Item 7Managements Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with the consolidated financial statements and notes included elsewhere in this report. The following discussion contains forward-looking statements that reflect our plans, estimates
and beliefs. Our actual results could differ materially from those discussed in the forward- looking statements. Factors that could cause or contribute to these differences include, but are not limited to, those discussed below and at Part I,
Item 1A, Risk Factors to this Annual Report.
Overview
Tumbleweed Communications Corp. (Tumbleweed or we) is a recognized expert in providing managed file transfer, email security, and
identity validation products for enterprise and government customers of all sizes. We provide comprehensive solutions that enable organizations to safely and confidently conduct business over the Internet, protecting data in motion and at rest with
intuitive, pragmatic solutions that promote collaboration, prevent data loss, and reduce the cost of doing business.
We offer solutions in four comprehensive product suites: Tumbleweed SecureTransport,
Tumbleweed Secure Messenger, Tumbleweed MailGate
®
, Tumbleweed Validation Authority. Tumbleweed SecureTransport is an enterprise-class managed file product that enables customers
to securely manage the exchange of large files and transactions without having to change internal infrastructure. Tumbleweed Secure Messenger is a policy-based email encryption product that enables deep-content inspection of incoming and outgoing
mail, and dynamic application of user-defined encryption and routing preferences. Tumbleweed MailGate is a comprehensive email security product that provides inbound and outbound protection with protection against virus outbreaks, spam, and denial
of service attacks, eliminating illegitimate email traffic before it can penetrate corporate firewalls. Tumbleweed Validation Authority is a leading product for determining the validity of digital certificates.
We are trusted by more than 3,200 enterprise and government customers who use our products to securely connect with employees, partners, and
customers. Our traditional market focus has been in the financial services, healthcare, and government markets, but we are expanding into other market sectors, such as retail, manufacturing, energy, transportation and technology. The worlds
most security conscious organizations use our products to safely exchange data, protect information assets, block email security threats, and ensure identity validation.
Revenue during 2007 decreased 7%, or $4.5 million, to $57.5 million from $62.0 million in 2006. This decrease was mainly due to a $7.8 million decrease in revenue from our Validation Authority products and a $2.3
million decrease in revenue from the licensing of intellectual property. These declines were partially offset by a 13%, or $5.5 million, combined increase in revenue from our SecureTransport, Secure Messenger, and MailGate products. The decrease in
revenue from our Validation Authority products was due to five license transactions of $1.0 million or more in 2006 with no comparable transactions in 2007. The increase in total license revenue from our other products was due to the increased
market adoption of those products due to an increase in the volume of license transactions and an increase in the size of our customer base. The impact of a decrease in our license revenue was partially offset by an increase in our service revenue
due to the expansion of our customer base under support agreements.
Net loss increased 121%, or $5.9 million, as compared to 2006. Our
increase in net loss was primarily due to a decrease in revenue and an increase in our cost of service revenue of $922,000 in 2007 as compared to 2006. Our cost of service revenue increased as professional services revenue increased in 2007 as
compared to 2006 while cost of service revenue as a percentage of service revenue remained flat at 23% in both 2007 and 2006.
29
Outlook
We believe that our success in 2008 will depend on our ability to effectively manage the transition from being primarily a direct sales organization to having a greater portion of our business come through reseller partners, to expand our
international revenue, to introduce competitive products while transitioning from our historic waterfall engineering practices to an agile product development model, and to maintain control over expenses and cash. We believe
that key risks include overall economic conditions and the overall level of information technology spending; economic and business conditions within our main vertical market segments of financial services, healthcare, and government industries;
timing of the closure of customer contracts; operational execution in growing our sales internationally; and competitive factors in our rapidly changing industry. Our prospects must be considered in light of the risks, expenses and difficulties
encountered by companies of a similar size and industry, particularly given that we operate in rapidly evolving markets, have completed several acquisitions and face an uncertain economic environment. We may not be successful in addressing such
risks and difficulties. Please refer to the Risk Factors section for additional information.
30
The following table sets forth the consolidated statements of operations for the periods indicated (in
thousands). These statements have been derived from the consolidated financial statements contained in this Annual Report. The operating results for any period should not be considered indicative of results for any future period. This information
should be read in conjunction with the consolidated financial statements and notes to the consolidated financial statements included elsewhere in this report.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
Product revenue
|
|
$
|
22,529
|
|
|
$
|
28,683
|
|
|
$
|
20,945
|
|
Service revenue
|
|
|
33,559
|
|
|
|
29,664
|
|
|
|
26,103
|
|
Intellectual property revenue
|
|
|
1,367
|
|
|
|
3,647
|
|
|
|
2,953
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
|
57,455
|
|
|
|
61,994
|
|
|
|
50,001
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of product revenue (1)
|
|
|
5,694
|
|
|
|
4,316
|
|
|
|
2,597
|
|
Provision for excess inventory
|
|
|
164
|
|
|
|
933
|
|
|
|
323
|
|
Cost of service revenue(1)
|
|
|
7,672
|
|
|
|
6,750
|
|
|
|
5,407
|
|
Amortization of intangible assets
|
|
|
936
|
|
|
|
1,467
|
|
|
|
2,040
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of revenue
|
|
|
14,466
|
|
|
|
13,466
|
|
|
|
10,367
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
42,989
|
|
|
|
48,528
|
|
|
|
39,634
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development (1)
|
|
|
15,107
|
|
|
|
14,836
|
|
|
|
12,107
|
|
Sales and marketing (1)
|
|
|
28,575
|
|
|
|
28,002
|
|
|
|
25,194
|
|
General and administrative (1)
|
|
|
10,157
|
|
|
|
10,622
|
|
|
|
6,013
|
|
Amortization of intangible assets
|
|
|
305
|
|
|
|
1,041
|
|
|
|
1,284
|
|
Merger-related and other credit
|
|
|
|
|
|
|
|
|
|
|
(96
|
)
|
Restructuring costs
|
|
|
930
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
55,074
|
|
|
|
54,501
|
|
|
|
44,502
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating loss
|
|
|
(12,085
|
)
|
|
|
(5,973
|
)
|
|
|
(4,868
|
)
|
Other income, net
|
|
|
1,336
|
|
|
|
1,206
|
|
|
|
982
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss before provision for income taxes
|
|
|
(10,749
|
)
|
|
|
(4,767
|
)
|
|
|
(3,886
|
)
|
Provision for income taxes
|
|
|
16
|
|
|
|
115
|
|
|
|
23
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(10,765
|
)
|
|
$
|
(4,882
|
)
|
|
$
|
(3,909
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) Including stock-based compensation expense as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of product revenue
|
|
$
|
|
|
|
$
|
9
|
|
|
$
|
|
|
Cost of service revenue
|
|
|
142
|
|
|
|
142
|
|
|
|
2
|
|
Research and development
|
|
|
946
|
|
|
|
1,256
|
|
|
|
219
|
|
Sales and marketing
|
|
|
1,205
|
|
|
|
569
|
|
|
|
168
|
|
General and administrative
|
|
|
2,211
|
|
|
|
2,629
|
|
|
|
121
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total stock-based compensation expense
|
|
$
|
4,504
|
|
|
$
|
4,605
|
|
|
$
|
510
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years ended December 31, 2007 and 2006
Revenue
. Revenue, which consists of product revenue, service revenue, and intellectual property revenue, results from new contracts and
backlog. We define backlog as deferred revenue, contractual commitments that are not due and payable as of the balance sheet date, or for which the product or service has not yet been delivered and/or for which collectibility is not considered
probable. Product revenue consists of license fees and
31
appliance fees (for products that are delivered on an appliance platform), and subscription-based license fees. Service revenue includes support and
maintenance fees, consulting fees, and training fees. Intellectual property revenue consists of patent license agreement fees. Total revenue decreased to $57.5 million in 2007 from $62.0 million in 2006. The decrease in total revenue was primarily
due to a $6.2 million decrease in product revenue and a $2.3 million decrease in patent license revenue, partially offset by a $2.4 million increase in support and maintenance revenue and a $1.4 decrease in professional services revenue.
Product revenue decreased to $22.5 million in 2007 from $28.7 million in 2006. The decrease in product revenue was due to a decrease in license
revenue from our Validation Authority products of $9.1 million, partially offset by a total combined increase in license revenue from our SecureTransport, Secure Messenger, and MailGate products of $2.9 million. The decrease in license revenue from
our Validation Authority products was due to five license transactions of $1.0 million or more in 2006 with no comparable transactions in 2007. The increase in total license revenue from our other products was due to the increased market adoption of
those products due to an increase in the volume of license transactions and an increase in the size of our customer base.
Service revenue
increased to $33.6 million in 2007 from $29.7 million in 2006 due to an increased number of customers covered by support agreements due to the expansion of our customer base and due to an increased customer demand for consulting and training
services related to our SecureTransport product line.
Intellectual property revenue decreased to $1.4 million in 2007 from $3.6 million in
2006. The decrease in intellectual property revenue was due to a decrease in patent license revenue caused by having a large patent agreement during the three months ended June 30, 2006, with no comparable transactions in 2007.
Cost of Revenue.
Cost of revenue is comprised of costs for product revenue, service costs, provision for excess inventory, and the
amortization of intangible assets for core/developed technology and maintenance agreements relating to corporate acquisitions. Cost of product revenue is primarily comprised of royalties paid to third parties for software licensed by us for
inclusion in our products, and the cost of our products sold on appliances including related shipping and warranty costs. Service costs are comprised primarily of employee and employee-related costs, including stock-based compensation expense, for
customer support, consulting and training, and contract development projects with third parties. Provision for excess inventory is comprised of costs associated with excess inventory resulting from our transitions to new appliance manufacturers.
Total cost of revenue increased to $14.5 million in 2007 (or 25% of total 2007 revenue) from $13.5 million in 2006 (or 22% of total 2006 revenue), primarily due to a $1.4 million increase in our cost of product revenue, a $922,000 increase in our
service costs, partially offset by a $769,000 decrease in our provision for excess inventory and a $531,000 decrease in our amortization of intangible assets.
Cost of product revenue increased to $5.7 million in 2007 (or 10% of total 2007 revenue) from $4.3 million in 2006 (or 7% of total 2006 revenue) due primarily to an increase in appliance costs and royalty costs.
Appliance costs increased by $1.1 million during 2007 due to an increase in the number of appliances shipped to our customers as customer adoption of our appliance products increased relative to 2006. Royalties paid to third parties for software
licensed by us for inclusion in our products increased by $619,000 during 2007, due to an increase in revenue from our anti-virus products and the increase in the number of appliance units shipped to our customers, both of which require third-party
licenses for which we pay royalties. We expect cost of product revenue to increase during 2008 due to an expected increase in the number of appliance products to be shipped.
Provision for excess inventory of $164,000 in 2007 (or less than 1% of total 2007 revenue) and $933,000 in 2006 (or 2% of total 2006 revenue) was the
estimated loss for excess inventory and purchase commitments associated with transitioning our hardware products to new appliance manufacturers.
Cost of service revenue increased to $7.7 million in 2007 (or 13% of total 2007 revenue) from $6.8 million in 2006 (or 11% of total 2006 revenue) due primarily to an $851,000 increase in employee-related costs. Employee-related costs
increased due to an increase in average services headcount and an increase in incentive compensation as professional services revenue increased in 2007 as compared to 2006. Average services headcount increased to 77
32
employees in 2007 from 65 employees in 2006 primarily due to transitioning from a partial utilization of third parties in our support function towards a full
employee-based support model and due to the need for greater personnel resources to fulfill our customer service requirements due to our increased service revenues.
Amortization of intangible assets included in cost of revenue decreased to $936,000 in 2007 (or 2% of total 2007 revenue) from $1.5 million in 2006 (or 2% of total 2006 revenue) due to the amortization in full during
the three months ended June 30, 2006 of the intangible assets for core/developed technology and maintenance agreements acquired during the acquisition of Valicert. Intangible assets, amortization for which is included in cost of revenue, will
be amortized in full in the three months ended March 31, 2008.
Research and Development Expenses.
Research and
development expenses are primarily comprised of employee and employee-related costs, including stock-based compensation expense and other costs required for the development and quality assurance of our products. Research and development expenses
increased to $15.1 million in 2007 (or 26% of total 2007 revenue) from $14.8 million in 2006 (or 24% of total 2006 revenue), primarily due to a $226,000 increase in consulting costs. Consulting costs increased due to a greater utilization of
third-parties to assist in our research and development processes.
Sales and Marketing Expenses.
Sales and marketing expenses
are primarily comprised of employee and employee-related costs, including stock-based compensation expense, travel expenses, and costs associated with marketing program costs. Sales and marketing expenses increased to $28.6 million in 2007 (or 50%
of total 2007 revenue) from $28.0 million in 2006 (or 45% of total 2006 revenue) primarily due to a $636,000 increase in stock-based compensation expense. Stock-based compensation expense increased primarily due to the expense associated with the
terminations of certain employees and a greater number of stock options vesting over 2007 as compared to 2006.
General and
Administrative Expenses.
General and administrative expenses consist primarily of employee and employee-related costs, including stock-based compensation expense, for our administrative, finance, legal, and human resources departments, as
well as public reporting costs and professional fees including intellectual property enforcement and protection costs. General and administrative expenses decreased to $10.2 million in 2007 (or 18% of total 2007 revenue) from $10.6 million in 2006
(or 17% of total 2006 revenue). The decrease in general and administrative expense was primarily due to a $418,000 decrease in stock-based compensation expense. Stock-based compensation expense decreased due to recognition of expense related to a
large stock-based award, a portion of which vested immediately upon the grant in January 2006 with no comparable expense in 2007.
Amortization of intangible assets.
Amortization of intangible assets included in operating expenses consists of the amortization of intangible assets for customer base and reseller agreements and trademarks and tradenames recorded as
a result of the Valicert, Incubator Limited, and Corvigo, Inc. acquisitions. Amortization of intangible assets included in operating expenses decreased to $305,000 in 2007 (or 1% of total 2007 revenue) from $1.0 million in 2006 (or 2% of total 2006
revenue). The decrease in the amortization of intangible assets included in operating expenses was due to the amortization in full during the three months ended June 30, 2006 of the customer base and reseller agreements acquired during the
Valicert acquisition. Intangible assets, amortization for which is included in operating expenses, will be amortized in full in the three months ended March 31, 2008.
Restructuring costs.
Restructuring costs of $930,000 for 2007 were comprised of severance costs to terminated employees and associated legal
expenses. During the fourth quarter of 2007, an expense reduction program was implemented that included the termination of approximately 40 employees. As of December 31, 2007, the remaining liability related to these costs is $520,000. There
were no restructuring costs in 2006.
Other income, net.
Other income, net, is generally comprised of interest income earned on
investment securities. Other income, net, increased to $1.3 million in 2007 from $1.2 million in 2006. The increase in other income, net, was primarily due to increase in interest income driven by an increase in interest rates.
33
Years ended December 31, 2006 and 2005
Revenue
. Total revenue increased to $62.0 million in 2006 from $50.0 million in 2005. The increase in total revenue was primarily due to a
$7.7 million increase in product revenue, a $3.6 million increase in support and maintenance revenue, and a $694,000 increase in patent license revenue.
Product revenue increased to $28.7 million in 2006 from $20.9 million in 2005. The increase in product revenue was due to an increase in license revenue of $8.2 million, partially offset by decreases in
subscription-based license revenue and transaction-based license revenue of $363,000 and $97,000, respectively. The increase in license revenue was primarily due to an increased volume of contracts with customers along with revenue growth in the
financial services and government industries. The decreases in subscription-based license revenue and transaction-based license revenue were due to our continued transition away from those selling models and towards selling perpetual licenses with
associated support and maintenance contracts.
Service revenue increased to $29.7 million in 2006 from $26.1 million in 2005. The increase
in service revenue was primarily due to a $3.6 million increase in support and maintenance revenue. The increase in support and maintenance revenue was due to revenue growth in our installed customer base, an increase in sales of our anti-spam
service which is sold on a subscription fee basis, and an expansion of our customer base.
Intellectual property revenue increased to $3.6
million in 2006 from $3.0 million in 2005. The increase in intellectual property revenue was due to an increase in patent license revenue.
Cost of Revenue.
Total cost of revenue increased to $13.5 million in 2006 (or 22% of total 2006 revenue) from $10.4 million in 2005 (or 21% of total 2005 revenue), primarily due to a $1.7 million increase in product costs, a
$1.3 million increase in service costs, and a $610,000 increase in provision for excess inventory, partially offset by a decrease in amortization of intangible assets of $573,000.
Cost of product revenue increased to $4.3 million in 2006 (or 7% of total 2006 revenue) from $2.6 million in 2005 (or 5% of total 2005 revenue) due
primarily to an increase in appliance costs and royalty costs. Appliance costs increased by $709,000 during 2006 due to an increase in the number of appliance products shipped, resulting from higher sales of our products sold on appliances.
Royalties paid to third parties for software licensed by us for inclusion in our products increased by $889,000 during 2006, due to an increase in our product revenues and the addition of new software licenses from third parties included in our
products.
Provision for excess inventory of $933,000 in 2006 (or 2% of total 2006 revenue) is the estimated loss for excess inventory and
purchase commitments associated with transitioning our hardware products to a new appliance manufacturer and from a proprietary design to a standard product offering. Provision for excess inventory of $323,000 in 2005 (or 1% of total 2005 revenue)
is the expense incurred for obsolete inventory associated with our transition to a new appliance manufacturer.
Cost of service revenue
increased to $6.8 million in 2006 (or 11% of total 2006 revenue) from $5.4 million in 2005 (or 11% of total 2005 revenue), primarily due to an increase in employee and employee-related costs, including stock-based compensation expense, an increase
in consulting costs, an increase in travel expenses, and an increase in allocated overhead charges. Employee and employee-related costs increased by $632,000 during 2006 due to an increase in average services headcount and a $140,000 increase in
stock-based compensation expense due to our adoption of SFAS 123R during 2006. Average services headcount increased to 65 employees in 2006 from 48 employees in 2005 primarily due to transitioning from a partial utilization of third parties in our
support function towards a full employee-based support model and due to the need for greater personnel resources to fulfill our customer service requirements due to our increased service revenues. Consulting costs increased by $168,000 during 2006
due to a greater utilization of third parties to assist with providing service to our customers. Travel expenses increased by $211,000 during 2006 due to increased travel related to customer projects. Allocated overhead charges increased by $189,000
during 2006 due to an increase in our allocable cost base caused by higher information technology costs including an upgrade to our computer network infrastructure performed during 2006.
34
Amortization of intangible assets included in cost of revenue decreased to $1.5 million in 2006 (or 2% of
total 2006 revenue) from $2.0 million in 2005 (or 4% of total 2005 revenue) due to the amortization in full during the three months ended June 30, 2006 of the intangible assets for core/developed technology and maintenance agreements acquired
during the acquisition of Valicert.
Research and Development Expenses.
Research and development expenses increased to $14.8
million in 2006 (or 24% of total 2006 revenue) from $12.1 million in 2005 (or 24% of total 2005 revenue), primarily due to a $2.6 million increase in employee and employee-related costs. Employee and employee-related costs increased primarily due to
an increase in stock-based compensation expense of $1.0 million resulting from our adoption of SFAS 123R during 2006 as well as salary increases and growth in average research and development headcount. Average research and development headcount
increased to 155 in 2006 from 149 in 2005 driven by our efforts to broaden and upgrade our products.
Sales and Marketing
Expenses.
Sales and marketing expenses increased to $28.0 million in 2006 (or 45% of total 2006 revenue) from $25.2 million in 2005 (or 50% of total 2005 revenue) primarily due to a $2.7 million increase in employee and employee-related
costs. Employee and employee-related costs increased due to an increase in commissions of $1.0 million, an increase in stock-based compensation expenses of $401,000 resulting from our adoption of SFAS 123R during 2006, salary increases, growth in
average sales and marketing headcount, and expenses related to changes in sales and marketing management. Commissions increased as a result of increased sales in 2006. Average sales and marketing headcount increased to 89 in 2006 from 84 in 2005 due
to our efforts to expand our capabilities in this area.
General and Administrative Expenses.
General and administrative expenses
increased to $10.6 million in 2006 (or 17% of total 2006 revenue) from $6.0 million in 2005 (or 12% of total 2005 revenue). The increase in general and administrative expense was primarily due to an increase in employee and employee-related costs,
legal expenses, and consulting costs. Employee and employee-related costs increased by $4.0 million during 2006. Employee and employee-related costs increased due to an increase in stock-based compensation expenses of $2.5 million during 2006, due
to our adoption of SFAS 123R, as well as an increase in salary expenses due to growth in average general and administrative headcount and salary increases. Average general and administrative headcount increased to 38 in 2006 from 23 in 2005, largely
due to a realignment of resources into our general and administrative function from other functions during 2006. Legal expenses increased by $357,000 during 2006 due to various legal matters. Consulting costs increased by $216,000 during 2006 due to
a greater utilization of third parties to assist us with projects associated with our growth as a company.
Amortization of intangible
assets.
Amortization of intangible assets included in operating expenses decreased to $1.0 million in 2006 (or 2% of total 2006 revenue) from $1.3 million in 2005 (or 3% of total 2005 revenue). The decrease in the amortization of intangible
assets included in operating expenses was due to the amortization in full during the three months ended June 30, 2006 of the customer base and reseller agreements acquired during the Valicert acquisition.
Merger-related and other credit.
There were no merger-related and other credit in 2006. Merger-related and other costs of a net credit of
$96,000 for 2005 consist of a $296,000 credit related to the termination of an operating lease in Slough, United Kingdom and a $200,000 severance cost associated with the resignation of our former Chief Executive Officer. The combined cost of the
final lease settlement payments, commissions, brokerage fees, and legal fees related to the termination of the Slough lease was less than the existing accrual for the loss on the lease, resulting in the expense credit.
Other income, net.
Other income, net, increased to $1.2 million in 2006 from $982,000 in 2005. The increase in other income, net, was primarily
due to increase in interest income driven by an increase in interest rates and a larger cash balance.
35
Liquidity and Capital Resources
Since inception, we have financed our operations primarily through the issuance of equity securities. As of December 31, 2007, we had approximately $26.3 million in cash and cash equivalents.
Net cash used in operating activities in 2007 was $4.2 million, which was primarily the result of our net loss of $10.8 million, offset by non-cash
charges of $4.5 million for stock-based compensation expense and $2.6 million for depreciation and amortization expenses.
Net cash used in
operating activities for 2007 was $4.2 million compared to net cash provided by operating activities for 2006 of $3.8 million. This was primarily the result of a $5.9 million increase in our net loss and a $992,000 decrease in depreciation and
amortization expense in 2007 compared to 2006.
Net cash used in investing activities decreased to $1.5 million in 2007 from $1.6 million
in 2006. Net cash used in investing activities for both 2007 and 2006 was comprised of purchases of property and equipment. Net cash used in investing activities decreased in 2007 as compared to 2006 due to the timing of payments.
Net cash provided by financing activities was $1.4 million in 2007 and 2006, respectively. Net cash provided by financing activities for both 2007 and
2006 was comprised of proceeds from the issuance of our common stock.
As of December 31, 2007, our principal commitments consisted of
obligations related to outstanding operating leases and unconditional purchase obligations. We do not anticipate a substantial increase in operating lease obligations in the immediate future.
Our capital requirements depend on numerous factors, including revenue generated from operations and market acceptance of our products and services, and
the resources devoted to the development of our products and services and to sales and marketing and other operating activities. We believe that our existing capital resources should enable us to maintain our current and planned operations for at
least the next twelve months. Our current cash reserves, however, may be insufficient if we experience either lower than expected revenues or extraordinary or unexpected cash expenses, or for other reasons. Funding, if pursued, may not be available
on acceptable terms or at all. If adequate funds are not available, we may be required to curtail significantly or defer one or more of our operating goals or programs, or take other steps that could harm our business or future operating results. We
may consider future financing alternatives, which may include the incurrence of debt, additional public or private equity offerings or an equity investment by a strategic partner.
Off-Balance Sheet Arrangements
At December 31, 2007, we did not have any relationships with
unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements.
Tabular Disclosure of Contractual Obligations
Future cash payments for contractual obligations and commercial commitments as of December 31, 2007, are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less than
1 Year
|
|
1 3
Years
|
|
3 5
Years
|
|
More than
5 Years
|
|
Total
|
Operating leases
|
|
$
|
1,221
|
|
$
|
838
|
|
$
|
791
|
|
$
|
|
|
$
|
2,850
|
Unconditional purchase obligations
|
|
|
1,870
|
|
|
1,579
|
|
|
|
|
|
|
|
|
3,449
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
3,091
|
|
$
|
2,417
|
|
$
|
791
|
|
$
|
|
|
$
|
6,299
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
36
Indemnifications
In the ordinary course of business, we enter into contractual arrangements under which we may agree to indemnify the third-party to such arrangement from any losses incurred relating to the services they perform on
behalf of us or for losses arising from certain events as defined within the particular contract, which may include, for example, litigation or claims relating to past performance. Such indemnification obligations may not be subject to maximum loss
clauses. Historically, payments we have made related to these indemnifications have been immaterial.
Recent Accounting Pronouncements
In July 2006, the Financial Accounting Standards Board (FASB) issued Financial Interpretation 48,
Accounting for Uncertainty in Income
Taxesan interpretation of FASB Statement 109
(FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with SFAS 109,
Accounting for Income Taxes
and requires a two-step approach to evaluate tax positions and determine if they should be recognized in the financial statements. The two-step approach involves recognizing any tax positions that are more likely than not to occur and
then measuring those positions to determine if they are recognizable in the financial statements. The interpretation is effective for fiscal years beginning after December 15, 2006. We adopted FIN 48 on January 1, 2007. The impact of FIN
48 did not have a material effect on our consolidated financial position, results of operations, or cash flows.
As of January 1,
2007, we did not have any federal, state, and foreign unrecognized tax benefits. Upon the adoption of FIN 48, we adopted an accounting policy to classify interest and penalties on unrecognized tax benefits as income tax expense. For the years
prior to adoption of FIN 48, we did not have interest or penalties on unrecognized tax benefits and therefore, had no established accounting policy. As of January 1, 2007, we had no interest or penalties accrued on unrecognized tax benefits. We
file income tax returns in the U.S. federal jurisdiction, various states, and foreign jurisdictions. Due to our net operating losses, we are subject to examinations by U.S. federal and state income tax authorities for all our historical periods. As
of December 31, 2007, we did not have and do not expect to have any material changes to unrecognized tax benefits within the next twelve months.
In June 2006, the FASB ratified the Emerging Issues Task Force (EITF) consensus on Issue 06-03, How Sales Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented
in the Income Statement (EITF 06-03). EITF 06-03 provides guidance on an entitys disclosure of its accounting policy regarding the gross or net presentation of certain taxes and provides that if taxes included in gross
revenues are significant, a company should disclose the amount of such taxes for each period for which an income statement is presented (i.e., both interim and annual periods). Taxes within the scope of EITF 06-03 are those that are imposed on and
concurrent with a specific revenue-producing transaction. The guidance is effective for interim and annual periods beginning after December 15, 2006. We did not have and do not expect to have any material impact of EITF 06-03 on our financial
position and results of operations.
In June 2006, the FASB ratified the EITF consensus on Issue 06-02,
Accounting for Sabbatical
Leave and Other Similar Benefits Pursuant to FASB Statement No. 43, Accounting for Compensated Absences
(EITF 06-02). EITF 06-02 requires that the costs associated with unrestricted sabbaticals and other similar benefit
arrangements be recognized over the service period during which the employee earns the benefit. The provisions of EITF 06-02 are effective for fiscal years beginning after December 15, 2006. We applied the provisions of EITF 06-02 through a
cumulative effect adjustment that resulted in increases of $117,000 each to our accumulated deficit and accrued liabilities balances, respectively. The changes in accumulated deficit for 2007 are as follows:
|
|
|
|
|
|
|
(In thousands)
|
|
Balance as of December 31, 2006
|
|
$
|
(295,812
|
)
|
Net loss
|
|
|
(10,765
|
)
|
Adoption effect of EITF 06-02
|
|
|
(117
|
)
|
|
|
|
|
|
Balance as of December 31, 2007
|
|
$
|
(306,694
|
)
|
|
|
|
|
|
37
In September 2006, the FASB issued SFAS No. 157,
Fair Value Measurements
(SFAS 157). SFAS 157 provides guidance for using fair value to measure assets and liabilities. It also responds to investors requests for expanded information about the extent to which companies measure assets and
liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. SFAS 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value, and
does not expand the use of fair value in any new circumstances. SFAS 157 is generally effective for financial statements issued for fiscal years beginning after November 15, 2007 and for nonfinancial assets and liabilities that are not
remeasured at fair value on a recurring basis for fiscal years beginning after December 31, 2008. We do not expect SFAS 157 to have a material impact on our financial statements.
In December 2007, the FASB issued SFAS No. 141 (revised 2007),
Business Combinations
(SFAS 141R), which establishes
principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree in a business combination. SFAS 141R also
establishes principles around how goodwill acquired in a business combination or a gain from a bargain purchase should be recognized and measured, as well as provides guidelines on the disclosure requirements on the nature and financial impact of
the business combination. SFAS 141R is effective for fiscal years beginning after December 15, 2008 and will be adopted by us beginning in the first quarter of 2010. Although we will continue to evaluate the application of SFAS No. 141R,
we do not currently believe adoption will have a material impact on our financial condition or operating results.
In December 2007, the
FASB issued SFAS No. 141 (revised 2007),
Business Combinations
(SFAS 141R), and SFAS No. 160,
Noncontrolling Interests in Consolidated Financial Statements, an amendment of Accounting Research
Bulletin No. 51
(SFAS 160). SFAS 141R changes how business acquisitions are accounted for and impacts financial statements both on the acquisition date and in subsequent periods. SFAS 160 changes the accounting and
reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity. SFAS 141R and SFAS 160 are effective for fiscal years beginning after December 15, 2008 and will be adopted by
us beginning in the first quarter of 2009. Although we will continue to evaluate the application of SFAS 141R and SFAS 160, we do not currently believe adoption will have a material impact on our financial condition or operating results.
Critical Accounting Policies and Estimates
Our
discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The
preparation of these financial statements requires us to make estimates and judgments in determining the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We regularly
evaluate our estimates, including those related to revenue recognition, customer arrangements, collectibility of accounts receivable, valuation of assets, and contingencies and litigation. When making estimates, we consider our historical
experience, our knowledge of economic and market factors and various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.
We believe that the following critical accounting policies represent areas where significant judgments and estimates have been used in the preparation of
our consolidated financial statements.
Revenue Recognition
We derive our revenue from three sources: (i) product revenue, which includes license fees and appliance fees (for products that are delivered on an appliance platform), and subscription-based license fees;
(ii) service revenue, which consists of support and maintenance fees, consulting fees, and training fees; and (iii) intellectual property revenue, which consists of patent license agreement fees. 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 based on the judgments and estimates made by our
management.
38
We recognize revenue in accordance with Statement of Position (SOP) 97-2,
Software Revenue
Recognition
(SOP 97-2), as amended by SOP 98-9,
Modification of SOP 97-2
, Software Revenue Recognition
With Respect to Certain Transactions
(SOP 98-9). We make significant judgments related to
revenue recognition. Specifically, as set forth in paragraph 8 of SOP 97-2 in connection with each transaction involving our products, we must evaluate whether: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred,
(iii) the fee is fixed or determinable, and (iv) collectibility is probable. We apply these criteria as discussed below.
|
|
|
Persuasive evidence of an arrangement exists.
We require a written contract, signed by both the customer and us, or a purchase order from those customers
that have previously negotiated a standard license arrangement or volume purchase agreement with us prior to recognizing revenue on an arrangement.
|
|
|
|
Delivery has occurred.
We deliver software to our customers physically or electronically. For physical deliveries, our transfer terms are typically free on
board, or FOB, shipping point. For electronic deliveries, delivery occurs when we provide the customer access codes or keys that allow the customer to take immediate possession of the software.
|
|
|
|
The fee is fixed or determinable.
Our determination that an arrangement fee is fixed or determinable depends principally on the arrangements payment
terms. Our standard payment terms require the arrangement fee to be due within a maximum of 90 days. Where these terms apply, we regard the fee as fixed or determinable, and we recognize revenue upon delivery pursuant to the terms of the
arrangement, assuming all other revenue recognition criteria are met. If the payment terms do not meet this standard, which we refer to as extended payment terms, we do not consider the fee to be fixed or determinable and generally
recognize revenue when customer installments are due and payable.
|
|
|
|
Collectibility is probable.
To recognize revenue, we must judge collectibility of the arrangement fees, which we do on a customer-by-customer basis pursuant
to our credit review policy. We typically sell to customers with whom we have a history of successful collection. For new customers, we evaluate the customers financial position and ability to pay. If we determined that collectibility is not
probable based upon our credit review process or the customers payment history, we recognize revenue when payment is received.
|
We allocate revenue on software transactions (referred to as arrangements in the accounting literature) involving multiple elements to each undelivered element based on their respective fair values.
Specifically, in a multi-element arrangement we allocate revenue first to undelivered elements such as support and maintenance, consulting services, and training based on each elements fair value and the residual is allocated to the product
license as product revenue. The fair value of support and maintenance fees is recognized ratably over the contractual term of the maintenance, typically one year. The fair value of services not considered essential to the functionality of the
product or technology delivered is initially deferred and recognized as revenue as the services are performed. Our determination of the fair value of each element in multiple element arrangements is based on vendor-specific objective evidence
(VSOE). We limit our assessment of the VSOE of fair value for each element to the price charged when that element is sold separately.
Arrangements that include consulting services are evaluated to determine whether those services are essential to the functionality of the other elements of the arrangement. When services are not considered essential, the revenue allocable
to the services is recognized separately from the software, provided VSOE of the fair value of these services exists. If we provide consulting services that are considered essential to the functionality of the software products, both the product
revenue and service revenue are recognized under contract accounting in accordance with the provisions of SOP 81-1,
Accounting for Performance of Construction-Type and Certain Production-Type Contracts
. Revenue from these arrangements is
recognized under the percentage of completion method based on the ratio of direct labor hours incurred to date to total projected labor hours except in limited circumstances where completion status cannot be reasonably estimated, in which case the
completed contract method is used.
39
Our software products are typically fully functional upon delivery and do not require significant
modification or alteration. For arrangements where services are not essential to the functionality of the software, customers typically purchase consulting services to facilitate the adoption of our technology, but they may also decide to use their
own resources or appoint other professional service organizations to perform these services. Software products and related support and maintenance services may be billed separately and independently from professional services, which are typically
billed on either a time-and-materials basis or a fixed fee basis. For time-and-materials contracts, we recognize revenue as the services are performed. For fixed fee engagements with milestones or acceptance provisions, revenue is recognized upon
the completion of a milestone or acceptance, if applicable.
We recognize revenue from patent license agreements when (i) the patent
license agreement is executed, (ii) the amounts due are fixed, determinable, and billable, and (iii) collection of the resulting receivable is probable.
We recognize revenue from indirect channels such as resellers using the same criteria as is used for arrangements obtained through our direct sales team.
We typically grant our customers a warranty which guarantees that our products will substantially conform to our current specifications for 90 days from
the delivery date pursuant to the terms of the arrangement. We account for the estimated cost of product and service warranties in accordance with SFAS 5,
Accounting for Contingencies
, provided that it is probable that a liability exists, and
provided the cost to repair or otherwise satisfy the claim can be reasonably estimated. The amount of the reserve recorded is equal to the costs to repair or otherwise satisfy the claim. Costs related to warranty claims were $231,000, $278,000, and
$0 in 2007, 2006, and 2005, respectively.
Stock-based Compensation Expense
Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS 123R, using the modified prospective transition method.
Under this transition method, stock-based compensation expense includes compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in
accordance with the original provisions of SFAS 123,
Accounting for Stock-Based Compensation
(SFAS 123). We recognize stock-based compensation expense for the unvested portion of stock-based compensation awards granted
prior to, but not yet vested, as of January 1, 2006 on an accelerated basis over the vesting period of the individual award consistent with our methodology prior to the adoption of SFAS 123R and consistent with the method described in Financial
Accounting Standards Board Interpretation 28,
Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans
. Stock-based compensation expense for all stock-based compensation awards granted after January 1, 2006
is based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R and compensation cost for these awards is recognized on a straight-line basis over the requisite service period of the award, which is generally the
option vesting term. In accordance with the provisions of SFAS 123R, we recognize stock-based compensation expense net of an estimated forfeiture rate and recognize the compensation expense for only those shares expected to vest over the requisite
service period of the award, which is generally the option vesting term. We estimate the forfeiture rate based on our historical experience during the preceding term that equals the expected life of the options. The expected life of the options is
based on the weighted-average period of time that options granted are expected to be outstanding giving consideration to vesting schedules and our historical exercise patterns. Our expected volatility is based on the daily historical volatility of
our common stock, over the expected life of the option. The risk-free rate is based on the implied yield currently available on U.S. Treasury zero-coupon issues with an equivalent remaining term to the expected life of the option. Where the expected
term of our stock-based awards does not correspond with the terms for which interest rates are quoted, we perform a straight-line interpolation to determine the rate from the available term maturities. Determining the fair value of stock based
awards at the grant date requires judgment, including estimating the expected life of stock options, the expected volatility of our stock and the amount of stock options expected to be forfeited. To the extent actual results or updated estimates
differ from our current estimates, such
40
amounts will be recorded as a cumulative adjustment in the period estimates are revised. Actual results, and future changes in estimates, may differ
substantially from our current estimates and our results of operations could be materially impacted.
Prior to January 1, 2006, we
accounted for our stock-based compensation arrangements for employees and non-employees using the intrinsic-value method pursuant to Accounting Principles Board Opinion 25,
Accounting for Stock Issued to Employees
(APB25).
Accordingly, stock-based compensation expense was generally recorded for fixed plan stock options on the date of grant only when either options were granted to non-employees or the fair value of the underlying common stock exceeded the exercise
price for stock options granted.
On June 30, 2006, we exchanged 959,531 vested stock options held by 18 employees with exercise
prices ranging from $3.86 to $118.44 for 422,472 vested stock options to those same employees at an exercise price of $2.85, which was our common stock price on the date of the exchange. Neither our officers nor members of our Board of Directors
participated in this exchange program. We did not recognize any stock-based compensation expense as a result of the exchange since the fair values of the new awards were less than the fair values of the original awards immediately prior to the
exchange.
On July 19, 2005, our Board of Directors approved the acceleration of vesting of certain unvested stock options with
exercise prices equal to or greater than $3.82 per share previously awarded to our employees (including our executive officers) and our Directors under our stock option plans. The acceleration of vesting was effective for stock options outstanding
as of July 19, 2005. Options to purchase approximately 1.7 million shares of common stock were accelerated. All of the options accelerated had exercise prices greater than our common stock price of $3.24 on the date of acceleration. The
weighted-average exercise price of the options accelerated was $5.00. In accordance with the provisions of APB25, no stock-based compensation expense was recognized as a result of the acceleration since the exercise price of all the accelerated
options exceeded our common stock price on the date of acceleration. The purpose of the acceleration was to enable us to avoid recognizing compensation expense associated with these options in future periods in our consolidated statement of
operations upon our adoption of SFAS 123R.
Valuation of Allowance for Doubtful Accounts
We must make estimates of the collectibility of our accounts receivable. We maintain an allowance for doubtful accounts for estimated losses resulting
from the inability of our customers to make required payments. A considerable amount of judgment is required when we assess the realization of receivables, including assessing the probability of collection and the current credit-worthiness of each
customer. We specifically analyze accounts receivable, including review of historical bad debts, customer credit-worthiness, current economic trends, aging of the balance, estimated collectibility percentages for different aging ranges, and changes
in our customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. If the financial condition of certain of our customers were to deteriorate, resulting in an impairment of their ability to make payments, we may
record a specific allowance against amounts owed to us by those customers, and thereby reduce the value of the receivable to the amount we reasonably believe will be collected. If all collection efforts have been exhausted, we would write off the
receivable against the allowance.
Valuation of Long-Lived Assets and Goodwill
We assess the impairment of identifiable intangibles, long-lived assets and goodwill whenever events or changes in circumstances indicate that the
carrying value may not be recoverable. Factors we consider important, which could trigger an impairment review, include the following:
|
|
|
significant underperformance relative to historical or projected future operating results;
|
|
|
|
significant changes in the manner or our use of the acquired assets or the strategy for our overall business;
|
41
|
|
|
significant negative industry or economic trends;
|
|
|
|
significant decline in our stock price for a sustained period; and
|
|
|
|
our market capitalization relative to our net book value.
|
We evaluate whether goodwill is impaired on at least an annual basis in accordance with SFAS 142,
Goodwill and Other Intangible Assets
(SFAS 142) or more frequently if certain indicators are
present. If this evaluation indicates that the value of the goodwill may be impaired, we make an assessment of the impairment of the goodwill using the two-step method prescribed by SFAS 142. Any such impairment charge could be significant and have
a material adverse effect on our reported financial statements. We completed our annual assessment of goodwill in the three months ended June 30, 2007, 2006, and 2005, respectively, and no impairment of goodwill was determined as a result of
these assessments. Any future impairment loss related to the goodwill recorded in connection with acquisitions will not be deductible by Tumbleweed for federal income tax purposes. As of December 31, 2007, we had goodwill of $48.1 million.
Accrual for Anticipated Operating Lease Losses
We assess anticipated operating lease losses whenever we determine that our usage of our facility space will be impacted by business conditions and subsequently reevaluate anticipated losses each time a sublease is entered into or exited.
Changing market conditions make anticipated operating lease losses difficult to determine. During 2003 we recognized a charge of $996,000 related to potential losses on an operating lease in Slough, United Kingdom that was included in our
consolidated statement of operations as Merger-related and other costs. The charge was estimated to include contractually required repairs, remaining lease liabilities, and brokerage fees, offset by estimated sublease income. During 2004 we
recognized a charge of $168,000 on an operating lease in Slough, United Kingdom, that was included in our consolidated statement of operations as Merger-related and other costs due to a revised estimate of the term of expected subleases on the
building which required an increase to the existing liability recorded for the anticipated lease loss on this lease. During 2005, we recognized a $296,000 credit related to this same lease that was included in our consolidated statement of
operations as Merger-related and other costs due to the combined cost of the final lease settlement payments, commissions, brokerage fees, and legal fees related to the termination of this lease being less than the existing accrual for the loss on
the lease. Estimates related to sublease costs and income are based on assumptions regarding the period required to locate and contract with a sublessee, sublease rates, and brokerage fees. Each reporting period we review these estimates, and to the
extent that our assumptions change and/or actual charges are incurred, the ultimate charge for the loss on this operating lease could vary from our current estimates.
Item 8Financial Statements and Supplementary Data
TUMBLEWEED COMMUNICATIONS CORP.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
43
R
EPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and
Stockholders
Tumbleweed Communications Corp.:
We have audited the accompanying consolidated balance sheets of Tumbleweed Communications Corp. and subsidiaries (the Company) as of December 31,
2007 and 2006, and the related consolidated statements of operations, stockholders equity and comprehensive loss, and cash flows for each of the years in the three-year period ended December 31, 2007. We also have audited the
Companys internal control over financial reporting as of December 31, 2007, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
The Companys management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting,
included in the accompanying Managements Report on Internal Control Over Financial Reporting appearing under item 9A(c). Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the
Companys internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of
the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective
internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of
internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such
other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinion.
A
companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect
the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our
opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2007 and 2006, and the results of their operations and their cash flows for each
of the years in the three-year period ended December 31, 2007, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2007, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
/s/ KPMG LLP
Mountain View, California
March 14, 2008
44
T
UMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except par value and share data)
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
2007
|
|
|
2006
|
|
ASSETS
|
|
|
|
|
|
|
Current assets:
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
26,299
|
|
|
$
|
30,511
|
|
Accounts receivable, net of allowance for doubtful accounts of $368 and $431 as of December 31, 2007 and 2006,
respectively
|
|
|
13,074
|
|
|
|
12,506
|
|
Other current assets
|
|
|
1,733
|
|
|
|
1,938
|
|
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
41,106
|
|
|
|
44,955
|
|
Property and equipment, net
|
|
|
2,038
|
|
|
|
1,820
|
|
Goodwill
|
|
|
48,074
|
|
|
|
48,074
|
|
Intangible assets, net
|
|
|
233
|
|
|
|
1,470
|
|
Other assets
|
|
|
385
|
|
|
|
612
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
91,836
|
|
|
$
|
96,931
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS EQUITY
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
820
|
|
|
$
|
1,808
|
|
Accrued liabilities
|
|
|
6,795
|
|
|
|
7,522
|
|
Accrued merger-related and other costs
|
|
|
|
|
|
|
97
|
|
Deferred revenue
|
|
|
20,996
|
|
|
|
20,003
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities
|
|
|
28,611
|
|
|
|
29,430
|
|
Deferred revenue, excluding current portion
|
|
|
5,401
|
|
|
|
4,728
|
|
Other long-term liabilities
|
|
|
13
|
|
|
|
63
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
34,025
|
|
|
|
34,221
|
|
|
|
|
|
|
|
|
|
|
Stockholders equity:
|
|
|
|
|
|
|
|
|
Preferred stock, $0.001 par value; 10,000,000 shares authorized, zero shares outstanding as of December 31, 2007 and 2006, respectively
|
|
|
|
|
|
|
|
|
Common stock, $0.001 par value; 100,000,000 shares authorized, 51,129,313 and 50,427,209 shares outstanding as of December 31, 2007 and
2006, respectively
|
|
|
52
|
|
|
|
51
|
|
Additional paid-in capital
|
|
|
365,155
|
|
|
|
359,238
|
|
Treasury stock (717,500 shares as of December 31, 2007 and 2006, respectively)
|
|
|
(796
|
)
|
|
|
(796
|
)
|
Accumulated other comprehensive income
|
|
|
94
|
|
|
|
29
|
|
Accumulated deficit
|
|
|
(306,694
|
)
|
|
|
(295,812
|
)
|
|
|
|
|
|
|
|
|
|
Total stockholders equity
|
|
|
57,811
|
|
|
|
62,710
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and stockholders equity
|
|
$
|
91,836
|
|
|
$
|
96,931
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
45
T
UMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
Product revenue
|
|
$
|
22,529
|
|
|
$
|
28,683
|
|
|
$
|
20,945
|
|
Service revenue
|
|
|
33,559
|
|
|
|
29,664
|
|
|
|
26,103
|
|
Intellectual property revenue
|
|
|
1,367
|
|
|
|
3,647
|
|
|
|
2,953
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
|
57,455
|
|
|
|
61,994
|
|
|
|
50,001
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of product revenue(1)
|
|
|
5,694
|
|
|
|
4,316
|
|
|
|
2,597
|
|
Provision for excess inventory
|
|
|
164
|
|
|
|
933
|
|
|
|
323
|
|
Cost of service revenue(1)
|
|
|
7,672
|
|
|
|
6,750
|
|
|
|
5,407
|
|
Amortization of intangible assets
|
|
|
936
|
|
|
|
1,467
|
|
|
|
2,040
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of revenue
|
|
|
14,466
|
|
|
|
13,466
|
|
|
|
10,367
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
42,989
|
|
|
|
48,528
|
|
|
|
39,634
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development(1)
|
|
|
15,107
|
|
|
|
14,836
|
|
|
|
12,107
|
|
Sales and marketing(1)
|
|
|
28,575
|
|
|
|
28,002
|
|
|
|
25,194
|
|
General and administrative(1)
|
|
|
10,157
|
|
|
|
10,622
|
|
|
|
6,013
|
|
Amortization of intangible assets
|
|
|
305
|
|
|
|
1,041
|
|
|
|
1,284
|
|
Merger-related and other credit
|
|
|
|
|
|
|
|
|
|
|
(96
|
)
|
Restructuring costs
|
|
|
930
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
55,074
|
|
|
|
54,501
|
|
|
|
44,502
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating loss
|
|
|
(12,085
|
)
|
|
|
(5,973
|
)
|
|
|
(4,868
|
)
|
Other income, net
|
|
|
1,336
|
|
|
|
1,206
|
|
|
|
982
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss before provision for income taxes
|
|
|
(10,749
|
)
|
|
|
(4,767
|
)
|
|
|
(3,886
|
)
|
Provision for income taxes
|
|
|
16
|
|
|
|
115
|
|
|
|
23
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(10,765
|
)
|
|
$
|
(4,882
|
)
|
|
$
|
(3,909
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss per sharebasic and diluted
|
|
$
|
(0.21
|
)
|
|
$
|
(0.10
|
)
|
|
$
|
(0.08
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average sharesbasic and diluted
|
|
|
51,028
|
|
|
|
50,007
|
|
|
|
48,627
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) Including stock-based compensation expense as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of product revenue
|
|
$
|
|
|
|
$
|
9
|
|
|
$
|
|
|
Cost of service revenue
|
|
|
142
|
|
|
|
142
|
|
|
|
2
|
|
Research and development
|
|
|
946
|
|
|
|
1,256
|
|
|
|
219
|
|
Sales and marketing
|
|
|
1,205
|
|
|
|
569
|
|
|
|
168
|
|
General and administrative
|
|
|
2,211
|
|
|
|
2,629
|
|
|
|
121
|
|
See accompanying notes to consolidated financial statements.
46
T
UMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY AND
COMPREHENSIVE LOSS
Years Ended December 31, 2007, 2006 and 2005
(in thousands, except share data)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common
Stock
Shares
|
|
Common
Stock
Amount
|
|
Additional
Paid-In
Capital
|
|
|
Treasury
Stock
|
|
|
Deferred
Stock-Based
Compensation
|
|
|
Accumulated
Other
Comprehensive
Income (Loss)
|
|
|
Comprehensive
Loss
|
|
|
Accumulated
Deficit
|
|
|
Total
Stock
holders
Equity
|
|
BALANCES, DECEMBER 31, 2004
|
|
48,154,581
|
|
$
|
48
|
|
$
|
351,122
|
|
|
$
|
(796
|
)
|
|
$
|
(525
|
)
|
|
$
|
(651
|
)
|
|
|
|
|
|
$
|
(286,794
|
)
|
|
$
|
62,404
|
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(3,909
|
)
|
|
|
(3,909
|
)
|
|
|
(3,909
|
)
|
Foreign currency translation adjustment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
58
|
|
|
|
58
|
|
|
|
|
|
|
|
58
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(3,851
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuance of common stock upon exercise of stock options
|
|
1,338,379
|
|
|
2
|
|
|
2,152
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,154
|
|
Amortization of deferred stock-based compensation expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
446
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
446
|
|
Credit to deferred stock-based compensation related to terminated employees
|
|
|
|
|
|
|
|
(172
|
)
|
|
|
|
|
|
|
92
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(80
|
)
|
Deferred stock-based compensation expense related to severance agreements
|
|
|
|
|
|
|
|
144
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
144
|
|
Deferred stock-based compensation expense related to stock options granted to non-employees
|
|
|
|
|
|
|
|
178
|
|
|
|
|
|
|
|
(178
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BALANCES, DECEMBER 31, 2005
|
|
49,492,960
|
|
$
|
50
|
|
$
|
353,424
|
|
|
$
|
(796
|
)
|
|
$
|
(165
|
)
|
|
$
|
(593
|
)
|
|
|
|
|
|
$
|
(290,703
|
)
|
|
$
|
61,217
|
|
Cumulative effect of adjustments from the adoption of SAB No. 108
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
624
|
|
|
|
|
|
|
|
(227
|
)
|
|
|
397
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
ADJUSTED BALANCES, DECEMBER 31, 2005
|
|
49,492,960
|
|
$
|
50
|
|
$
|
353,424
|
|
|
$
|
(796
|
)
|
|
$
|
(165
|
)
|
|
$
|
31
|
|
|
|
|
|
|
$
|
(290,930
|
)
|
|
$
|
61,614
|
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(4,882
|
)
|
|
|
(4,882
|
)
|
|
|
(4,882
|
)
|
Foreign currency translation adjustment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(2
|
)
|
|
|
(2
|
)
|
|
|
|
|
|
|
(2
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(4,884
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuance of common stock upon exercise of stock options
|
|
934,249
|
|
|
1
|
|
|
1,356
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,357
|
|
Additional paid in capital from stock-based compensation expense
|
|
|
|
|
|
|
|
4,605
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,605
|
|
Reduction in deferred stock-based compensation and additional paid in capital upon adoption of SFAS 123R
|
|
|
|
|
|
|
|
(165
|
)
|
|
|
|
|
|
|
165
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tax benefit from employee stock options
|
|
|
|
|
|
|
|
18
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
18
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BALANCES, DECEMBER 31, 2006
|
|
50,427,209
|
|
$
|
51
|
|
$
|
359,238
|
|
|
$
|
(796
|
)
|
|
$
|
|
|
|
$
|
29
|
|
|
|
|
|
|
$
|
(295,812
|
)
|
|
$
|
62,710
|
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(10,765
|
)
|
|
|
(10,765
|
)
|
|
|
(10,765
|
)
|
Foreign currency translation adjustment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
65
|
|
|
|
65
|
|
|
|
|
|
|
|
65
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(10,700
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuance of common stock upon exercise of stock options
|
|
702,104
|
|
|
1
|
|
|
1,413
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,414
|
|
Additional paid in capital from stock-based compensation expense
|
|
|
|
|
|
|
|
4,504
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,504
|
|
Adoption effect of EITF 06-02
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(117
|
)
|
|
|
(117
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
BALANCES, DECEMBER 31, 2007
|
|
51,129,313
|
|
$
|
52
|
|
$
|
365,155
|
|
|
$
|
(796
|
)
|
|
$
|
|
|
|
$
|
94
|
|
|
|
|
|
|
$
|
(306,694
|
)
|
|
$
|
57,811
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
47
T
UMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
Cash flows provided by (used in) operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(10,765
|
)
|
|
$
|
(4,882
|
)
|
|
$
|
(3,909
|
)
|
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock-based compensation expense
|
|
|
4,504
|
|
|
|
4,605
|
|
|
|
510
|
|
Depreciation and amortization expense
|
|
|
2,641
|
|
|
|
3,633
|
|
|
|
4,471
|
|
Bad debt expense
|
|
|
22
|
|
|
|
55
|
|
|
|
|
|
Loss (gain) on disposal of property and equipment
|
|
|
(163
|
)
|
|
|
44
|
|
|
|
45
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
(590
|
)
|
|
|
(3,493
|
)
|
|
|
(1,609
|
)
|
Other current assets and other assets
|
|
|
432
|
|
|
|
(594
|
)
|
|
|
177
|
|
Accounts payable, accrued liabilities, and other long-term liabilities
|
|
|
(1,819
|
)
|
|
|
2,800
|
|
|
|
1,214
|
|
Accrued merger-related and other costs
|
|
|
(97
|
)
|
|
|
(136
|
)
|
|
|
(972
|
)
|
Deferred revenue
|
|
|
1,666
|
|
|
|
1,785
|
|
|
|
4,783
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in) operating activities
|
|
|
(4,169
|
)
|
|
|
3,817
|
|
|
|
4,710
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows used in investing activitiespurchase of property and equipment
|
|
|
(1,522
|
)
|
|
|
(1,631
|
)
|
|
|
(938
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Repayments of borrowings
|
|
|
|
|
|
|
|
|
|
|
(467
|
)
|
Proceeds from issuance of common stock
|
|
|
1,414
|
|
|
|
1,357
|
|
|
|
2,154
|
|
Tax benefit from employee stock option plans
|
|
|
|
|
|
|
18
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by financing activities
|
|
|
1,414
|
|
|
|
1,375
|
|
|
|
1,687
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect of exchange rate fluctuations
|
|
|
65
|
|
|
|
(2
|
)
|
|
|
58
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net increase (decrease) in cash and cash equivalents
|
|
|
(4,212
|
)
|
|
|
3,559
|
|
|
|
5,517
|
|
Cash and cash equivalents, beginning of year
|
|
|
30,511
|
|
|
|
26,952
|
|
|
|
21,435
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents, end of year
|
|
$
|
26,299
|
|
|
$
|
30,511
|
|
|
$
|
26,952
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosures of cash flow information:
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash paid during the year for interest
|
|
$
|
|
|
|
$
|
|
|
|
$
|
20
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash paid during the year for taxes
|
|
$
|
80
|
|
|
$
|
13
|
|
|
$
|
11
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
48
T
UMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2007, 2006, and 2005
(1) Organization
Tumbleweed Communications Corp. (Tumbleweed) is a recognized expert in
providing managed file transfer, email security, and identity validation products for enterprise and government customers of all sizes. With Tumbleweeds products, organizations can block security threats, protect information, confidently
conduct business online, and reduce their cost of doing business. Tumbleweed provides comprehensive solutions for secure file transfer, email threat protection, email encryption, and identity validation that allow organizations to safely and
confidently conduct business over the Internet.
(2) Summary of Significant Accounting Policies
Basis of Presentation and Consolidation Policy
The accompanying consolidated financial statements include the accounts of Tumbleweed and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
Reclassifications
Certain
reclassifications have been made to prior years amounts to properly state cash capital expenditures in the consolidated financial statement of cash flows and to conform to the current year presentation. The effects of these reclassifications were
immaterial to operating and investing cash flows in 2006 and 2005.
Cash and Cash Equivalents
Tumbleweed considers all highly liquid investments purchased with original maturities of three months or less to be cash equivalents.
Concentrations of Credit Risk
Financial instruments, which potentially subject Tumbleweed to concentrations of credit risk, consist primarily of cash equivalents and accounts receivable. Tumbleweeds cash equivalents generally consist of money market funds with
qualified financial institutions. To analyze accounts receivable, Tumbleweed performs periodic evaluations of its customers financial condition and, when necessary, records bad debt expense. No single customer comprised 10% or more of
Tumbleweeds accounts receivable balance, net of allowance for doubtful accounts, at December 31, 2007. One customer comprised 27% of Tumbleweed accounts receivable balance, net of allowance for doubtful accounts, at December 31,
2006. This balance was collected in full during the three months ended March 31, 2007. For 2007 and 2005, respectively, no single customer comprised 10% or more of Tumbleweeds revenue. For 2006, one customer comprised 13% of revenue.
Property and Equipment
Property and equipment are stated at cost. Depreciation and amortization are computed using the straight-line method over the estimated useful life of the asset, generally 2 to 5 years for computers, software, furniture, and equipment; and
the shorter of the estimated useful life of the asset or the remaining lease term for leasehold improvements. Tumbleweed recorded depreciation expense of $1.4 million, $1.1 million, and $1.1 million for 2007, 2006, and 2005, respectively.
49
TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Maintenance and repairs are expensed as incurred. Renewals and betterments that materially extend the
lives of assets are capitalized and depreciated. Upon disposal, the assets cost and accumulated depreciation are removed from the balance sheet and any resulting gain or loss is recorded in the consolidated statement of operations.
Capitalized Software
Development
costs incurred in the research and development of new software products and enhancements to existing software products are expensed as incurred until technological feasibility in the form of a working model has been established. To date, capitalized
costs for software development have not been material. The period between the achievement of technological feasibility and the general release of Tumbleweeds products has typically been of a short duration.
Restricted Cash and Letters of Credit
Tumbleweed had restricted cash in the amounts of $0 and $26,000 included as a part of Other current assets on its consolidated balance sheets as of December 31, 2007 and 2006, respectively. Tumbleweed had restricted cash in the amounts
of $369,000 and $571,000 included as a part of Other assets on its consolidated balance sheets as of December 31, 2007 and 2006, respectively. The restricted cash primarily relates to letters of credit held by the lessors of Tumbleweeds
Redwood City, California and Sofia, Bulgaria offices and its former office in Palo Alto, California.
Goodwill and Intangible Assets
Tumbleweed assesses the impairment of identifiable intangibles, long-lived assets and goodwill whenever events or changes in
circumstances indicate that the carrying value may not be recoverable. Factors that are considered important, which could trigger an impairment review, include the following:
|
|
|
significant underperformance relative to historical or projected future operating results;
|
|
|
|
significant changes in the manner or use of the acquired assets or the strategy for the overall business;
|
|
|
|
significant negative industry or economic trends;
|
|
|
|
significant decline in Tumbleweeds stock price for a sustained period; and
|
|
|
|
Tumbleweeds market capitalization relative to its net book value.
|
Recoverability of intangible assets held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows
expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets, generally estimated using
discounted net cash flows. Assets to be disposed of are reported at the lower of their carrying amount or fair value less cost to sell.
As
of December 31, 2007, in connection with the acquisitions of Corvigo inc. (Corvigo), Incubator Limited (Incubator), and Valicert, Inc. (Valicert) on March 18, 2004, March 15, 2004, and
June 23, 2003, respectively, Tumbleweed recognized $33.4 million, $1.4 million, and $13.3 million of goodwill, respectively, representing the excess of the respective purchase prices over the fair values of the acquired net tangible and
identified intangible assets. In accordance with the provisions of Statement of Financial Accounting Standards (SFAS) 142
, Goodwill and Other Intangible Assets
, (SFAS 142), the goodwill acquired in the Corvigo,
Incubator, and Valicert acquisitions is not amortized, but instead, the goodwill balances will be tested for impairment at least annually and more frequently if certain indicators are present. Any future impairment loss related to the goodwill
recorded in connection with the acquisitions of Corvigo, Incubator, and Valicert will not be deductible by Tumbleweed for federal income tax purposes.
50
TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Revenue Recognition
Tumbleweed derives its revenue from three sources: (i) product revenue, which includes license fees and appliance fees (for products that are
delivered on an appliance platform), and subscription-based license fees; (ii) service revenue, which consists of support and maintenance fees, consulting fees, and training fees; and (iii) intellectual property revenue, which consists of
patent license agreement fees. 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
Tumbleweeds revenue for any period based on the judgments and estimates made by its management.
Tumbleweed recognizes revenue in
accordance with Statement of Position (SOP) 97-2,
Software Revenue Recognition
(SOP 97-2), as amended by SOP 98-9,
Modification of SOP 97-2
, Software Revenue Recognition
With Respect to Certain
Transactions
(SOP 98-9). Tumbleweed makes significant judgments related to revenue recognition. Specifically, as set forth in paragraph 8 of SOP 97-2 in connection with each transaction involving our products, Tumbleweed must
evaluate whether: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the fee is fixed or determinable, and (iv) collectibility is probable. Tumbleweed applies these criteria as discussed below.
|
|
|
Persuasive evidence of an arrangement exists.
Tumbleweed requires a written contract, signed by both the customer and Tumbleweed, or a
purchase order from those customers that have previously negotiated a standard license arrangement or volume purchase agreement with Tumbleweed prior to recognizing revenue on an arrangement.
|
|
|
|
Delivery has occurred.
Tumbleweed delivers software to its customers physically or electronically. For physical deliveries,
Tumbleweeds transfer terms are typically free on board, or FOB, shipping point. For electronic deliveries, delivery occurs when Tumbleweed provides the customer access codes or keys that allow the customer to take immediate
possession of the software.
|
|
|
|
The fee is fixed or determinable.
Tumbleweeds determination that an arrangement fee is fixed or determinable depends principally
on the arrangements payment terms. Tumbleweeds standard payment terms require the arrangement fee to be due within a maximum of 90 days. Where these terms apply, Tumbleweed regards the fee as fixed or determinable and recognizes revenue
upon delivery pursuant to the terms of the arrangement, assuming all other revenue recognition criteria are met. If the payment terms do not meet this standard, which Tumbleweed refers to as extended payment terms, Tumbleweed does not
consider the fee to be fixed or determinable and generally recognizes revenue when customer installments are due and payable.
|
|
|
|
Collectibility is probable.
To recognize revenue, Tumbleweed must judge collectibility of the arrangement fees, which it does on a
customer-by-customer basis pursuant to its credit review policy. Tumbleweed typically sells to customers with whom it has a history of successful collection. For new customers, Tumbleweed evaluates their financial position and ability to pay. If
Tumbleweed determines that collectibility is not probable based upon its credit review process or its customers payment history, Tumbleweed recognizes revenue when payment is received.
|
Tumbleweed allocates revenue on software transactions (referred to as arrangements in the accounting literature) involving multiple elements
to each undelivered element based on their respective fair values. Specifically, in a multi-element arrangement Tumbleweed allocates revenue first to undelivered elements such as support and maintenance, consulting services, and training based on
each elements fair value and the residual is allocated to the product license as product revenue. The fair value of support and maintenance fees is recognized ratably over the contractual term of the maintenance, typically one year. The
fair value of services not considered essential to the functionality of the product or technology delivered is initially deferred and recognized as
51
TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
revenue as the services are performed. Tumbleweeds determination of the fair value of each element in multiple element arrangements is based on
vendor-specific objective evidence (VSOE). Tumbleweed limits its assessment of the VSOE of fair value for each element to the price charged when that element is sold separately.
Arrangements that include consulting services are evaluated to determine whether those services are essential to the functionality of the other elements
of the arrangement. When services are not considered essential, the revenue allocable to the services is recognized separately from the software, provided VSOE of the fair value of these services exists. If Tumbleweed provides consulting services
that are considered essential to the functionality of the software products, both the product revenue and service revenue are recognized under contract accounting in accordance with the provisions of SOP 81-1,
Accounting for Performance of
Construction-Type and Certain Production-Type Contracts
. Revenue from these arrangements is recognized under the percentage of completion method based on the ratio of direct labor hours incurred to date to total projected labor hours except in
limited circumstances where completion status cannot be reasonably estimated, in which case the completed contract method is used.
Tumbleweeds software products are typically fully functional upon delivery and do not require significant modification or alteration. For arrangements where services are not essential to the functionality of the software, customers
typically purchase consulting services to facilitate the adoption of Tumbleweeds technology, but they may also decide to use their own resources or appoint other professional service organizations to perform these services. Software products
and related support and maintenance services may be billed separately and independently from professional services, which are typically billed on either a time-and-materials basis or a fixed fee basis. For time-and-materials contracts, Tumbleweed
recognizes revenue as the services are performed. For fixed fee engagements with milestones or acceptance provisions, revenue is recognized upon completion of a milestone or acceptance, if applicable.
Tumbleweed recognizes revenue from patent license agreements when (i) the patent license agreement is executed, (ii) the amounts due are fixed,
determinable, and billable, and (iii) collection of the resulting receivable is probable.
Tumbleweed recognizes revenue from indirect
channels such as resellers using the same criteria as are used for arrangements obtained through its direct sales team.
Tumbleweed
typically grants its customers a warranty which guarantees that its products will substantially conform to its current specifications for 90 days from the delivery date pursuant to the terms of the arrangement. Tumbleweed accounts for the estimated
cost of product and service warranties in accordance with SFAS 5,
Accounting for Contingencies
, provided that it is probable that a liability exists, and provided the cost to repair or otherwise satisfy the claim can be reasonably estimated.
The amount of the accrual recorded is equal to the costs to repair or otherwise satisfy the claim. Costs related to warranty claims were $231,000, $278,000, and $0 in 2007, 2006, and 2005, respectively.
Advertising
Tumbleweed expenses
advertising costs as incurred. Total advertising expense was $552,000, $236,000, and $111,000, for 2007, 2006, and 2005, respectively.
52
TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax basis and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or settled. A valuation allowance is recorded to reduce deferred tax assets to an amount whose realization is more likely than not. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
Stock-Based Compensation
Tumbleweeds stock-based compensation program is a broad-based, long-term retention program that is intended to attract and retain
employees and align stockholder and employee interests. The stock-based compensation program includes awards of stock options and restricted stock.
Tumbleweed recognizes stock-based compensation expense for the unvested portion of stock-based compensation awards granted prior to, but not yet vested, as of January 1, 2006 on an accelerated basis over the vesting period of the
individual award consistent with its methodology prior to the adoption of SFAS 123 (revised 2004),
Share-Based Payment
(SFAS 123R) and consistent with the method described in Financial Accounting Standards Board
Interpretation 28,
Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans
. Stock-based compensation expense for all stock-based compensation awards granted after January 1, 2006 is based on the grant-date
fair value estimated in accordance with the provisions of SFAS 123R and compensation cost for these awards is recognized on a straight-line basis over the requisite service period of the award, which is generally the option vesting term.
Prior to January 1, 2006, Tumbleweed accounted for its stock-based compensation arrangements for employees and non-employees using
the intrinsic-value method pursuant to Accounting Principles Board Opinion 25,
Accounting for Stock Issued to Employees
(APB25). Accordingly, stock-based compensation expense was generally recorded for fixed plan stock options on
the date of grant only when either options were granted to non-employees or the fair value of the underlying common stock exceeded the exercise price for stock options granted.
Had stock-based compensation expense for Tumbleweeds stock-based compensation plans been determined consistent with the fair value approach set
forth in SFAS 123, Tumbleweeds net losses for 2005 would have been as follows (in thousands, except per share amounts):
|
|
|
|
|
|
|
2005
|
|
Net loss as reported
|
|
$
|
(3,909
|
)
|
Add: Stock-based compensation expense included in net loss
|
|
|
510
|
|
Less: Total stock-based compensation determined under fair value based method for all awards
|
|
|
(10,650
|
)
|
|
|
|
|
|
Net loss pro forma
|
|
$
|
(14,049
|
)
|
|
|
|
|
|
Basic and diluted net loss per share as reported
|
|
$
|
(0.08
|
)
|
|
|
|
|
|
Basic and diluted net loss per share pro forma
|
|
$
|
(0.29
|
)
|
|
|
|
|
|
53
TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
On June 30, 2006, Tumbleweed exchanged 959,531 vested stock options held by 18 employees with
exercise prices ranging from $3.86 to $118.44 for 422,472 vested stock options to those same employees at an exercise price of $2.85, which was Tumbleweeds common stock price on the date of the exchange. Neither Tumbleweed officers nor members
of its Board of Directors participated in this exchange program. Tumbleweed did not recognize any stock-based compensation expense as a result of the exchange since the fair values of the new awards were less than the fair values of the original
awards immediately prior to the exchange.
On July 19, 2005, Tumbleweed Board of Directors approved the acceleration of vesting of
certain unvested stock options with exercise prices equal to or greater than $3.82 per share previously awarded to its employees (including executive officers) and Directors under Tumbleweed stock option plans. The acceleration of vesting was
effective for stock options outstanding as of July 19, 2005. Options to purchase approximately 1.7 million shares of common stock were accelerated. All of the options accelerated had exercise prices greater than our common stock price of
$3.24 on the date of acceleration. The weighted-average exercise price of the options accelerated was $5.00. In accordance with the provisions of APB25, no stock-based compensation expense was recognized as a result of the acceleration since the
exercise price of all the accelerated options exceeded our common stock price on the date of acceleration. The purpose of the acceleration was to enable Tumbleweed to avoid recognizing compensation expense associated with these options in future
periods in its consolidated statement of operations upon its adoption of SFAS 123R.
Tumbleweed estimates the fair value of stock options
granted using the Black-Scholes-Merton option-pricing model that uses the assumptions noted in the following table. The expected life of the options is based on the weighted-average period of time that options granted are expected to be outstanding,
giving consideration to vesting schedules and Tumbleweeds historical exercise patterns. Tumbleweeds expected volatility is based on the daily historical volatility of Tumbleweeds common stock, over the expected life of the option.
The risk-free interest rate is based on the implied yield currently available on U.S. Treasury zero-coupon issues with an equivalent remaining term to the expected life of the option. When the expected term of Tumbleweeds stock-based awards
does not correspond with the terms for which interest rates are quoted, Tumbleweed performs a straight-line interpolation to determine the rate from the available term maturities. Tumbleweed has not historically paid dividends, thus the expected
dividend yield is zero. Tumbleweed issues new shares of common stock upon the exercise of stock options. The assumptions for 2007, 2006, and 2005, respectively, are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
Stock options:
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average fair value of grants
|
|
$
|
1.65
|
|
|
$
|
1.86
|
|
|
$
|
2.16
|
|
Expected life
|
|
|
4.5 years
|
|
|
|
4.5 years
|
|
|
|
4.0 years
|
|
Expected volatility
|
|
|
69
|
%
|
|
|
81
|
%
|
|
|
89
|
%
|
Risk-free interest rate
|
|
|
4.40
|
%
|
|
|
4.75
|
%
|
|
|
3.99
|
%
|
Dividend yield
|
|
|
0
|
%
|
|
|
0
|
%
|
|
|
0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The cost of restricted stock awards is determined using the fair value of Tumbleweeds common
stock on the date of the grant, and compensation expense is recognized over the vesting period. Vesting periods are determined by Tumbleweed Board of Directors. Generally, restricted stock awards are subject to the employees continuing service
to Tumbleweed. The weighted-average grant date fair value of restricted stock granted during 2007 was $2.62.
54
TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Total stock-based compensation expense for 2007, 2006, and 2005 was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
2007
|
|
2006
|
|
2005
|
Cost of product revenue
|
|
$
|
|
|
$
|
9
|
|
$
|
|
Cost of service revenue
|
|
|
142
|
|
|
142
|
|
|
2
|
Research and development
|
|
|
946
|
|
|
1,256
|
|
|
219
|
Sales and marketing
|
|
|
1,205
|
|
|
569
|
|
|
168
|
General and administrative
|
|
|
2,211
|
|
|
2,629
|
|
|
121
|
|
|
|
|
|
|
|
|
|
|
Total stock-based compensation expense
|
|
$
|
4,504
|
|
$
|
4,605
|
|
$
|
510
|
|
|
|
|
|
|
|
|
|
|
Tumbleweed issues new shares of common stock upon the exercise of stock options. The following is
a summary of activity for Tumbleweeds stock option plans for 2007:
|
|
|
|
|
|
|
|
|
|
|
|
Options
|
|
Number of
Shares
|
|
|
Weighted-
average
Exercise Price
|
|
Weighted-
average
Remaining
Contractual
Term
|
|
Aggregate
Intrinsic
Value (in
thousands)
|
Outstanding at January 1, 2007
|
|
13,919,751
|
|
|
$
|
3.63
|
|
|
|
|
|
Granted
|
|
4,455,450
|
|
|
|
2.69
|
|
|
|
|
|
Exercised
|
|
(714,586
|
)
|
|
|
2.90
|
|
|
|
|
|
Forfeited, cancelled, and expired
|
|
(2,736,934
|
)
|
|
|
4.84
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 2007
|
|
14,923,681
|
|
|
$
|
3.21
|
|
7.30
|
|
$
|
663
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested and expected to vest at December 31, 2007
|
|
12,912,618
|
|
|
$
|
2.59
|
|
7.01
|
|
$
|
655
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at December 31, 2007
|
|
9,225,997
|
|
|
$
|
3.53
|
|
6.23
|
|
$
|
640
|
|
|
|
|
|
|
|
|
|
|
|
|
The aggregate intrinsic value of options exercised under Tumbleweeds stock option plans for
2007 was $700,000, determined as of the date of option exercise. During 2006, the aggregate intrinsic value of options exercised under Tumbleweeds stock option plans was $1.3 million, determined as of the date of option exercise.
As of December 31, 2007 there was $6.3 million of total unrecognized compensation cost, adjusted for estimated forfeitures, related to non-vested
stock options. That cost is expected to be recognized over a weighted-average period of 2.9 years. As of December 31, 2006 there was $5.3 million of total unrecognized compensation cost, adjusted for estimated forfeitures, related to non-vested
stock options. That cost is expected to be recognized over a weighted-average period of 2.1 years.
Non-vested restricted stock awards as
of December 31, 2007 and 2006 were as follows:
|
|
|
|
|
|
Options
|
|
Number of
Shares
|
|
Weighted-
average
Grant Date Fair
Value
|
Non-vested at December 31, 2006
|
|
|
|
$
|
|
Granted
|
|
83,000
|
|
|
2.62
|
|
|
|
|
|
|
Non-vested at December 31, 2007
|
|
83,000
|
|
$
|
2.62
|
|
|
|
|
|
|
55
TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
As of December 31, 2007, there was $116,000 of total unrecognized compensation cost, adjusted
for estimated forfeitures, related to non-vested restricted stock awards. That cost is expected to be recognized over a weighted-average period of 2.4 years.
At December 31, 2007, Tumbleweed has the following stock option plans as described below:
1999
Employee Stock Purchase Plan
The 1999 Employee Stock Purchase Plan (the Purchase Plan) was approved by Tumbleweeds
stockholders on August 3, 1999, which allows eligible employees to purchase common stock at a discount from fair market value. A total of 500,000 shares of common stock has been reserved for issuance under the Purchase Plan for each fiscal year
occurring during the term of the Purchase Plan, which will terminate in 2009. Tumbleweed suspended the Purchase Plan in 2002.
1993
Stock Option Plan
On September 30, 1993, Tumbleweed adopted the 1993 Stock Option Plan (the Plan). In 1999,
Tumbleweeds Board of Directors approved an amendment to the plan to increase the number of shares authorized for issuance by 650,000 shares to a total of 3,768,500 authorized shares. In August 1999, Tumbleweed ceased granting further options
under the Plan. Under the Plan, the exercise price for incentive options is at least 100% of the fair market value on the date of grant. The exercise price for nonqualified stock options is at least 85% of the fair market value on the date of grant.
Options generally expire in ten years. Vesting periods are determined by Tumbleweeds Board of Directors and generally provide for 25% of the options to vest on the first anniversary date of the grant with the remaining options vesting monthly
over the following 36 months.
1999 Omnibus Stock Incentive Plan
The 1999 Omnibus Stock Incentive Plan (the Incentive Plan) was approved by Tumbleweeds stockholders on August 3, 1999, for the
benefit of Tumbleweeds officers, directors, key employees, advisors and consultants. An aggregate of 16,882,858 shares of common stock is reserved for issuance under the Incentive Plan, which provides for the issuance of stock-based incentive
awards, including stock options, stock appreciation rights, limited stock appreciation rights, restricted stock, deferred stock, and performance shares. Options generally expire in ten years. The Incentive Plan provides for an automatic annual
increase in the number of stock options available for grant of the lesser of 2,000,000 shares or 5% of the number of Tumbleweeds outstanding shares on the last day of the immediately preceding fiscal year.
2000 NSO Incentive Stock Plan
The
2000 NSO Incentive Stock Plan (the NSO Incentive Plan) was adopted by Tumbleweeds Board of Directors on July 10, 2000. The NSO Incentive Plan qualifies as a broadly based plan and is for the benefit of
Tumbleweeds officers, directors, employees, advisors, and consultants. It provides for the issuance of stock-based incentive awards, including stock options, stock appreciation rights, restricted stock, deferred stock, and performance shares
or any combination of such. The options granted under the NSO Incentive Plan are not intended to qualify as incentive stock options within the meaning of Section 422 of the Internal Revenue Code of 1986. An aggregate of 4,181,500
shares of common stock are reserved for issuance under the NSO Incentive Plan, which will terminate on July 10, 2010.
56
TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Under the terms of the NSO Incentive Plan, the exercise price for stock options is determined by the
Board of Directors, Compensation Committee, or Administrators, generally 100% of the fair market value on the date of grant. The option term is determined by the Board of Directors, Compensation Committee, or Administrators, generally no longer than
ten years. Vesting periods are determined by the Board of Directors, Compensation Committee, or Administrators and generally provide for 25% of the options to vest on the first anniversary date of the grant with the remaining options vesting monthly
over the following 36 months.
Interface Stock Option Plans
On September 1, 2000, Tumbleweed assumed the Interface 1992 Stock Option Plan (the 1992 Plan) in connection with the Interface, Inc.
(Interface) acquisition. The 1992 Plan provided for the grant of both incentive stock options and non-qualified options to officers and key employees at not less than market price on the date of grant as determined by the Board of
Directors. Under the 1992 Plan, options generally vest at the rate of 33% per year after one year from the date of grant and have a term of ten years.
Valicert Stock Option Plans
On June 23, 2003, Tumbleweed assumed the Valicert 1998 Stock Option
Plan, the 2001 Non-Statutory Stock Plan, the 1996 Equity Incentive Plan, and the Receipt.com Plan in connection with the acquisition of Valicert. These stock plans provide for the grant of options and restricted stock to employees, consultants and
directors. Incentive stock options are granted at fair market value on the date of grant. Non-statutory options may be offered at not less than 85% of the fair market value on the date of the grant. Options generally vest over four years, and have a
maximum term of ten years. The number of stock options available for grant automatically increases on the first day of each fiscal year by the lesser of 1,413,912 shares or 5% of the number of Tumbleweeds outstanding shares on the last day of
the preceding year. An aggregate of 8,959,813 shares of common stock is reserved for issuance under the Valicert stock option plans.
Valicert stock option plans assumed by Tumbleweed were amended to conform with Tumbleweed stock option plans. This provides Tumbleweed with the flexibility to issue additional options as needed and promotes uniformity in new options issued
to ex-Valicert and Tumbleweed employees. Specifically, the 2001 Non-Statutory Stock Plan, the 1998 Stock Option Plan and the 1996 Equity Incentive Plan, were amended, including the forms of option agreements under each such plan, to conform the
terms and conditions applicable to options granted under such plans to the terms and conditions applicable to options granted under Tumbleweeds 1999 Omnibus Incentive Plan, including the form of option agreement under such plan.
In addition to conforming the terms of the Valicert stock option plans assumed by Tumbleweed to Tumbleweeds stock option plan, the 1998 Stock
Option Plan was further amended prior to the closing of the merger to provide the following:
|
|
|
the number of shares of Valicert common stock available for grant under the 1998 Stock Option Plan immediately following the close of the merger was no less than
1.5 million shares of Valicert common stock; and
|
|
|
|
the provision of the 1998 Stock Option Plan that provides for a 5% annual increase in the number of stock options available for grant under such plan shall be
calculated as a percentage of the number of Tumbleweed shares issued and outstanding rather than the number of Valicert shares issued and outstanding.
|
57
TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Corvigo Stock Option Plan
On March 18, 2004, Tumbleweed assumed the Corvigo 2002 Stock Option Plan in connection with the acquisition of Corvigo. This plan provides for the
grant of options to employees, consultants and directors. Incentive stock options are granted at fair market value on the date of grant. Non-statutory options may be offered at not less than 85% of the fair market value on the date of the grant.
Generally, 25% of the options vest on the first anniversary date of the grant with the remaining options vesting monthly over the following 36 months. Options have a maximum term of ten years. An aggregate of 884,678 shares of common stock is
reserved for issuance under the Corvigo 2002 Stock Option Plan, which will not grant new options after November 15, 2012.
The
following table summarizes information about stock options outstanding as of December 31, 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Outstanding
|
|
Options Exercisable
|
Range of
Exercise Prices
|
|
Number
Outstanding
|
|
Weighted
Average
Exercise
Price
|
|
Average
Remaining
Contractual
Life (Years)
|
|
Number
Exercisable
|
|
Weighted
Average
Exercise
Price
|
$0.00$0.99
|
|
704,624
|
|
$
|
0.91
|
|
4.7
|
|
704,624
|
|
$
|
0.91
|
1.002.52
|
|
2,715,626
|
|
|
2.03
|
|
8.4
|
|
1,025,339
|
|
|
2.06
|
2.532.99
|
|
6,336,491
|
|
|
2.73
|
|
7.8
|
|
4,087,185
|
|
|
2.71
|
3.004.59
|
|
3,938,019
|
|
|
3.32
|
|
6.8
|
|
2,179,928
|
|
|
3.39
|
4.805.99
|
|
668,434
|
|
|
4.83
|
|
6.3
|
|
668,434
|
|
|
4.83
|
6.009.99
|
|
215,390
|
|
|
6.84
|
|
5.4
|
|
215,390
|
|
|
6.84
|
10.0017.99
|
|
208,780
|
|
|
13.83
|
|
2.1
|
|
208,780
|
|
|
13.83
|
20.00118.99
|
|
136,317
|
|
|
27.47
|
|
2.4
|
|
136,317
|
|
|
27.47
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$0.05$118.44
|
|
14,923,681
|
|
$
|
3.21
|
|
7.3
|
|
9,225,997
|
|
$
|
3.53
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In conjunction with various financing arrangements and employment recruitment services provided to
us in 1998, 1999, and 2001, we issued warrants to purchase an aggregate of approximately 583,113 shares of common stock. Additional warrants to purchase an aggregate of 289,789 shares of common stock were assumed in 2003 as a result of the merger
with Valicert, none of which remained outstanding at December 31, 2007. As of December 31, 2007 and 2006, respectively, there were 69,015 and 72,845 warrants outstanding to purchase our common stock. Of the warrants that remain outstanding
at December 31, 2007, 21,129 expire in April 2008 with an exercise price of $4.91; 10,266 expire in April 2008 with an exercise price of $5.84; 2,566 expire in February 2010 with an exercise price of $49.09; 1,283 expire in April 2010 with an
exercise price of $49.09; and the remaining 33,771 expire in June 2011 with an exercise price of $6.66. During 2007 and 2006 no warrants were exercised.
Net Loss per Share
Basic net loss per common share has been computed using the weighted-average
number of shares of common stock outstanding during the period, less shares subject to repurchase. The following table presents the calculation of basic and diluted net loss per share (in thousands, except per share amounts):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
Net loss
|
|
$
|
(10,765
|
)
|
|
$
|
(4,882
|
)
|
|
$
|
(3,909
|
)
|
Weighted-average shares used in computing basic and diluted net loss per common share
|
|
|
51,028
|
|
|
|
50,007
|
|
|
|
48,627
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss per sharebasic and diluted
|
|
$
|
(0.21
|
)
|
|
$
|
(0.10
|
)
|
|
$
|
(0.08
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
58
TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Tumbleweed excludes potentially dilutive securities from its diluted net loss per share computation
when their effect would be antidilutive to net loss per share amounts. The following potential common shares were excluded from the net loss per share computation (in thousands):
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
2007
|
|
2006
|
|
2005
|
Warrants and options for which the exercise price was less than the average fair market value of Tumbleweeds common stock during the
period but were excluded as inclusion would decrease net loss per share
|
|
|
|
|
|
2,385
|
Warrants and options excluded due to the exercise price exceeding the average fair market value of common stock during the
period
|
|
12,761
|
|
7,725
|
|
7,082
|
|
|
|
|
|
|
|
Total potential common shares excluded from diluted net loss per share
|
|
12,761
|
|
7,725
|
|
9,467
|
|
|
|
|
|
|
|
Fair Value of Financial Instruments
The fair values of Tumbleweeds cash, cash equivalents, accounts receivable and accounts payable approximate their carrying values due to the short
maturity or variable-rate structure of those instruments.
Deferred Revenue and Accounts Receivable
Tumbleweed records as deferred revenue any billed amounts due from customers in excess of revenues recognized. Advance payments are also recorded as
deferred revenue until the products are shipped, services are delivered, or obligations are met. Accounts receivable includes amounts due from customers for which revenue has been recognized or amounts are legally due. Tumbleweed evaluates the
collectibility of its accounts receivable based on a combination of factors. In cases where Tumbleweed is aware of circumstances that may impair a specific customers ability to meet its financial obligations, Tumbleweed records a specific
allowance against amounts owed to it by that customer, and thereby reduces the net recognized receivable to the amount it reasonably believes will be collected. If all collection efforts have been exhausted, Tumbleweed writes off the receivable
against the allowance. In addition, Tumbleweed analyzes its accounts receivable balance in total, including review of historical bad debts, current economic trends, aging of the balances and estimated collectibility percentages for different aging
ranges, and changes in customer payment terms when evaluating the adequacy of the allowance for doubtful accounts.
Use of Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States
of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported
amounts of revenue and expenses during the reporting period. Specifically, there are significant judgments related to the allowance for doubtful accounts, the valuation of long-term assets, accrued liabilities, accrued merger-related and other
costs, and revenue recognition. Actual results could differ from those estimates.
Foreign Currency
The functional currency for each foreign subsidiary is its respective local currency. Accordingly, all assets and liabilities related to these operations
are translated at the current exchange rates at the end of each period. The resulting cumulative translation adjustments are recorded directly to the accumulated other comprehensive income account in stockholders equity. Revenues and expenses
are translated at average exchange rates in effect during the period. Foreign currency transaction gains and losses are included in the results of operations. At December 31, 2007 and 2006, no foreign currency transactions were hedged.
59
TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Recent Accounting Pronouncements
In July 2006, the Financial Accounting Standards Board (FASB) issued Financial Interpretation 48,
Accounting for Uncertainty in Income
Taxesan interpretation of FASB Statement 109
(FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with SFAS 109,
Accounting for Income Taxes
and requires a two-step approach to evaluate tax positions and determine if they should be recognized in the financial statements. The two-step approach involves recognizing any tax positions that are more likely than not to occur and
then measuring those positions to determine if they are recognizable in the financial statements. The interpretation is effective for fiscal years beginning after December 15, 2006. Tumbleweed adopted FIN 48 on January 1, 2007. The impact
of FIN 48 did not have a material effect on Tumbleweeds consolidated financial position, results of operations, or cash flows.
As of
January 1, 2007, Tumbleweed did not have any federal, state, and foreign unrecognized tax benefits. Upon the adoption of FIN 48, Tumbleweed adopted an accounting policy to classify interest and penalties on unrecognized tax benefits as
income tax expense. For the years prior to adoption of FIN 48, Tumbleweed did not have interest or penalties on unrecognized tax benefits and therefore, had no established accounting policy. As of January 1, 2007, Tumbleweed had no interest or
penalties accrued on unrecognized tax benefits. Tumbleweed files income tax returns in the U.S. federal jurisdiction, various states, and foreign jurisdictions. Due to its net operating losses, Tumbleweed is subject to examinations by U.S. federal
and state income tax authorities for all its historical periods. As of December 31, 2007, Tumbleweed did not have and does not expect to have any material changes to unrecognized tax benefits within the next twelve months.
In June 2006, the FASB ratified the Emerging Issues Task Force (EITF) consensus on Issue 06-03, How Sales Taxes Collected from
Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (EITF 06-03). EITF 06-03 provides guidance on an entitys disclosure of its accounting policy regarding the gross or net
presentation of certain taxes and provides that if taxes included in gross revenues are significant, a company should disclose the amount of such taxes for each period for which an income statement is presented (i.e., both interim and annual
periods). Taxes within the scope of EITF 06-03 are those that are imposed on and concurrent with a specific revenue-producing transaction. The guidance is effective for interim and annual periods beginning after December 15, 2006. Tumbleweed
did not have and does not expect to have any material impact of EITF 06-03 on its financial position and results of operations.
In June
2006, the FASB ratified the EITF consensus on Issue 06-02,
Accounting for Sabbatical Leave and Other Similar Benefits Pursuant to FASB Statement No. 43, Accounting for Compensated Absences
(EITF 06-02). EITF 06-02
requires that the costs associated with unrestricted sabbaticals and other similar benefit arrangements be recognized over the service period during which the employee earns the benefit. The provisions of EITF 06-02 are effective for fiscal years
beginning after December 15, 2006. The provisions of EITF 06-02 were applied by Tumbleweed through a cumulative effect adjustment to its accumulated deficit that resulted in increases of $117,000 each to its accumulated deficit and accrued
liabilities balances, respectively. The changes in accumulated deficit for 2007 are as follows:
|
|
|
|
|
|
|
(In thousands)
|
|
Balance as of December 31, 2006
|
|
$
|
(295,812
|
)
|
Net loss
|
|
|
(10,765
|
)
|
Adoption effect of EITF 06-02
|
|
|
(117
|
)
|
|
|
|
|
|
Balance as of December 31, 2007
|
|
$
|
(306,694
|
)
|
|
|
|
|
|
60
TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
In September 2006, the FASB issued SFAS No. 157,
Fair Value Measurements
(SFAS 157). SFAS 157 provides guidance for using fair value to measure assets and liabilities. It also responds to investors requests for expanded information about the extent to which companies measure assets and
liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. SFAS 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value, and
does not expand the use of fair value in any new circumstances. SFAS 157 is generally effective for financial statements issued for fiscal years beginning after November 15, 2007 and for nonfinancial assets and liabilities that are not
remesaured at fair value on a recurring basis for fiscal years beginning after December 31, 2008. Tumbleweed does not expect SFAS 157 to have a material impact on its financial statements.
In December 2007, the FASB issued SFAS No. 141 (revised 2007),
Business Combinations
(SFAS 141R), and SFAS
No. 160,
Noncontrolling Interests in Consolidated Financial Statements, an amendment of Accounting Research Bulletin No. 51
(SFAS 160). SFAS 141R changes how business acquisitions are accounted for and
impacts financial statements both on the acquisition date and in subsequent periods. SFAS 160 changes the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of
equity. SFAS 141R and SFAS 160 are effective for fiscal years beginning after December 15, 2008 and will be adopted by Tumbleweed beginning in the first quarter of 2009. Although Tumbleweed will continue to evaluate the application of SFAS 141R
and SFAS 160, it does not currently believe adoption will have a material impact on its financial condition or operating results.
Merger-related and Other Credit
Merger-related and other costs of a net credit of $96,000 for 2005 consist of a $296,000
credit related to the termination of an operating lease in Slough, United Kingdom partially offset by a $200,000 severance cost associated with the resignation of our former Chief Executive Officer. The combined cost of the final lease settlement
payments, commissions, brokerage fees, and legal fees related to the termination of the Slough lease was less than the existing accrual for the loss on the lease, resulting in the expense credit. The Slough lease was assumed during the acquisition
of Interface in 2000 and was for a term ending in 2020 with quarterly rent payments of approximately $65,000. The final lease settlement payment for the Slough lease of approximately $113,000 was made in July 2005. There were no merger-related and
other costs in 2007 or 2006.
The following table describes accrued merger-related and other costs recorded in 2007 and 2006 (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Severance
costs
|
|
|
Anticipated
operating
lease losses
|
|
|
Total
|
|
Balance December 31, 2005
|
|
$
|
149
|
|
|
$
|
84
|
|
|
$
|
233
|
|
2006 payments
|
|
|
(92
|
)
|
|
|
(44
|
)
|
|
|
(136
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance December 31, 2006
|
|
$
|
57
|
|
|
$
|
40
|
|
|
$
|
97
|
|
2007 payments
|
|
|
(57
|
)
|
|
|
(40
|
)
|
|
|
(97
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance December 31, 2007
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restructuring costs
Restructuring costs of $930,000 for 2007 were comprised of severance costs to terminated employees and associated legal expenses. The restructuring
program included a targeted staff reduction of approximately 40 employees. As of December 31, 2007, the remaining liability related to these costs is $520,000. There were no restructuring costs in 2006 or 2005.
61
TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(4) Financial Statement Components
A summary of cash and cash equivalents as of December 31, 2007 and 2006 is as follows (in thousands):
|
|
|
|
|
|
|
|
|
2007
|
|
2006
|
Cash
|
|
$
|
7,644
|
|
$
|
5,995
|
Money market mutual funds
|
|
|
18,655
|
|
|
24,516
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
26,299
|
|
$
|
30,511
|
|
|
|
|
|
|
|
A summary of property and equipment as of December 31, 2007 and 2006 is as follows (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
Office furniture
|
|
$
|
2,068
|
|
|
$
|
2,047
|
|
Computers and equipment
|
|
|
13,163
|
|
|
|
11,726
|
|
Leasehold improvements
|
|
|
1,011
|
|
|
|
1,010
|
|
|
|
|
|
|
|
|
|
|
|
|
|
16,242
|
|
|
|
14,783
|
|
Less accumulated depreciation
|
|
|
(14,204
|
)
|
|
|
(12,963
|
)
|
|
|
|
|
|
|
|
|
|
|
|
$
|
2,038
|
|
|
$
|
1,820
|
|
|
|
|
|
|
|
|
|
|
A summary of intangible assets as of December 31, 2007 is as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization
period
(in years)
|
|
Gross
carrying
amount
|
|
Accumulated
amortization
|
|
|
Net
|
Core/ developed technology
|
|
3 to 4
|
|
$
|
5,850
|
|
$
|
(5,675
|
)
|
|
$
|
175
|
Customer base and reseller agreements
|
|
3
|
|
|
3,700
|
|
|
(3,676
|
)
|
|
|
24
|
Maintenance agreements
|
|
3 to 4
|
|
|
1,200
|
|
|
(1,174
|
)
|
|
|
26
|
Trademarks and trade names
|
|
4
|
|
|
350
|
|
|
(342
|
)
|
|
|
8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
11,100
|
|
$
|
(10,867
|
)
|
|
$
|
233
|
|
|
|
|
|
|
|
|
|
|
|
|
|
A summary of intangible assets as of December 31, 2006 is as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization
period
(in years)
|
|
Gross
carrying
amount
|
|
Accumulated
amortization
|
|
|
Net
|
Core/ developed technology
|
|
3 to 4
|
|
$
|
5,850
|
|
$
|
(4,863
|
)
|
|
$
|
987
|
Customer base and reseller agreements
|
|
3
|
|
|
3,700
|
|
|
(3,432
|
)
|
|
|
268
|
Maintenance agreements
|
|
3 to 4
|
|
|
1,200
|
|
|
(1,049
|
)
|
|
|
151
|
Trademarks and trade names
|
|
4
|
|
|
350
|
|
|
(286
|
)
|
|
|
64
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
11,100
|
|
$
|
(9,630
|
)
|
|
$
|
1,470
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Intangible assets will be amortized in full in the three months ended March 31, 2008.
Expected amortization expense for 2008 is $233,000.
Goodwill represents the excess of the purchase price over the fair value of acquired
net tangible and identified intangible assets. In accordance with the provisions of SFAS 142,
Goodwill and Other Intangible Assets,
goodwill is not amortized, but instead, is tested for impairment at least annually and more frequently if
62
TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
certain impairment conditions exist. Tumbleweed completed its annual assessment of goodwill in the three months ended June 30, 2007 and no impairment of
goodwill was determined as a result of this assessment. Any future impairment loss related to the goodwill recorded in connection with acquisitions will not be deductible by Tumbleweed for federal income tax purposes.
A summary of accrued liabilities as of December 31, 2007 and 2006 is as follows (in thousands):
|
|
|
|
|
|
|
|
|
2007
|
|
2006
|
Accrued compensation
|
|
$
|
2,225
|
|
$
|
3,735
|
Accrued restructuring charges
|
|
|
520
|
|
|
|
Accrued professional fees
|
|
|
903
|
|
|
613
|
Accrued taxes
|
|
|
307
|
|
|
456
|
Other
|
|
|
2,840
|
|
|
2,718
|
|
|
|
|
|
|
|
|
|
$
|
6,795
|
|
$
|
7,522
|
|
|
|
|
|
|
|
Other income, net consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
Interest income
|
|
$
|
1,338
|
|
|
$
|
1,237
|
|
|
$
|
611
|
|
Interest expense
|
|
|
|
|
|
|
|
|
|
|
(35
|
)
|
Recovery of value added tax related to Valicert subsidiary
|
|
|
|
|
|
|
|
|
|
|
204
|
|
Other, net
|
|
|
(2
|
)
|
|
|
(31
|
)
|
|
|
202
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
1,336
|
|
|
$
|
1,206
|
|
|
$
|
982
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for Doubtful Accounts (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
Description
|
|
Balance at
Beginning
of Period
|
|
Additions
|
|
Reductions
|
|
|
Balance
at End
of Period
|
|
|
|
|
(a)
|
|
(b)
|
|
|
|
Allowance for doubtful accounts:
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, 2005
|
|
$
|
605
|
|
|
|
(195
|
)
|
|
$
|
410
|
Year Ended December 31, 2006
|
|
$
|
410
|
|
55
|
|
(34
|
)
|
|
$
|
431
|
Year Ended December 31, 2007
|
|
$
|
431
|
|
22
|
|
(85
|
)
|
|
$
|
368
|
(a)
|
Additions relate to bad debt expense
|
(b)
|
Reductions relate to write-offs of specific accounts receivable, net of recoveries.
|
(5) Related Party and Other Transactions
Legal Counsel
Gregory C. Smith, a brother of Jeffrey C. Smith, a director and Tumbleweeds former Chairman and Chief Executive Officer, is a partner of the law
firm of Skadden, Arps, Slate, Meagher & Flom LLP (Skadden Arps), which began providing legal services to Tumbleweed in July 1998. Total fees paid to Skadden Arps were approximately $277,000, $430,000, and $315,000 in 2007, 2006,
and 2005, respectively, for matters relating to Tumbleweeds intellectual property and ongoing general and other litigation matters.
63
TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(6) Debt
In the acquisition of Valicert, Tumbleweed assumed debt of $855,000 resulting from equipment leases with two financing companies. During 2003, this debt was refinanced with an $800,000 loan with a bank. This debt was
repaid in full during 2005. No debt was outstanding at either December 31, 2007 or 2006.
(7) Income Taxes
The components of loss before income taxes attributable to domestic and foreign operations for the years ended December 31, 2007, 2006, and 2005,
respectively, are presented below (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
U.S.
|
|
$
|
(11,267
|
)
|
|
$
|
(5,108
|
)
|
|
$
|
(4,146
|
)
|
Foreign
|
|
|
518
|
|
|
|
341
|
|
|
|
260
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total loss before income taxes
|
|
$
|
(10,749
|
)
|
|
$
|
(4,767
|
)
|
|
$
|
(3,886
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The federal and foreign income tax provisions for the years ended December 31, 2007, 2006,
and 2005, respectively, are presented below (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
2005
|
U.S.
|
|
$
|
(14
|
)
|
|
$
|
70
|
|
$
|
|
Foreign
|
|
|
30
|
|
|
|
45
|
|
|
23
|
|
|
|
|
|
|
|
|
|
|
|
Total income tax provision
|
|
$
|
16
|
|
|
$
|
115
|
|
$
|
23
|
|
|
|
|
|
|
|
|
|
|
|
The amount of income tax expense recorded for 2007, 2006, and 2005 differed from the amounts
computed by applying the U.S. federal income tax rate of 35% to pretax income as a result of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
Statutory federal income tax benefit
|
|
$
|
(3,762
|
)
|
|
$
|
(1,668
|
)
|
|
$
|
(1,360
|
)
|
State income tax expense (benefit)
|
|
|
|
|
|
|
1
|
|
|
|
(121
|
)
|
Foreign income tax expense
|
|
|
|
|
|
|
|
|
|
|
23
|
|
Losses and credits, not utilized
|
|
|
3,396
|
|
|
|
1,586
|
|
|
|
1,798
|
|
Federal R&D credit
|
|
|
(196
|
)
|
|
|
(159
|
)
|
|
|
(400
|
)
|
Stock-based compensation expense
|
|
|
681
|
|
|
|
431
|
|
|
|
178
|
|
Foreign rate differential
|
|
|
(129
|
)
|
|
|
(67
|
)
|
|
|
(68
|
)
|
Other permanent differences
|
|
|
26
|
|
|
|
(9
|
)
|
|
|
(27
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for income taxes
|
|
$
|
16
|
|
|
$
|
115
|
|
|
$
|
23
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
64
TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
The types of temporary differences that give rise to significant portions of Tumbleweeds
deferred tax assets and liabilities as of December 31, 2007 and 2006, respectively, are presented below (in thousands):
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
Deferred tax assets:
|
|
|
|
|
|
|
|
|
Deferred revenue, reserves, and accruals not currently deductible
|
|
$
|
5,997
|
|
|
$
|
4,884
|
|
Deferred research and development costs
|
|
|
801
|
|
|
|
38
|
|
Net operating loss carryforwards
|
|
$
|
108,768
|
|
|
$
|
107,753
|
|
Tax credit carryforwards
|
|
|
8,108
|
|
|
|
8,327
|
|
Deferred research and development costs
|
|
|
|
|
|
|
347
|
|
Property and equipment
|
|
|
516
|
|
|
|
555
|
|
|
|
|
|
|
|
|
|
|
Gross deferred tax assets
|
|
$
|
124,191
|
|
|
$
|
121,904
|
|
Less: valuation allowance
|
|
|
(123,601
|
)
|
|
|
(121,311
|
)
|
|
|
|
|
|
|
|
|
|
Net deferred tax assets
|
|
|
590
|
|
|
|
593
|
|
Deferred tax liabilities:
|
|
|
|
|
|
|
|
|
Acquired intangibles
|
|
|
(590
|
)
|
|
|
(593
|
)
|
|
|
|
|
|
|
|
|
|
Net deferred tax assets (liabilities)
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
A valuation allowance against Tumbleweeds net deferred tax assets has been established since
it cannot be concluded that it is more likely than not that deferred tax assets in excess of deferred tax liabilities will be realized. The valuation allowance of $121.3 million at December 31, 2006 has increased by $2.3 million to $123.6
million at December 31, 2007. The valuation allowance at December 31, 2007 includes approximately $21.0 million related to windfall stock option deductions, the benefit of which will be credited to additional paid in capital if and when
realized.
In connection with certain the acquisitions, deferred tax assets of approximately $43.2 million were recorded. A full valuation
allowance was recorded against these deferred tax assets. In the event the valuation allowance related to these acquired deferred tax assets is reduced, the tax benefits of such deferred tax assets will be applied, first, to reduce to zero any
goodwill related to this acquisition; second, to reduce to zero other non-current intangible assets related to this acquisition; and third, to reduce income tax expense.
As of December 31, 2007, Tumbleweed had net operating loss carryforwards for Federal and California income tax purposes of approximately $296.9 million and $108.3 million, respectively, available to reduce future
income subject to income taxes. The federal net operating loss carryforwards will expire in the years 2008 through 2026 and the California net operating loss carryforwards expire in the years 2008 through 2016.
As of December 31, 2007, Tumbleweed also had research and development tax credit carryforwards for Federal and California income tax return purposes
of approximately $4.3 million and $5.7 million, respectively, available to reduce future income taxes. Tumbleweed also has California Manufacturing Credit carryforwards of $262,000. The Federal research and development tax credit will expire in
years 2008 through 2027. The California research and development tax credit carries forward indefinitely.
65
TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Tumbleweeds ability to utilize the net operating losses and tax credit carryforwards in the
future may be subject to substantial restriction in the event of past or future ownership changes as defined in Section 382 of the Internal Revenue Code and similar state tax law.
(8) Stockholders Equity
Under Tumbleweeds certificate of
incorporation, Tumbleweed is authorized to issue 100,000,000 shares of common stock, each with a par value of $0.001. As of December 31, 2007 and 2006, respectively, Tumbleweed had 51,129,313 and 50,427,209 shares outstanding. Tumbleweed is
also authorized to issue 10,000,000 shares of preferred stock, each with a par value of $0.001. Tumbleweed has zero preferred shares outstanding as of December 31, 2007 and 2006, respectively.
(9) Employee Benefit Plan
Tumbleweed has a 401(k) plan that allows eligible employees to contribute a percentage of their compensation, limited to $15,500 ($20,500 for employees over age 50), $15,000 ($20,000 for employees over age 50), and $14,000 ($18,000 for
employees over age 50) in 2007, 2006, and 2005, respectively. Tumbleweed did not match contributions to employees 401(k) plans in 2007, 2006, or 2005.
(10) Commitments and Contingencies
Lease Commitments
Tumbleweed leases its facilities and certain equipment under operating lease agreements. The facilities leases expire at various dates through 2012.
Tumbleweed has an operating lease covering approximately 40,000 square feet of office space in Redwood City, California. The lease expires in July 2008 with current monthly rent payments of approximately $88,000. Tumbleweed is in the process of
determining whether to renew this lease or relocate to a new leased office facility.
Future minimum lease payments for operating leases as
of December 31, 2007, are as follows (in thousands):
|
|
|
|
Year Ending December 31,
|
|
Operating
Leases
|
2008
|
|
|
1,221
|
2009
|
|
|
434
|
2010
|
|
|
404
|
2011
|
|
|
404
|
2012
|
|
|
387
|
|
|
|
|
Future minimum lease payments
|
|
$
|
2,850
|
|
|
|
|
Total rent expense under operating leases for 2007, 2006, and 2005, was $1.9 million, $1.6
million, and $1.5 million, respectively.
Contingencies
In December 2001, certain plaintiffs filed a class action lawsuit in the United States District Court for the Southern District of New York (the
District Court) on behalf of purchasers of the common stock of Valicert, Inc. (which was later acquired by Tumbleweed) alleging violations of federal securities laws.
In re Valicert, Inc. Initial Public Offering Securities
Litigation
, No. 01-CV-10889 (SAS) (S.D.N.Y.), related to
In re Initial Public Offering
66
TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Securities Litigation
, No. 21 MC 92 (SAS). The operative amended complaint is brought on purported behalf of all persons who purchased Valicert
common stock from the date of its July 27, 2000 initial public offering (IPO) through December 6, 2000. It names as defendants Valicert, its former Chief Executive Officer, and its Chief Financial Officer (the Valicert
Defendants), as well as an investment banking firm that served as an underwriter for the IPO. The complaint alleges liability under Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of
1934, on the grounds that the registration statement for the IPO did not disclose that: (1) the underwriter agreed to allow certain customers to purchase shares in the IPO in exchange for excess commissions to be paid to the underwriter; and
(2) the underwriter arranged for certain customers to purchase additional shares in the aftermarket at predetermined prices. The complaint also appears to allege that false or misleading analyst reports were issued. The complaint does not claim
any specific amount of damages. Similar allegations have been made in lawsuits relating to more than 300 other initial public offerings conducted in 1999 and 2000, all of which have been consolidated for pretrial purposes. In February 2003, the
Court issued a ruling on all defendants motions to dismiss, denying Valicerts motion to dismiss the claims under the Securities Act of 1933, but granting Valicerts motion to dismiss the claims under the Securities Exchange Act of
1934.
In June 2003, shortly before being acquired by Tumbleweed, Valicert accepted a settlement proposal presented to all issuer
defendants in this case. Under the proposed settlement, the plaintiffs will dismiss and release all claims against the Valicert Defendants in exchange for a contingent payment guaranty by the insurance companies collectively responsible for insuring
the issuers in all the consolidated cases, and the assignment or surrender of control to the plaintiffs of certain claims the issuer defendants may have against the underwriters. Under the guaranty, the insurers will be required to pay the amount,
if any, by which $1 billion exceeds the aggregate amount ultimately collected by the plaintiffs from the underwriter defendants in all of the cases. If the plaintiffs fail to recover $1 billion and payment is required under the guaranty, Valicert
would be responsible to pay its pro rata portion of the shortfall, up to the amount of the deductible retention under its insurance policy, which is $500,000. The timing and amount of payments that Valicert could be required to make under the
proposed settlement will depend on several factors, principally the timing and amount of any payment required by the insurers pursuant to the $1 billion guaranty. The proposed settlement is subject to approval of the Court, which cannot be assured.
In April 2006, the District Court held a hearing on the proposed settlement but has not yet issued a ruling on the
issue. Subsequently, the Court of Appeals for the Second Circuit (the Court of Appeals) vacated the class certification of plaintiffs claims against the underwriters in six cases designated as focus or test cases.
Miles v.
Merrill Lynch & Co. (In re Initial Public Offering Securities Litigation
, 471 F.3d 24 (2d Cir. 2006). Thereafter, the District Court ordered a stay of all proceedings in all of the lawsuits pending the outcome of plaintiffs
petition to the Court of Appeals for rehearing en banc and resolution of the class certification issue. On April 6, 2007, the Court of Appeals denied plaintiffs petition for rehearing, but clarified that the plaintiffs may seek to certify
a more limited class in the District Court.
Accordingly, the stay remains in place and the plaintiffs and issuers have stated that they
are prepared to discuss how the settlement might be amended or renegotiated to comply with the ruling of the Court of Appeals. Failure of the District Court to approve the settlement (or an amended or renegotiated settlement) followed by
an adverse outcome could harm Tumbleweeds business and operating results. Moreover, the costs in defending this lawsuit could harm future operating results. The accompanying consolidated financial statements do not include a reserve
for any potential loss, as Tumbleweed does not consider a loss to be probable at this time. All costs incurred as a result of this legal proceeding are charged to expense as incurred.
Tumbleweed indemnifies its customers from third party claims of intellectual property infringement relating to the use of its products. Historically,
costs related to these guarantees have not been significant. Tumbleweed is unable to estimate the potential impact of these guarantees on its future results of operations.
67
TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Tumbleweed is engaged in other legal actions arising in the ordinary course of business. Although
there can be no assurance as to the outcome of such litigation, Tumbleweed believes it has adequate legal defenses and it believes that the ultimate outcome of any of these actions will not have a material effect on its consolidated financial
positions or results of operations.
(11) Indemnifications
In the ordinary course of business, Tumbleweed enters into contractual arrangements under which it may agree to indemnify the third-party to such
arrangement from any losses incurred relating to the services they perform on behalf of Tumbleweed or for losses arising from certain events as defined within the particular contract, which may include, for example, litigation or claims relating to
past performance. Such indemnification obligations may not be subject to maximum loss clauses. Historically, payments Tumbleweed has made related to these indemnifications have been immaterial.
(12) Segment Information
As
defined by SFAS 131,
Disclosure About Segments of an Enterprise and Related Information
, Tumbleweeds chief operating decision-maker is its Chief Executive Officer. This officer reviews financial information presented on a consolidated
basis accompanied by disaggregated information about revenue by geographic region for purposes of making operating decisions and assessing financial performance. The consolidated financial information reviewed is the information presented in the
accompanying consolidated statement of operations. Tumbleweed operates in a single reporting segment providing managed file transfer and email security products that are developed and sold in similar ways to enterprise and government customers of
all sizes. Furthermore, discrete product line information is impractical to obtain, as Tumbleweed often cross-sells its products to its customers.
Revenue information regarding operations in the different geographic regions is as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
2007
|
|
2006
|
|
2005
|
North America
|
|
$
|
50,377
|
|
$
|
57,666
|
|
$
|
44,940
|
Europe, Middle East, and Africa
|
|
|
4,901
|
|
|
2,980
|
|
|
3,742
|
Asia Pacific
|
|
|
2,001
|
|
|
1,024
|
|
|
1,074
|
Latin America
|
|
|
176
|
|
|
324
|
|
|
245
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
$
|
57,455
|
|
$
|
61,994
|
|
$
|
50,001
|
|
|
|
|
|
|
|
|
|
|
Revenue information by product area is as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
2007
|
|
2006
|
|
2005
|
Managed file transfer and email security
|
|
$
|
49,033
|
|
$
|
43,530
|
|
$
|
39,716
|
Identity validation
|
|
|
7,055
|
|
|
14,817
|
|
|
7,332
|
Intellectual property
|
|
|
1,367
|
|
|
3,647
|
|
|
2,953
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
$
|
57,455
|
|
$
|
61,994
|
|
$
|
50,001
|
|
|
|
|
|
|
|
|
|
|
68
TUMBLEWEED COMMUNICATIONS CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
Tumbleweeds property and equipment located in the different geographic regions as of
December 31, 2007 and 2006 is as follows (in thousands):
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
2007
|
|
2006
|
North America
|
|
$
|
1,659
|
|
$
|
1,403
|
Bulgaria
|
|
|
361
|
|
|
388
|
Other
|
|
|
18
|
|
|
29
|
|
|
|
|
|
|
|
Total long-lived assets
|
|
$
|
2,038
|
|
$
|
1,820
|
|
|
|
|
|
|
|
69