard as proprietary. Policing unauthorized use of software
is difficult, and some foreign laws do not protect proprietary rights to the
same extent as United States laws. Litigation may be necessary in the future to
enforce our intellectual property rights, to protect our trade secrets, or to
determine the validity and scope of the proprietary rights of others, any of
which could adversely affect our revenues and operating results.
26
If we become involved in an intellectual property dispute, we may incur
significant expenses or may be required to cease selling our products, which
would substantially impair our revenues and operating results.
In recent years, there has been significant litigation in the United States
involving intellectual property rights, including rights of companies in the
software industry. Intellectual property claims against us, and any resulting
lawsuit, may result in our incurring significant expenses and could subject us
to significant liability for damages and invalidate what we currently believe
are our proprietary rights. These lawsuits, regardless of their success, would
likely be time-consuming and expensive to resolve and could divert management's
time and attention. Any potential intellectual property litigation against us
could also force us to do one or more of the following:
. cease selling or using products or services that incorporate the
infringed intellectual property;
. obtain from the holder of the infringed intellectual property a
license to sell or use the relevant technology, which license may
not be available on acceptable terms, if at all; or
. redesign those products or services that incorporate the disputed
technology, which could result in substantial unanticipated
development expenses.
If we are subject to a successful claim of infringement and we fail to
develop non-infringing technology or license the infringed technology on
acceptable terms and on a timely basis, our revenues could decline or our
expenses could increase.
We may in the future initiate claims or litigation against third parties
for infringement of our proprietary rights or to determine the scope and
validity of our proprietary rights or the proprietary rights of competitors.
These claims could also result in significant expense and the diversion of
technical and management personnel's attention.
Our stock price has been and is likely to continue to be highly volatile,
which may make our common stock difficult to resell at attractive times and
prices.
The trading price of our common stock has been and is likely to be highly
volatile. Our stock price could be subject to wide fluctuations in response to a
variety of factors, including the following:
. actual or anticipated variations in our quarterly operating
results;
. announcements of technological innovations;
. new products or services offered by us or our competitors;
. conditions or trends in the software industry generally or
specifically in the markets for asset management enterprise
solutions;
. changes in the economic performance and/or market valuations of our
competitors and the software industry in general;
. announcements by us or our competitors of significant contracts,
changes in pricing policies, acquisitions, strategic partnerships,
joint ventures, or capital commitments;
. adoption of industry standards and the inclusion of our technology
in, or compatibility of our technology with, the standards;
. adverse or unfavorable publicity regarding us or our products;
. our loss of a major customer;
. additions or departures of key personnel;
. sales of our common stock in the public market; and
. other events or factors that may be beyond our control.
In addition, the markets for securities of technology and software
companies have experienced extreme price and volume volatility and a significant
cumulative decline in recent months. This volatility has affected many companies
irrespective of, or disproportionately to, the operating performance of these
companies. These industry factors can materially and adversely affect the market
price of our common stock, regardless of our actual operating performance.
We risk liability from potential product liability claims that our
insurance may not cover which could materially adversely affect our business,
financial condition, and results of operations.
In testing, manufacturing, and marketing our products, we risk liability
from the failure of the products to perform as we expect. Although we currently
have product liability insurance and seek to obtain indemnification from
licensees of the products, obtaining additional insurance or indemnification may
be inadequate, unobtainable, or prohibitively expensive. We must renew our
policies each year. We may not be able to renew our current policies or obtain
additional insurance in the future on
27
acceptable terms or at all. Our inability to obtain sufficient insurance
coverage on reasonable terms, or otherwise protect ourselves against potential
product liability claims in excess of our insurance, could materially adversely
affect our business, financial condition, and results of operations.
Future changes in accounting standards, particularly changes affecting
revenue recognition, could cause unexpected revenue fluctuations.
Future changes in accounting standards, particularly those affecting
revenue recognition, could require us to change our accounting policies. These
changes could cause deferment of revenue recognized in current periods to
subsequent periods or accelerate recognition of deferred revenue to current
periods, each of which could cause shortfalls in meeting investors'
expectations. Any of these shortfalls could cause a decline in our stock price.
The Nasdaq Stock Market, Inc. may delist our common stock from The Nasdaq
SmallCap Market if we fail to meet their continued listing requirements,
including maintaining a $1.00 per share minimum bid price. The delisting of our
common stock could materially adversely affect the market price and market
liquidity of our common stock.
We currently are not in compliance with the $1.00 minimum bid price listing
requirement for continued listing on The Nasdaq Smallcap Market and have been
notified by Nasdaq that we have until October 1, 2002 to demonstrate a closing
bid price of at least $1.00 per share or more for a minimum of ten consecutive
trading days. If we fail to meet Nasdaq's continued listing requirements by
October 1, 2002, we may be delisted from The Nasdaq SmallCap Market. If our
common stock is delisted from The Nasdaq SmallCap Market, trading, if any, of
our common stock would thereafter have to be conducted in the over-the-counter
market. In such an event, an investor could find it more difficult to dispose
of, or to obtain accurate quotations as to the market value of our common stock.
In addition, if our common stock were to be delisted from trading on The Nasdaq
SmallCap Market and the trading price of the common stock were to remain below
$5.00 per share, trading in our common stock could also be subject to the
requirements of certain rules promulgated under the Securities Exchange Act of
1934, as amended, which require additional disclosure by broker-dealers in
connection with any trades involving a stock defined as a "penny stock"
(generally, any non-Nasdaq and non-national exchange equity security that has a
market price of less than $5.00 per share, subject to certain exceptions). The
additional burdens imposed upon broker-dealers by such requirements could
discourage broker-dealers from effecting transactions in our common stock, which
could severely limit the market liquidity of our common stock and the ability of
investors to trade our common stock. Many brokerage firms are reluctant to
recommend lower price stocks for their clients, and the policies and practices
of a number of brokerage houses tend to discourage individual brokers within
those firms from dealing in lower price stocks. Also, the brokerage commission
on the purchase or sale of a stock with a relatively low per share price
generally tends to represent a higher percentage of the sales price than the
brokerage commission charged on a stock with a relatively higher per share
price, to the detriment of our shareholders and the market for our common stock.
Certain provisions of Pennsylvania law and our articles of incorporation
and bylaws could have the effect of making it more difficult for a third-party
to acquire, or of discouraging a third-party from attempting to acquire, control
of us.
We are a Pennsylvania corporation. Certain provisions of Pennsylvania law
and our articles of incorporation and bylaws could have the effect of making it
more difficult for a third-party to acquire, or of discouraging a third-party
from attempting to acquire, control of us. While these provisions may provide us
with flexibility in managing our business, they could discourage or make a
merger, tender offer, or proxy contest more difficult, even though certain
shareholders may wish to participate in the transaction. These provisions could
also potentially adversely affect the market price of the common stock. These
provisions include:
. a provision allowing us to issue preferred stock with rights senior
to those of the common stock without any further vote or action by
the holders of common stock; and
. the issuance of preferred stock could decrease the amount of
earnings and assets available for distribution to the holders of
common stock or could adversely affect the rights and powers,
including voting rights, of the holders of the common stock. In
certain circumstances, the issuance of preferred stock could have
the effect of decreasing the market price of the common stock.
CONTROL BY SAFEGUARD SCIENTIFICS, INC.
Safeguard Scientifics, Inc. ("Safeguard") beneficially owns approximately
55% of our outstanding common stock and 3,000 shares of the Series F Convertible
Preferred Stock. The 3,000 shares of Series F Preferred Stock are convertible at
any time at the option of the holder into 1,500,000 shares of common stock,
subject to anti-dilution adjustments. Safeguard is entitled to one vote for each
share of common stock into which the Series F Preferred Stock may be converted
and may vote on all matters
28
submitted to a vote of the holders of common stock. Therefore, Safeguard
controls approximately 59% of the Company's outstanding voting shares.
As a result, Safeguard has the ability to control the election of Tangram's
Board of Directors and the outcome of all other matters submitted to our
shareholders. In addition, Safeguard's influence may either deter any
acquisition of Tangram or our ability to acquire another entity, and its
significant ownership position reduces the public float for our common stock.
Consequently, this influence and significant ownership could adversely affect
the market price and liquidity of our common stock.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We are exposed to market risk from changes in interest rates. Such changes
in interest rates impact interest cost on our interest rate sensitive
liabilities. Interest rate sensitive liabilities are assumed to be those for
which the stated interest rate is not contractually fixed for the next 12-month
period. Thus, liabilities that have a market-based index, such as the prime
rate, are rate sensitive. As of August 12, 2002, the only interest rate
sensitive liability is the $3.0 million unsecured revolving line of credit with
Safeguard. Assuming a hypothetical, immediate 100 basis point increase in the
interest rate, our interest expense over the following 12-month period would be
increased by approximately $13,000. The hypothetical model prepared by us
assumes that the balance of interest rate sensitive liabilities fluctuates based
on our anticipated borrowing levels over the next 12-month period. Thus, this
model represents a static analysis, which cannot adequately portray how we would
respond to significant changes in market conditions. Furthermore, the analysis
does not necessarily reflect our expectations regarding the movement of interest
rates in the near term, including the likelihood of an immediate 100 basis point
change in the interest rates nor the actual effect on interest cost if such a
rate change were to occur. We have not historically used financial instruments
to hedge interest rate exposure, do not use financial instruments for trading
purposes, and are not a party to any leveraged derivatives.
The majority of international revenue has been denominated in United States
currency; therefore, we have not experienced any significant currency
fluctuations. If we are successful in growing our international revenues, we
will be exposed to risks inherent with fluctuations in currency exchange rates.
29
PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Pursuant to an Asset Purchase Agreement dated February 13, 2001, we issued
3,000,000 shares of our common stock and $1.5 million in non-interest bearing
Promissory Notes ("Notes") to Axial Technology Holding AG ("Axial") for all
rights of ownership to Axial's proprietary asset management technology. The
Notes require the payment of $300,000, $500,000, and $700,000 on the first,
second, and third anniversaries, respectively, of the Asset Purchase Agreement.
With respect to the first note payment, we could elect to provide, in lieu of
cash, a number of shares of common stock, equivalent in aggregate value to the
amount of such cash payment, the value of each such share to be deemed equal to
80% of the average Nasdaq closing price during the 20 trading days immediately
prior to the relevant note payment date. On March 1, 2002 we issued 381,098
shares of our common stock in lieu of the first note payment due on March 1,
2002.
Under the terms of the Series F Convertible Preferred Stock ("Series F
Shares"), holders of the Series F Shares are entitled to a cumulative quarterly
dividend, when and if declared by the Board, at a rate per share equal to 2% of
the issuance price per quarter. At March 31, 2002, dividends in arrears on the
Series F Shares were approximately $340,000.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits
Exhibit
Number Exhibit Description
------- -------------------
None
b) Reports on Form 8-K
On May 10, 2002, we filed a Current Report on Form 8-K announcing that we
held a conference call to discuss the Company's first quarter financial results.
We voluntarily elected to file a copy of the transcript on this Form 8-K to
ensure that the contents of such conference call were fully disseminated and
that all of our investor had full access to such transcript.
30
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TANGRAM ENTERPRISE SOLUTIONS, INC.
Date August 14, 2002 /s/ John N. Nelli
--------------- -------------------------------
John N. Nelli
Senior Vice President and Chief Financial Officer
(Principal Financial & Accounting Officer)