<PAGE>
CONFIDENTIAL PAGE 1 08/13/98
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
____________
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1998
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 0-24081
EVOLVING SYSTEMS, INC.
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 84-1010843
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
9777 MT. PYRAMID COURT, ENGLEWOOD, COLORADO 80112
(Address of Principal Executive Offices) (Zip Code)
(303) 802-1000
(Registrant's Telephone Number, Including Area Code)
Indicate by check whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to filed such reports, and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No _____
____
As of June 30, 1998, there were outstanding 11,573,890 shares of
Registrant's Common Stock (par value $0.001 per share).
<PAGE>
CONFIDENTIAL PAGE 2 08/13/98
EVOLVING SYSTEMS, INC.
<TABLE>
<CAPTION>
PART 1 FINANCIAL INFORMATION PAGE
<S> <C> <C>
Item 1. Financial Statements
Balance Sheets
June 30, 1998 (unaudited) and December 31, 1997................... 3
Statements of Operations
for the three-month and six month periods ended June 30,
1998 and 1997 (unaudited)......................................... 4
Condensed Statements of Cash Flow
for the six month periods ended June 30, 1998 and
1997 (unaudited).................................................. 5
Statement of Changes in Stockholders Equity
for the six month period ended June 30, 1998...................... 6
Notes to Financial Statements........................................... 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations..................................................... 8
PART II OTHER INFORMATION................................................. 14
Item 1. Legal Proceedings 14
Item 2. Changes in Securities 14
Item 3. Defaults on Senior Securities 14
Item 4. Submission of Matters to a Vote of Security Holders 14
Item 5. Other Information 14
Item 6. Exhibits and Reports on Form 8-K 14
SIGNATURES....................................................................... 14
</TABLE>
<PAGE>
CONFIDENTIAL PAGE 3 08/13/98
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
EVOLVING SYSTEMS, INC.
BALANCE SHEETS
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
June 30, Dec. 31,
1998 1997
---------- -----------
<S> <C> <C> <C>
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $30,315 $ 1,171
Certificates of deposit -- 131
Contract receivables, net 11,121 13,344
Unbilled work-in-process 3,838 841
Deferred tax asset 1,769 1,276
Prepaid and other current assets 685 1,077
------- -------
Total current assets 47,728 17,840
Property and equipment, net 9,079 9,803
Other assets 213 216
------- -------
Total assets $57,020 $27,859
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term obligations $ 2,525 $ 3,178
Accounts payable 2,108 2,047
Accrued liabilities 1,298 1,195
Unearned revenue and customer deposits 1,801 6,054
------- -------
Total current liabilities 7,732 12,474
Long-term obligations 660 13,287
Deferred income taxes 414 400
------- -------
Stockholders' equity:
Preferred stock, $.001 par value, 2,000,000
shares authorized,
no shares issued -- --
Series A preferred stock, $.001 par value; 0 and 8,160
shares authorized, issued and outstanding at June 30, 1998 and
December 31, 1997 -- --
(liquidation preference $6,250 per share)
Common stock, $.001 par value; 4,930,000 non-voting shares
authorized; 1,620,760 non-voting shares issued
and outstanding as of December 31, 1997;25,000,000 voting 12 2
shares authorized; 11,573,890 voting shares issued
and outstanding as of June 30, 1998
Additional paid-in-capital 50,480 2,423
Deferred compensation (878) (992)
Retained earnings (deficit) (1,400) 265
------- -------
Total stockholders' equity 48,214 1,698
------- -------
Total liabilities and stockholders' equity $57,020 $27,859
======= =======
</TABLE>
The accompanying notes are an integral part of the financial statements.
<PAGE>
CONFIDENTIAL PAGE 4 08/13/98
EVOLVING SYSTEMS, INC.
STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT PER SHARE DATA)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
-------------------------- -------------------------
Revenue: 1998 1997 1998 1997
<S> <C> <C> <C> <C>
License fees and related services $ 2,869 $ 5,370 $ 8,656 $ 7,570
Other services 6,712 4,924 14,054 10,797
------- ------- ------- -------
Total revenue 9,581 10,294 22,710 18,367
------- ------- ------- -------
Cost of revenue:
License fees and related services 2,484 1,964 4,403 3,519
Other services 4,284 4,267 8,979 8,472
------- ------- ------- -------
Total cost of revenue 6,768 6,231 13,382 11,991
------- ------- ------- -------
Gross margin 2,813 4,063 9,328 6,376
Operating expenses:
Sales and marketing 1,603 977 2,991 1,595
General and administrative 1,715 2,265 3,853 4,273
Research and development 1,879 364 3,841 1,105
------- ------- ------- -------
Total operating expenses 5,197 3,606 10,685 6,973
------- ------- ------- -------
Income (loss) from operations (2,384) 457 (1,357) (597)
OTHER EXPENSE, NET (91) (404) (463) (769)
------- ------- ------- -------
Income (loss) before income taxes (2,475) 53 (1,820) (1,366)
Provision for (benefit from) income taxes (817) 46 (601) (1,182)
------- ------- ------- -------
Income (loss) before Extraordinary item (1,658) 7 (1,219) (184)
Extraordinary item, net of applicable income taxes (446) -- (446) --
------- ------- ------- -------
Net income (loss) $(2,104) $ 7 $(1,665) $ (184)
======= ======= ======= =======
BASIC EARNINGS PER COMMON SHARE:
Income (loss) before extraordinary item $ (.25) $ -- $ (.30) $ (.12)
Extraordinary item (.07) (.11)
------- -------
Net income (loss) per common share $ (.32) $ -- $ (.41) $ (.12)
======= ======= ======= =======
DILUTED EARNINGS PER COMMON SHARE:
Income (loss) before extraordinary item $ (.25) $ -- $ (.30) $ (.12)
Extraordinary item (.07) (.11)
------- -------
Net income (loss) per common share $ (.32) $ -- $ (.41) $ (.12)
======= ======= ======= =======
Basic shares outstanding 6,610 1,554 4,118 1,545
Diluted shares outstanding 6,610 8,837 4,118 1,545
</TABLE>
The accompanying notes are an integral part of the financial statements.
<PAGE>
CONFIDENTIAL PAGE 5 08/13/98
EVOLVING SYSTEMS, INC.
CONDENSED STATEMENTS OF CASH FLOW
(IN THOUSANDS)
(unaudited)
<TABLE>
<CAPTION>
Six Months Ended June 30,
-------------------------
<S> <C> <C>
1998 1997
-------- --------
OPERATING ACTIVITIES:
Net loss $ (1,665) $ (184)
Adjustments to reconcile net (loss) to net cash provided by (used in)
operating activities:
Provision for uncollectable contract receivables -- 96
Amortization of deferred compensation 114 --
Depreciation and amortization 2,031 1,648
Change in operating assets and liabilities:
Contract receivables 2,223 (798)
Unbilled work-in-process (2,997) (901)
Prepaid and other assets 47 (1,146)
Accounts payable 61 (467)
Accrued liabilities 103 324
Unearned revenue and customer deposits (4,253) 5,378
-------- --------
Net cash provided by (used in) operating activities (4,331) 3.950
INVESTING ACTIVITIES:
Purchases of property and equipment (1,307) (793)
-------- --------
Net cash used in investing activities (1,307) (793)
FINANCING ACTIVITIES:
Repayment of long-term obligations (13,280) (1,360)
Sale of stock 48,067 15
-------- --------
Net cash provided by (used in) financing activities 34,782 (1,345)
-------- --------
Net increase in cash and cash equivalents 29,144 1,812
Cash and cash equivalents at beginning of period 1,171 3,184
-------- --------
Cash and cash equivalents at end of period $ 30,315 $ 4,996
======== ========
</TABLE>
The accompanying notes are an integral part of the financial statements.
<PAGE>
CONFIDENTIAL PAGE 6 08/13/98
EVOLVING SYSTEMS, INC.
STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(in thousands except share data)
<TABLE>
<CAPTION>
$.001 PAR
SERIES A $.01 PAR VOTING NON-VOTING
PREFERRED STOCK COMMON STOCK COMMON STOCK ADDITIONAL RETAINED TOTAL
---------------- --------------- -------------- PAID-IN DEFERRED EARNINGS STOCKHOLDERS
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION (DEFICIT) CAPITAL
------ ------ ------ ------ ------ ------ ---------- ------------ --------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1997.... 8,160 $ 8 $ 0 1,620,760 2 $ 2,423 $ (992) $ 265,076 $ 1,698
====== ====== ======= ========= ====== ========== ============ ========= ============
Stock option exercises........ 35,130 35 34 34
Amortization of deferred
compensation.................. 114 114,000
Issuance of common stock...... 3,798,000 4 48,024 48,027
Conversion of preferred to
common........................ (8,160) (8) 6,120,000 6 6
Net loss...................... (1,665) (1,665)
Balance, June 30, 1998........ 11,573,890 $ 12 $ 50,480 $ (878) $ (1,399) $ 48,214
========== ====== ========== ============ ========= ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
CONFIDENTIAL PAGE 7 08/13/98
EVOLVING SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
(1) BASIS OF PRESENTATION
Interim Financial Statements. The accompanying financial statements of
Evolving Systems, Inc. (the "Company") have been prepared pursuant to the rules
and regulations of the Securities and Exchange Commission ("SEC"). Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations. However, the
Company believes that the disclosures are adequate to make the information
presented not misleading. The unaudited financial statements included herein
have been prepared on the same basis as the annual financial statements and
reflect all adjustments, which include only normal recurring adjustments,
necessary for a fair presentation in accordance with generally accepted
accounting principles. The results for the period ended June 30, 1998 are not
necessarily indicative of the results to be expected for any subsequent quarter
or full fiscal year. These financial statements should be read in conjunction
with the audited financial statements and the notes thereto for the year ended
December 31, 1997 included in the Company's Registration Statement on Form S-1
(No. 333-43973), which was declared effective by the SEC on May 11, 1998.
Use of Estimates. The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenue and expenses during the
reporting period. Actual results could differ from those estimates.
(2) EARNINGS (LOSS) PER COMMON SHARE
The Company was required to adopt Statement of Financial Accounting
Standards ("SFAS") No. 128, "Earnings Per Share," in its financial statements
effective retroactively to 1997. Prior period earnings per common share ("EPS")
were restated to conform with the new statement. This pronouncement established
new standards for computing and presenting EPS on a basis that is more
comparable to international standards and provides for the presentation of basic
and diluted EPS, replacing the previously required primary and fully-diluted
EPS. Basic EPS was computed by dividing net income (loss) by the weighted
average number of common shares outstanding during the period. Diluted EPS was
computed using the weighted average number of common shares plus all dilutive
potential common shares outstanding during the period unless the effect of the
potential common shares is anti-dilutive.
The following is the reconciliation of the numerators and denominators of
the basic and diluted EPS computations (in thousands, except per share data):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1998 1997 1998 1997
<S> <C> <C> <C> <C>
Basic earnings per share:
Net income (loss) $(2,104) $ 7 $(1,665) $ (184)
Weighted average common shares outstanding 6,610 1,554 4,118 1,545
Basic net income (loss) per common share $ (.32) $ .00 $ (.41) $ (.12)
Effect of dilutive securities:
Options and warrants 1,163
Preferred Stock 6,120
------
Diluted weighted average common shares outstanding 6,610 8,837 4,118 1,545
Diluted net income (loss) per common share $ (.32) $ .00 $ (.41) $ (.12)
</TABLE>
In February 1998, the Company effected a one-for-two reverse stock split.
All references in the financial statements to shares, share prices, and per
share amounts have been adjusted retroactively for all periods presented to
reflect the stock split.
(3) INITIAL PUBLIC OFFERING
In May 1998, the Company effected an initial public offering on Form S-1.
In connection with the offering, the Company issued 3,798,000 shares of common
stock, including shares issued to cover the Underwriters' (as hereinafter
defined) over-allotment option, and received net proceeds of approximately $48
million. In addition, all of the Preferred Stock was converted into common stock
upon the closing of the initial public offering.
<PAGE>
CONFIDENTIAL PAGE 8 08/13/98
(4) CONTINGENCIES
In June, 1998, three class action lawsuits were filed in the U.S. District
Court for the District of Colorado against the Company and certain of its
officers and directors and, in one case, the Company's Underwriters on behalf of
purchasers of the Company's common stock between May 12, 1998 and June 17, 1998.
The lawsuits seek an unspecified amount of damages and allege that the
defendants disseminated false and misleading statements about the Company's
business, finances and future prospects. The Company believes it has
meritorious legal defenses with respect to these suits and intends to vigorously
defend against these actions. However, the Company is currently unable to (a)
determine the ultimate outcome of the complaints, (b) determine whether
resolution of this matter will have a material adverse impact on the Company's
financial position or results of operations, or (c) reasonably estimate the
amount of loss, if any, which may result from resolution of this matter.
The Company is, from time to time, subject to certain other claims, assertions
or litigation by outside parties as part of its ongoing business operations.
The outcome of any such contingencies are not expected to have a material
adverse effect on the financial condition, operations or cash flows of the
Company.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
---------------------------------------------------------------
RESULTS OF OPERATIONS
---------------------
GENERAL
- -------
Evolving Systems, Inc. is a leading provider of selected software solutions
and services that enable telecommunications carriers to address the technical
challenges to their operational support systems created by the industry's
rapidly changing competitive and regulatory environment. The Company also
provides custom software development services to leading telecommunications
companies.
The Company adopted the provisions of Statement of Position 97-2, "Software
Revenue Recognition," for transactions entered into after January 1, 1998. The
Company derives revenue from license fees and services under the terms of both
fixed price and time and materials contracts. License fees and related services
revenue consists of revenue from contracts that generally provide for both
licenses and services or development fees related to the Company's standard
software products. Other services revenue consists of revenue from custom
programming, systems integration of third-party products, annual maintenance
contracts and training.
License fees and related services revenue is generally recognized using the
percentage-of-completion method of accounting. The percentage-of-completion for
each contract is determined based on the ratio of direct labor hours incurred to
total estimated direct labor hours. Amounts billed in advance of services being
performed are recorded as unearned revenue. Unbilled work in-progress
represents revenue earned but not yet billable under contract terms and all such
amounts are expected to be billed and collected during the succeeding twelve
months.
Services revenue provided under fixed price contracts is generally
recognized using the percentage-of-completion method of accounting described
above. Revenue from other services provided pursuant to time-and-materials
contracts is recognized as the services are performed.
Annual maintenance revenue is recorded as deferred revenue and is
recognized ratably over the service period, which is generally 12 months.
Revenue from training services is recognized as the training services are
performed. When maintenance or training services are bundled with the original
license fee arrangement, their fair value is deferred and recognized during the
period such services are provided.
The Company may encounter budget and schedule overruns on fixed-price
contracts caused by increased material, labor, or overhead costs. Adjustments
to cost estimates are made in the periods in which the facts requiring such
revisions become known. Estimated losses, if any, are recorded in the period in
which current estimates of total contract revenue and contract cost indicate a
loss.
On May 15, 1998, the Company completed an initial public offering of Common
Stock that was managed by Goldman, Sachs & Company, BancAmerica Robertson
Stephens, Hambrecht & Quist, and UBS Securities, (the "Underwriters"). On May
11, 1998 the Commission declared effective the Company's Registration Statement
on Form S-1 (Registration Statement No. 333-43973), which should be read in
conjunction with this document for further information regarding the Company's
business, risk factors, and accounting policies.
<PAGE>
CONFIDENTIAL PAGE 9 08/13/98
RESULTS OF OPERATIONS
- ---------------------
The following table presents, for the periods indicated, certain items in the
Company's unaudited statement of operations reflected as a percentage of total
revenue.
<TABLE>
<CAPTION>
Three Months June 30, Six Months Ended June 30,
--------------------- -------------------------
(unaudited)
---------------------
1998 1997 1998 1997
------- ------- ------- -------
<S> <C> <C> <C> <C>
Revenue:
License fees and related services 30.0% 52.2% 38.1% 41.2%
Other services 70.0 47.8 61.9 58.8
------ ----- ----- -----
Total revenue 100.0 100.0 100.0 100.0
Cost of revenue:
License fees and related services 25.9 19.1 19.4 19.2
Other services 44.7 41.4 39.5 46.1
------ ----- ----- -----
Total cost of revenue 70.6 60.5 58.9 65.3
Gross margin 29.4 39.5 41.1 34.7
Operating expenses:
Sales and marketing 16.7 9.5 13.2 8.7
General and administrative 17.9 22.0 16.9 23.2
Research and development 19.6 3.5 16.9 6.0
------ ----- ----- -----
Total operating expenses 54.2 35.0 47.0 37.9
Income (loss) from operations (24.8) 4.5 (5.9) (3.2)
Other expense, net (1.0) (3.9) (2.0) (4.1)
Income (loss) before income taxes (25.8) 0.6 (8.0) (7.4)
Provision for (benefit from) income taxes (8.5) 0.4 (2.6) (6.4)
------ ----- ----- -----
Income (loss) before extraordinary item (17.3) 0.2 (5.4) (1.0)
Extraordinary item (4.7) - (1.9)
------ -----
Net income (loss) (22.0)% 0.2% (7.3)% (1.0)%
====== ===== ===== =====
</TABLE>
THE THREE MONTHS ENDED JUNE 30, 1998 COMPARED TO THE THREE MONTHS ENDED JUNE 30,
1997
REVENUE. Total revenue decreased approximately $713,000 or 7% to $9.6 million
in the three months-ended June 30,1998 from $10.3 million in the three months
ended June 30, 1997. License fees and related services revenue decreased by
$2.5 million or 47% to $2.9 million in the three months ended June 30, 1998 from
$5.4 million in the three months ended June 30, 1997, reflecting the completion
of certain major LNP projects in 1998 and, conversely, the acceleration of the
LNP market in mid 1997. Other services revenue increased by $1.8 million or 36%
to $6.7 million in the three months ended June 30, 1998 from $4.9 million in the
three months ended June 30, 1997, reflecting growth in consulting and custom
programming projects with long-standing customers. As a percentage of total
revenue other services revenue increased to 70% for the three months ended June
30, 1998 from 48% for the three months ended June 30, 1997.
COST OF REVENUE. Total cost of revenue increased by $537,000 or 9% to $6.8
million in the three months ended June 30, 1998 from $6.2 million in the three
months ended June 30, 1997. As a percentage of total revenue costs increased
from 61% of revenue in the three months ended June 30, 1997 to 71% of revenue
due to the decline in revenue in the three months ended June 30, 1998. Cost of
license fees and related services increased by $520,000 or 26% to $2.5 million
for the three months ended June 30, 1998 from $2.0 million for the three months
ended June 30, 1997. As a percentage of total revenue, cost of license fees and
related services increased to 26% for the three months ended June 30, 1998 from
19% in the three months ended June 30, 1997. The cost increase in license fees
and related services in absolute dollar terms reflects the cost of third party
software incorporated in license products as well as increases in personnel
assigned to systems integration efforts. Cost of other services was constant at
$4.3 million in the three months ended June 30, 1998 and 1997. Other services
cost levels remained constant in spite of higher revenues reflecting lower
staffing related to such projects and expense controls initiated in late 1997.
The Company's expense levels are based in significant part on its expectations
regarding future revenues. The Company's revenue is difficult to forecast
because the market for the Company's products and services is rapidly evolving,
and the Company's sales cycle and the size and timing of significant contracts
vary substantially among customers. Accordingly, the Company may be unable to
adjust spending in cost of revenue or operating areas in a timely manner to
compensate for any unexpected shortfall in revenue.
<PAGE>
CONFIDENTIAL PAGE 10 08/13/98
SALES AND MARKETING. Sales and marketing expenses increased by $626,000 or 64%
to $1.6 million in the three months ended June 30, 1998 from $977,000 in the
three months ended June 30, 1997. As a percentage of revenue, sales and
marketing increased to 17% of revenue in the three months ended June 30, 1998
from 10% in the three months ended June 30, 1997. This increase reflects both
increased sales and marketing staffing and associated costs as well as increased
promotional expenses over the prior period.
GENERAL AND ADMINISTRATIVE. General and administrative expenses decreased by
$550,000 or 24% to $1.7 million in the three months ended June 30, 1998 from
$2.3 million in the three months ended June 30, 1997. As a percentage of
revenue, general and administrative expenses decreased to 18% in the three
months ended June 30, 1998 from 22% in the three months ended June 30, 1997.
The decrease in absolute dollars is attributable to elimination of bonuses due
to the performance shortfall in the three months ended June 30, 1998 as well as
lower equipment costs and spending controls initiated in late 1997.
RESEARCH AND DEVELOPMENT. Research and development expenses increased by $1.5
million, or 416%, to $1.9 million in the three months ended June 30, 1998 from
$364,000 in the three months ended June 30, 1997. As a percentage of revenue,
research and development expenses increased to 20% in the three months ended
June 30, 1998 from 4% in the three months ended June 30, 1997, reflecting both
absolute dollar increases in spending due to staff increases related to MetOSS
product development projects, and percentage increases due to lower revenue
levels.
OTHER EXPENSE, NET. Other expense, net decreased by $313,000, or 77%, to
$91,000 in the three months ended June 30, 1998 from $404,000 in the three
months ended June 30, 1997. As a percentage of revenue, other expense decreased
to 1% in the three months ended June 30, 1998 from 4% in the three months ended
June 30,1997. This expense results principally from interest expense related to
funding the Company's operations and the decrease from prior periods reflects
the repayment of most outstanding long term debt and line of credit advances
following the company's initial public offering in May, 1998 as well as interest
income on the Company's cash subsequent to the offering.
PROVISION FOR (BENEFIT FROM) INCOME TAXES. The Company recorded an income tax
benefit of $817,000 for the three months ended June 30, 1998 compared to a tax
provision of $46,000 for the three months ended June 30, 1997.
EXTRAORDINARY ITEM. The Company recorded an extraordinary item of $446,000
relating to early retirement penalties and the write off of capitalized debt
issue costs resulting from the repayment of debt associated with completion of
the Company's initial public offering. The Company recorded a tax benefit of
$220,000 relating to the extraordinary item recorded in the three months ended
June 30, 1998.
THE SIX MONTHS ENDED JUNE 30, 1998 COMPARED TO THE SIX MONTHS ENDED JUNE 30,
1997
REVENUE. Total revenue increased approximately $4.3 million or 23% to $22.7
million in the six months-ended June 30,1998 from $18.4 million in the six
months ended June 30, 1997. License fees and related services revenue increased
by $1.1 million or 14% to $8.7 million in the six months ended June 30, 1998
from $7.6 million in the six months ended June 30, 1997, reflecting LNP product
strength in the first three months of 1998. Other services revenue increased by
$3.2 million or 30% to $14.0 million in the six months ended June 30, 1998 from
$10.8 million in the six months ended June 30, 1997, reflecting strength in
consulting and custom development projects with long-standing customers. As a
percentage of total revenue, other services revenue increased to 62% for the six
months ended June 30, 1998 from 59% for the six months ended June 30, 1997.
COST OF REVENUE. Cost of revenue increased $1.4 million or 12% to $13.4 million
in the six months ended June 30, 1998 from $12.0 million in the six months ended
June 30, 1997. License fees and related services cost increased by $884,000 or
25% to $4.5 million for the six months ended June 30, 1998 from $3.5 million for
the six months ended June 30, 1997. Increased third party software costs as
well as increased staffing for product support due to higher LNP revenues in the
period is reflected in this increase. Other services cost increased $507,000 or
6% to $9.0 million in the six months ended June 30, 1998 from $8.5 million in
the six months ended June 30, 1997. This increase in other services cost was
due to higher revenue levels and increased subcontractor costs related to an
unusually complex project.
SALES AND MARKETING. Sales and marketing expenses increased by $1.4 million or
88% to $3.0 million in the six months ended June 30, 1998 from $1.6 million in
the six months ended June 30, 1997. As a percentage of revenue, sales and
marketing expenses increased to 13% of revenue in the six months ended June 30,
1998 from 9% in the six months ended June 30, 1997. This increase reflects the
absolute dollar spending increase related to personnel increases and promotional
expenses.
GENERAL AND ADMINISTRATIVE. General and administrative expenses decreased by
$420,000 or 10% to $3.9 million in the six months ended June 30, 1998 from $4.3
million in the six months ended June 30, 1997. As a percentage of revenue,
general and administrative expenses decreased to 17% in the six months ended
June 30, 1998 from 23% in the six months ended June 30, 1997. This decrease in
absolute dollars is attributable to lower salary, bonus, and equipment costs;
the decline in percentage of revenue is attributable to higher revenue levels.
RESEARCH AND DEVELOPMENT. Research and development expenses increased by $2.7
million, or 245%, to $3.8 million in the six months ended June 30, 1998 from
$1.1 million in the six months ended June 30, 1997. As a percentage of revenue,
research and development expenses increased to 17% in the six months ended June
30, 1998 from 6% in the six months
<PAGE>
CONFIDENTIAL PAGE 11 08/13/98
ended June 30, 1997, reflecting absolute dollar increases in spending due to
staff increases related to MetOSS product development projects.
OTHER EXPENSE, NET. Other expense, net decreased by $306,000, or 40%, to
$463,000 in the six months ended June 30, 1998 from $769,000 in the six months
ended June 30, 1997. As a percentage of revenue, other expense decreased to 2%
in the six months ended June 30, 1998 from 4% in the six months ended June
30,1997. This expense is principally interest expense related to funding the
Company's operations and reflects the payoff of the majority of outstanding long
term debt and line of credit advances following the company's initial public
offering in May 1998, as well as interest income on the Company's cash
investments subsequent to the offering.
PROVISION FOR (BENEFIT FROM) INCOME TAXES. The Company recorded a net income
tax benefit of $601,000 for the six months ended June 30, 1998. This compares to
a tax benefit of $1.2 million for the six months ended June 30, 1997.
EXTRAORDINARY ITEM. The Company recorded an extraordinary item of $446,000 net
of taxes relating to early retirement penalties and the write off of capitalized
debt issue costs resulting from the repayment of debt associated with completion
of the Company's initial public offering during the six months ended June 30,
1998. The Company recorded a tax benefit of $220,000 relating to the
extraordinary item recorded in the six months ended June 30, 1998.
LIQUIDITY AND CAPITAL RESOURCES.
The Company has historically financed its operations through a combination
of cash flow from operations and borrowings. On May 15, 1998, the Company
completed its initial public offering of common stock and subsequently repaid
most outstanding borrowings. At June 30, 1998, the Company's principal sources
of liquidity included $30.3 million in cash and cash equivalents, a $10.0
million secured bank line of credit and an equipment term loan agreement of $1.5
million, both of which expire in September 1998. As of June 30, 1998, the
Company had no outstanding balance under the line of credit and $660,000
outstanding with respect to the equipment term loan agreement. The Company is
required under the credit line to comply with certain financial covenants
regarding tangible net worth, performance ratios relating to profitability,
debt, asset performance and working capital. At June 30, 1998, the Company was
in compliance with such covenants or had obtained waivers.
At March 31, 1998, the Company had senior promissory notes payable to
stockholders in the amount of $6.8 million bearing semi-annual interest payments
at a rate of 9% beginning April 1996, and principal repayments of $1.6 million
due semi-annually beginning in 2000. The Company also had notes payable to
stockholders in the amount of $5.1 million bearing annual interest payments of
7.25%, with the principal due in 2006. Following the Company's initial public
offering in May, 1998, these notes and accrued interest obligations were
retired.
Net cash used in operating activities was $4.4 million in the six months
ended June 30, 1998 compared to a positive contribution of $3.9 million in the
six months ended June 30, 1997. The main contributors to the usage of cash by
operations in the six months ended June 30, 1998 were an increase in unbilled
work-in-process by $3.0 million reflecting milestone extensions which must be
met prior to final invoicing and a decline in customer deposits and unearned
revenue by $4.2 million, primarily the result of the completion of several large
LNP projects. Receivables provided cash of $2.2 million during this period
reflecting increased collections on major accounts. In the six months ended
June 30, 1997, the cash contribution by operations was largely the result of an
increase of $5.4 million in customer deposits and unearned revenue due to large
LNP contracts entered into during that period.
Net cash used in investing activities during the six months ended June 30,
1998 and June 30, 1997 was $1.3 million and $793,000 respectively in the area
of equipment and facilities to support operations.
Financing activities provided $34.8 million in cash in the six months ended
June 30, 1998 compared to using $1.3 million in the six months ended June 30,
1997. The Company's initial public offering generated approximately $48 million
and all outstanding debt of the Company except for capital lease obligations was
repaid during the three months ended June 30, 1998.
The Company believes that its current cash and short-term investments,
together with anticipated cash flow from operations and its existing credit
facilities and the net proceeds from the initial public offering will be
sufficient to meet its working capital and capital expenditure requirements for
at least the next twelve months. Thereafter, the Company may require additional
funds to support such activity through public or private equity financing or
from other sources. There can be no assurance that additional financing will be
available at all or that if available, such financing will be obtainable on
terms favorable to the Company and would not be dilutive.
FACTORS THAT MIGHT EFFECT OPERATING RESULTS.
The Company's operating results have fluctuated significantly in the past
and are likely to continue to fluctuate significantly in the future.
Fluctuations in operating results may result in volatility in the price of the
Company's Common Stock. There can be no assurance that the Company will be
profitable in the future or that the Company's level of profitability will not
vary significantly between quarters. These quarterly fluctuations may result
from a number of factors, including the magnitude, timing and signing of new
contracts; the Company's rate of progress under such contracts; the timing of
customer and market acceptance of the Company's product and service offerings;
actual or anticipated changes in
<PAGE>
CONFIDENTIAL PAGE 12 08/13/98
government laws and regulations related to the telecommunications market or
judicial or administrative actions with respect to such laws or regulations; the
nature and pace of enforcement of the Telecommunications Act of 1996; product
lifecycles; the Company' success in effecting its planned transition to a
product-based business; the mix of products and services sold; changes in demand
for the Company's products and services; the timing of third-party contractors'
delivery of software and hardware; budgeting cycles of the Company's customers;
changes in the renewal rate of support agreements; the timing and amount of
expenditures made by the Company for research and development and sales, general
and administrative expenses; competition by existing and emerging competitors in
the telecommunications software markets; the Company's success in developing and
marketing new products, controlling costs, attracting and retaining qualified
personnel and expanding its sales and marketing programs; regional office
expansion; software defects and other product quality problems; changes in the
Company's strategy; the extent of industry consolidation; expansion of the
Company's international operations, and general economic conditions.
A significant portion of the Company's revenue has been and is expected to
continue to be derived from a small number of customers. Accordingly, the loss
of any significant customer, delays in delivery or acceptance of any of the
Company's products or delays in the performance of services could have a
material adverse effect on the Company's business, financial condition and
results of operations. Historically, the Company has generally recognized both
license fees and service fee revenue under its customer contracts using the
percentage-of-completion method. The Company is broadening its strategy to
include the development and sale of software products. To the extent that the
Company is successful in doing so, the Company expects that it may be able to
record future revenue from license fees upon the delivery of a software product
to a customer. The Company's ability to recognize revenue on software licenses
as packaged software solutions at the time of delivery depends on its ability to
engage third parties to implement its software and to separately license the
software and separately sell implementation services, as well as technical
factors and customer expectations and requirements. There can be no assurance
that the Company will be able to achieve or maintain a sales model that allows
the Company to record license fees when software products are delivered to
customers. Software companies that account for revenue from license fees upon
delivery of software products may be exposed to increased risk of quarterly
fluctuations. To the extent that this pattern develops at the Company, any
failure or delay in the delivery of orders during any given quarter could have a
material adverse effect on the Company's business, financial condition and
results of operations. The timing of revenue recognition from the Company's
contracts has caused, and may continue to cause, material fluctuations in the
Company's operating results, particularly on a quarterly basis.
The Company's expense levels are based in significant part on its
expectations regarding future revenue. The Company's revenue is difficult to
forecast because the market for the Company's products and services is rapidly
evolving, and the Company's sales cycle and the size and timing of significant
contracts vary substantially among customers. Accordingly, the Company may be
unable to adjust spending in a timely manner to compensate for any unexpected
shortfall in revenue. Any significant shortfall from anticipated levels of
demand for the Company's products and services could have a material adverse
effect on the Company's business, financial condition and results of operations.
Based on all of the foregoing, the Company believes that future revenue,
expenses and operating results are likely to vary significantly from quarter to
quarter. As a result, quarter-to-quarter comparisons of operating results are
not necessarily meaningful or indicative of future performance. Furthermore,
the Company believes it is likely that in some future quarter the Company's
operating results will be below the expectations of public market analysts or
investors. In such event, or in the event that adverse conditions prevail, or
are perceived to prevail, with respect to the Company's business or generally,
the market price of the Company's Common Stock would likely be materially
adversely affected.
These results should be read in conjunction with the risk factors defined
in the Company's Registration Statement on Form S-1 (No. 333-43973) which was
declared effective by the SEC on May 11, 1998. Statements contained in this
Form 10-Q with respect to future revenue and expenses are "forward-looking
statements" within the meaning of Section 21E of the Securities Exchange Act of
1934, as amended. Actual results may differ. Among the factors that could
cause actual results to differ are the following: (i) the Company's dependence
on the rapidly evolving telecommunications industry, (ii) the customer's
acceptance of Local Number Portability Products, (iii) delays associated with
customers' internal approval and contracting procedures, procurement practices,
and testing and acceptance process, and (iv) rapid technological change and
intense competition in the Company's industry.
IMPACT OF THE YEAR 2000 ISSUE
Many currently installed computer systems and software products are coded
to accept only two digit entries in the date code field. These date code fields
will need to accept four digit entries to distinguish 21st century dates from
20th century dates. As a result, in less than two years, computer systems
and/or software used by many companies may need to be upgraded to comply with
such Year 2000 requirements. Significant uncertainty exists in the software
industry concerning the potential effects associated with such compliance.
The Company is impacted by the Year 2000 issue both internally with regard
to its operations and externally with regard to its product and services
offerings and the vulnerability of its customer base. The Company is in the
process of assessing its state of readiness in all areas costs associated with
remediation, risks, and contingency plans. The following graph should be used
as an approximate guide of the Company's activities to date in regard to this
problem.
<PAGE>
CONFIDENTIAL PAGE 13 08/13/98
[GRAPH APPEARS HERE]
Products and Services: The Company currently offers software products that are
designed to be Year 2000 compliant and the Company's current contracts with its
customers require that the Company warrant Year 2000 capability. Although the
Company has designed its products to be Year 2000 capable and tests third-party
software that is incorporated with the Company's products, there can be no
assurance that the Company's software products, particularly when such products
incorporate third-party software, contain all necessary date code changes. The
Company is continuing its review of its products to ensure compliance. The
Company's operations may be at risk if its suppliers and other third parties
fail to adequately address the problem or if software conversions result in
system incompatibilities with these third parties. This issue could result in
system failures or generation of erroneous information and could significantly
disrupt business activities.
Customers: The Company offers software products and services to
telecommunications carriers and telecommunication companies. Currently, the
Company is assisting several of these customers in the evaluation of their
software and systems to be compliant with Year 2000 requirements. As these
companies products and services are largely dependent on integrated software and
hardware networks as described above, there can be no assurance that assessment
and remediation will have been completed by all such customers within the
appropriate timeframe. As a result, the Company's business with these customers
could be negatively or positively influenced by these customers financial and
operational results and consequent decisions regarding the purchase of the
Company's products and services. Such a disruption of buying patterns could
cause a material adverse effect on the Company's business, results of operations
and financial condition.
Evolving Systems' Internal Operations:
IT - Software: The Company utilizes off-the-shelf and custom software developed
internally and by third parties. The Company's ERP (enterprise resource
planning) systems as well as its internal communication software has been
replaced within the past three years by new systems that are certified by their
vendors to be date code compliant. A final, non-compliant subsystem is
scheduled to be replaced within the next six months. All such upgrades were
undertaken to increase efficiency and effectiveness of the Company's operations
and were not approved primarily for the reasons of date code compliance. The
Company has initiated correspondence with suppliers and is continuing to review
what actions will be required to make all software systems used internally Year
2000 compliant as well as to mitigate its vulnerability to problems with the
systems used by its suppliers and other third parties. To the extent that such
software and systems do not comply with Year 2000 requirements, there can be no
assurance that potential systems interruptions or the cost necessary to update
such software will not have a material adverse effect on the Company's business,
financial condition and results of operations.
IT - Hardware: The Company utilizes off-the-shelf hardware in its processing and
network operations. Such equipment either has been certified to be date code
compliant or correspondence with suppliers is being initiated to validate such
condition.
Non-IT - Hardware: The Company will initiate correspondence with suppliers to
review what actions will be required to make all embedded systems date code
compliant in the facilities it occupies. The costs associated with such actions
is not expected to have a material effect on the Company's business, results
operations or financial condition.
Suppliers: The Company will initiate correspondence with service suppliers to
review what actions will be undertaken to make all embedded systems date code
compliant. Such actions include a review of vendor contracts and formal
communication with suppliers to request certification that products are Year
2000 compliant. The total cost and time associated with the impact of Year 2000
compliance cannot presently be estimated. The costs associated with such
actions is not expected to have a material effect on the Company's business,
results of operations or financial condition.
The Company does not, at this time, have a formal contingency plan in the event
of the failure of remediation efforts with regard to its internal operations.
Such a plan can only be developed after a full assessment of potential points of
failure. Following the completion of the assessment phase in all areas, the
Company anticipates the development of such a plan.
<PAGE>
CONFIDENTIAL Page 14 08/13/98
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
In June, 1998, three class action lawsuits were filed in the United States
District Court of the District Court of Colorado against the Company and certain
of its officers and directors. The actions are purportedly brought on behalf of
purchasers of the Company's common stock between May 12, 1998 and June 17, 1998.
The claims allege violations of Sections 11 and 12 of the Securities Act of 1933
and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. The
actions seek unspecified compensatory and punitive damages, interest, attorneys'
fees and other costs. The Company believes that it has meritorious defenses to
both actions and intends to vigorously defend the actions.
Item 2. Changes in Securities
None
Item 3. Defaults on Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
On January 28, 1998, the Company solicited the written consent of its
security holders with respect to (a) Election of Directors; (b) One-for-two
reverse stock split; (c) Amendments to Articles of Incorporation; (d) Amendment
of the Company's Stock Option Plan; (e) Adoption of the Company's Employee Stock
Purchase Plan; (f) Adoption of Amended and Restated Bylaws; and (g) Approval of
Standard Indemnification Agreement. 8,160 shares of Series A Preferred Stock
were voted in favor of such proposal, no shares of Series A Preferred Stock were
voted against such proposal.
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
10.27 Financial Data Schedule
(b) Reports on Form 8-K
None
SIGNATURES
Pursuant to the requirements of the Securities exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: 8/14/98 /s/ Roger A. Barnes
------------------------------
Roger A. Barnes
Senior Vice President of Finance,
Chief Financial Officer and Treasurer
(Principal Financial and Accounting Officer)
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