<PAGE>
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 September 30, 1999
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 Identification No.)
Incorporation or Organization)
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 September 30, 1999, there were outstanding 12,209,497 shares of
Registrant's Common Stock (par value $0.001 per share).
<PAGE>
EVOLVING SYSTEMS, INC.
PART 1 FINANCIAL INFORMATION PAGE
Item 1. Financial Statements
Balance Sheets
September 30, 1999 (unaudited) and December 31, 1998.......... 3
Statements of Operations
for the three-month and nine month periods ended September 30,
1999 and 1998 (unaudited)..................................... 4
Statements of Cash Flows
for the nine month periods ended September 30, 1999 and
1998 (unaudited) ............................................. 5
Notes to Financial Statements (unaudited)........................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations......................................... 7
PART II OTHER INFORMATION............................................ 13
Item 1. Legal Proceedings 13
Item 2. Changes in Securities 13
Item 3. Defaults on Senior Securities 13
Item 4. Submission of Matters to a Vote of Security Holders 13
Item 5. Other Information 14
Item 6. Exhibits and Reports on Form 8-K 14
SIGNATURES................................................................. 14
2
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
EVOLVING SYSTEMS, INC.
BALANCE SHEETS
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
Sept. 30, Dec. 31,
1999 1998
--------- --------
(unaudited)
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 328 $ 11,707
Short-term investments - unrestricted 15,684 6,950
Short-term investments - restricted 5,800 --
Contract receivables, net 8,769 14,239
Unbilled work-in-process 7,121 3,374
Prepaid and other current assets 1,107 2,031
-------- --------
Total current assets 38,809 38,301
Property and equipment, net 6,657 7,631
Other assets 1,547 1,547
-------- --------
Total assets $ 47,013 $ 47,479
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term obligations $ 702 $ 1,211
Accounts payable and accrued liabilities 1,868 3,002
Unearned revenue and customer deposits 8,814 3,079
-------- --------
Total current liabilities 11,384 7,292
Long-term obligations 304 825
Stockholders' equity:
Preferred stock, $.001 par value, 2,000,000 shares
authorized, no shares issued -- --
Common stock, $.001 par value; 25,000,000 shares 12 12
authorized; 12,209,497 and 11,888,021 shares issued and
outstanding as of September 30, 1999 (unaudited) and
December 31, 1998, respectively.
Additional paid-in-capital 51,111 50,703
Deferred compensation (149) (345)
Retained deficit (15,649) (11,008)
-------- --------
Total stockholders' equity 35,325 39,362
-------- --------
Total liabilities and stockholders' equity $ 47,013 $ 47,479
======== ========
</TABLE>
The accompanying notes are an integral part of the financial statements.
3
<PAGE>
EVOLVING SYSTEMS, INC.
STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT PER SHARE DATA)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended Sept 30, Nine Months Ended Sept 30,
-------------------------- -------------------------
<S> <C> <C> <C> <C>
Revenue: 1999 1998 1999 1998
------ ----- ------ ------
License fees and related services $3,130 $434 $4,434 $9,090
Other services 7,652 5,711 25,013 19,765
------ ----- ------ ------
Total revenue 10,782 6,145 29,447 28,855
------ ----- ------ ------
Cost of revenue:
License fees and related services 2,051 1,927 6,120 6,331
Other services 4,302 4,870 14,177 13,848
----- ----- ------ ------
Total cost of revenue 6,353 6,797 20,297 20,179
----- ----- ------ ------
Gross margin 4,429 (652) 9,150 8,676
Operating expenses:
Sales and marketing 1,231 1,247 2,813 4,238
General and administrative 2,585 2,267 7,400 6,119
Research and development 504 1,934 897 5,775
Restructuring -- 361 -- 361
------ ------ ------ ------
Total operating expenses 4,320 5,809 11,110 16,493
------ ------ ------ ------
Income (loss) from operations 109 (6,461) (1,960) (7,817)
Other (income) expense, net (271) (293) 2,681 199
------ ------ ------ ------
Income (loss) before income taxes 380 (6,168) (4,641) (8,016)
Provision for (benefit from) income taxes -- -- -- (601)
------ ------ ------ ------
Income (loss) before extraordinary item 380 (6,168) (4,641) (7,415)
Extraordinary item, net of applicable income taxes -- -- -- (446)
------ ------ ------ ------
Net income (loss) $380 $(6,168) $ (4,641) $(7,861)
====== ======= ======== =======
Basic earnings per common share:
Income (loss) before extraordinary item $.03 $ (.53) $ (.38) $ (1.12)
Extraordinary item -- -- -- (.07)
------ ------ ------ ------
Net income (loss) per common share $.03 $ (.53) $ (.38) $ (1.19)
====== ======= ======= =======
Diluted earnings per common share:
Income (loss) before extraordinary item $.03 $ (.53) $ ( .38) $(1.12)
Extraordinary item -- -- -- (.07)
------ ------ ------ ------
Net income (loss) per common share $.03 $ (.53) $ (.38) $(1.19)
====== ======= ======== =======
Basic shares outstanding 12,192 11,602 12,100 6,613
Diluted shares outstanding 13,182 11,602 12,100 6,613
</TABLE>
The accompanying notes are an integral part of the financial statements.
4
<PAGE>
EVOLVING SYSTEMS, INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(unaudited)
<TABLE>
<CAPTION>
Nine Months Ended September 30,
-------------------------------
1999 1998
---------- ---------
<S> <C> <C>
Operating activities:
Net loss $ (4,641) $ (7,861)
Adjustments to reconcile net loss to net cash provided by (used
in) operating activities:
Amortization of deferred compensation 196 308
Depreciation and amortization 2,274 3,135
Change in operating assets and liabilities:
Contract receivables 5,470 4,560
Unbilled work-in-process (3,747) (3,561)
Prepaid and other assets 924 (293)
Accounts payable and accrued liabilities (1,134) (855)
Unearned revenue and customer deposits 5,735 (4,600)
---------- ---------
Net cash provided by (used in) operating activities 5,077 (9,167)
---------- ---------
Investing activities:
Purchases of property and equipment (1,300) (1,645)
Purchase of short-term investments (14,534) --
---------- ---------
Net cash used in investing activities (15,834) (1,645)
---------- ---------
Financing activities:
Repayment of long-term obligations (1,030) (13,787)
Proceeds from the issuance of stock 408 48,051
---------- ---------
Net cash provided by (used in) financing activities (622) 34,264
---------- ---------
Net increase (decrease) in cash and cash equivalents (11,379) 23,452
Cash and cash equivalents at beginning of period 11,707 1,171
---------- ---------
Cash and cash equivalents at end of period $ 328 $ 24,623
========== =========
</TABLE>
The accompanying notes are an integral part of the financial statements.
5
<PAGE>
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 September 30, 1999 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, 1998 included in the Company's Form 10-K, filed on
March 31, 1999.
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
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.
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. During the quarter ended September 30, 1998, the
Company repriced 361,976 options to purchase common stock at $2.75 per share.
Subsequently on November 5, 1998, the company repriced an additional 238,230
options to purchase common stock at $2.75.
(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.
(4) Restructuring
During the three months ended September 30, 1998, in response to continued
reductions in purchases of the Company's products and services, the Company
completed voluntary separation plans for several individuals in conjunction with
the consolidation of and deletion of several functions. In connection with these
actions, a restructuring charge of $361,481 was recorded and paid in the three
months ended September 30, 1998. This charge related solely to severance and
benefits.
(5) Contingencies
In June, 1998, four 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 two cases, the Company's Underwriters in the
initial public offering on behalf of purchasers of the Company's common stock
between May 12, 1998 and June 17, 1998. In October 1998, these cases were
consolidated, class action status was certified, and the class period was
extended to July 23, 1998. The parties reached a settlement of $10 million, of
which the Company paid $2.5 million in April 1999. The settlement was approved
by the Court on October 4, 1999. The Company incurred approximately $700,000 in
legal costs associated with the lawsuit.
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.
6
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
---------------------------------------------------------------
RESULTS OF OPERATIONS
---------------------
GENERAL
- -------
Evolving Systems builds the software infrastructure that powers telephony
and Internet companies' ability to provide the new generation of enhanced and
broadband services. Founded in 1985, Evolving Systems develops and integrates
products and services that solve complex problems for some of the world's top
telecommunications companies. Evolving Systems' areas of expertise include
service order entry and automated provisioning systems, wireless data
applications, network management, billing, local number portability solutions
and other enhanced services. The Company offers a comprehensive training
curriculum and is involved in setting standards in the telephony industry.
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). This Registration
Statement and the Company's Form 10-K for the year ended December 31, 1998,
filed on March 31, 1999, should be read in conjunction with this document for
further information regarding the Company's business, risk factors, and
accounting policies.
7
<PAGE>
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 Sept 30, Nine Months Ended Sept 30,
--------------------- --------------------------
(unaudited) (unaudited)
----------- -----------
<S> <C> <C> <C> <C>
Revenue: 1999 1998 1999 1998
---- ---- ---- ----
License fees and related services 29.0% 7.1% 15.1% 31.5%
Other services 71.0 92.9 84.9 68.5
----- ------- ------ ------
Total revenue 100.0 100.0 100.0 100.0
Cost of revenue:
License fees and related services 19.0 31.4 20.8 21.9
Other services 39.9 79.3 48.1 48.0
----- ------- ------ ------
Total cost of revenue 58.9 110.6 68.9 69.9
Gross margin 41.1 (10.6) 31.1 30.1
Operating expenses:
Sales and marketing 11.4 20.3 9.6 14.7
General and administrative 24.0 36.9 25.1 21.2
Research and development 4.7 31.5 3.0 20.0
Restructuring 0 5.9 0 1.3
----- ------- ------ ------
Total operating expenses 40.1 94.5 37.7 57.2
Income (loss) from operations 1.0 (105.1) (6.6) (27.0)
Other (income) expense, net (2.5) (4.7) (9.1) 0.7
Income (loss) before income taxes 3.5 (100.4) (15.7) (27.7)
Provision for (benefit from) income taxes 0.0 0.0 --- (2.0)
----- ------- ------ ------
Income (loss) before extraordinary item 3.5 (100.4) (15.7) (25.7)
Extraordinary item 0.0 0.0 --- (1.5)
----- ------- ------ ------
Net income (loss) 3.5% (100.4)% (15.7)% (27.2)%
===== ======= ====== ======
</TABLE>
The three months ended September 30, 1999 compared to the three months ended
September 30, 1998
Revenue. Total revenue increased approximately $4.6 million or 75% to $10.8
million in the three months-ended September 30,1999 from $6.1 million in the
three months ended September 30, 1998. License fees and related services revenue
increased by $2.7 million or 621% to $3.1 million in the three months ended
September 30, 1999 from $434,000 in the three months ended September 30, 1998,
reflecting the sale of LNP products to new customers. Other services revenue
increased by $1.9 million or 34% to $7.7 million in the three months ended
September 30, 1999 from $5.7 million in the three months ended September 30,
1998, reflecting growth in consulting and custom programming projects with
long-standing customers. As a percentage of total revenue other services revenue
decreased to 71% for the three months ended September 30, 1999 from 93% for the
three months ended September 30, 1998.
Cost of revenue. Total cost of revenue decreased by $444,000 or 7% to $6.4
million in the three months ended September 30, 1999 from $6.8 million in the
three months ended September 30, 1998. As a percentage of total revenue, costs
decreased from 111% of revenue in the three months ended September 30, 1998 to
59% of revenue due to the decline in staffing costs for the months ended
September 30, 1999. Cost of license fees and related services increased by
$124,000 or 6% to $2.1 million for the three months ended September 30, 1999
from $1.9 million for the three months ended September 30, 1998. As a percentage
of total revenue, cost of license fees and related services decreased to 19% for
the three months ended September 30, 1999 from 31% in the three months ended
September 30, 1998. The cost increase in license fees and related services in
absolute dollar terms reflects the cost of third party software incorporated in
license products. Cost of other services decreased by $568,000 or 12% to $4.3
million for the three months ended September 30, 1999 from $4.9 million for the
three months ended September 30, 1998. Other services cost levels were favorably
impacted by efficiencies initiated in late 1998 which allowed for increases in
staff utilization. The Company experienced an improved total gross margin in the
three months ended September 30, 1999 due to the increase in revenue previously
discussed and a largely fixed cost of goods based on staffing. 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.
8
<PAGE>
Sales and marketing. Sales and marketing expenses decreased slightly by $16,000
or 1% to $1.2 million in the three months ended September 30, 1999 from $1.2
million in the three months ended September 30, 1998. As a percentage of
revenue, sales and marketing decreased to 11% of revenue in the three months
ended September 30, 1999 from 20% in the three months ended September 30, 1998.
This percentage decrease reflects increased revenue over the prior period. In
absolute dollar terms, the reduction in expense reflects cost containment on
discretionary marketing efforts.
General and administrative. General and administrative expenses increased by
$318,000 or 14% to $2.6 million in the three months ended September 30, 1999
from $2.3 million in the three months ended September 30, 1998. As a percentage
of revenue, general and administrative expenses decreased to 24% in the three
months ended September 30, 1999 from 37% in the three months ended September 30,
1998. The increase in absolute dollars is attributable to increased insurance
premium expense for officers and directors and real estate property taxes
beginning midyear 1999 and ratably expensed over 12 months in the three months
ended September 30, 1999.
Research and development. Research and development expenses decreased by $1.4
million, or 74%, to $504,000 in the three months ended September 30, 1999 from
$1.9 million in the three months ended September 30, 1998. As a percentage of
revenue, research and development expenses decreased to 5% in the three months
ended September 30, 1999 from 31% in the three months ended September 30, 1998,
reflecting both absolute dollar decreases in spending due to staff decreases
related to LNP product development projects, and percentage decreases due to
higher revenue levels.
Other (income) expense, net. Other (income) expense, net reflected decreased
income by $22,000, or 8%, to $271,000 in the three months ended September 30,
1999 from $293,000 expense in the three months ended September 30, 1998. This
income decline results principally from interest income on the Company's cash
and short-term investment balances as previous operating losses have reduced
cash balances.
Provision for (benefit from) Income Taxes. The Company recorded no income tax
provision relating to its operating profit of $380,000 for the three months
ended September 30, 1999 compared to a tax provision of $0 for the three months
ended September 30, 1998. The Company believes that the year to date operating
loss will negate taxes in the current quarter and it considers it inappropriate
to record additional benefits related to existing tax net operating loss
carryforwards until the market for the Company's products and services
stabilizes and projected operating results reflect greater certainty of
profitability and the ability to realize such benefits.
The nine months ended September 30, 1999 compared to the nine months ended
September 30, 1998
Revenue. Total revenue increased approximately $592,000 or 2% to $29.4 million
in the nine months ended September 30,1999 from $28.9 million in the nine months
ended September 30, 1998. License fees and related services revenue decreased by
$4.7 million or 51% to $4.4 million in the nine months ended September 30, 1999
from $9.1 million in the nine months ended September 30, 1998, reflecting LNP
product strength in the first three months of 1998. Other services revenue
increased by $5.2 million or 27% to $25.0 million in the nine months ended
September 30, 1999 from $19.8 million in the nine months ended September 30,
1998, reflecting strength in consulting and custom development projects with
long-standing customers in 1999. As a percentage of total revenue, other
services revenue increased to 85% for the nine months ended September 30, 1999
from 69% for the nine months ended September 30, 1998.
Cost of revenue. Cost of revenue increased $118,000 or 1% to $20.3 million in
the nine months ended September 30, 1999 from $20.2 million in the nine months
ended September 30, 1998. The cost of license fees and related services
decreased by $211,000 or 3% to $6.1 million for the nine months ended
September 30, 1999 from $6.3 million for the nine months ended September 30,
1998. Increased third party software costs as well as decreased dedicated
staffing is reflected in this decrease. Other services cost increased $329,000
or 2% to $14.2 million in the nine months ended September 30, 1999 from $13.8
million in the nine months ended September 30, 1998. This increase in other
services cost was due to much higher revenue in 1999.
Sales and marketing. Sales and marketing expenses decreased by $1.4 million or
34% to $2.8 million in the nine months ended September 30, 1999 from $4.2
million in the nine months ended September 30, 1998. As a percentage of revenue,
sales and marketing expenses decreased to 10% of revenue in the nine months
ended September 30, 1999 from 15% in the nine months ended September 30, 1998.
This decrease reflects the absolute dollar spending decrease related to
personnel reductions and reduced promotional expenses in 1999.
General and administrative. General and administrative expenses increased by
$1.3 million or 21% to $7.4 million in the nine months ended September 30, 1999
from $6.1 million in the nine months ended September 30, 1998. As a percentage
of revenue, general and administrative expenses increased to 25% in the nine
months ended September 30, 1999 from 21% the nine months ended September 30,
1998. The increase in absolute dollars is attributable to increased insurance
premium expense for officers and directors and real estate property taxes
beginning midyear 1999 and ratably expensed over 12 months in the three months
ended September 30, 1999.
Research and development. Research and development expenses decreased by $4.9
million, or 85%, to $897,000 in the nine months ended September 30, 1999 from
$5.8 million in the nine months ended September 30, 1998. As a percentage of
revenue, research and development expenses decreased to 3% in the nine months
ended September 30, 1999 from 20%
9
<PAGE>
in the nine months ended September 30, 1998, reflecting absolute dollar
decreases in spending due to staff reductions related to LNP product development
projects.
Other (income) expense, net. Other (income) expense, net increased by $2.5
million, or 1247%, to $2.7 million in the nine months ended September 30, 1999
from $199,000 in the nine months ended September 30, 1998. This income is
principally interest income related to the Company's cash balances 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.
Other (income) expense balances are net of both expenses and income. During the
nine months ended September 30, 1999, an expense of $3.1 million was recorded
for the settlement of the shareholder lawsuit.
Provision for (benefit from) Income Taxes. The Company recorded a net income tax
benefit of $601,000 for the nine months ended September 30, 1998. The Company
recorded no income tax benefit relating to its operating loss of $4.6 million
for the nine months ended September 30, 1999. The Company believes that the year
to date operating loss will negate taxes in the current quarter and it considers
it inappropriate to record additional benefits related to existing tax net
operating loss carryforwards until the market for the Company's products and
services stabilizes and projected operating results reflect greater certainty of
profitability and the ability to realize such benefits.
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 nine months ended September
30, 1998. The Company recorded a tax benefit of $220,000 relating to the
extraordinary item recorded in the nine months ended September 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 September 30, 1999, the Company's principal
sources of liquidity included $21.8 million in cash and short-term investments
and a $5.0 million secured bank line of credit, which expires in September 2000.
As of September 30, 1999, the Company had no outstanding balance under the line
of credit. The Company has secured the line of credit with short-term
investments and is in compliance with the bank agreement.
Net cash provided by operating activities was $5.1 million in the nine
months ended September 30, 1999 compared to cash used of $9.2 million in the
nine months ended September 30, 1998. The main contributors to the provision of
cash by operations in the nine months ended September 30, 1999 were an increase
in customer deposits and increased collection of contracts receivable, which was
partially offset by an increase in unbilled work-in-process due to revenue
earned but not yet billable under contract terms. In the nine months ended
September 30, 1998, the main contributors to cash usage were an increase in
unbilled work-in-process and a decrease in unearned revenue.
Net cash used in investing activities during the nine months ended
September 30, 1999 and September 30, 1998 was $15.8 million and $1.6 million
respectively. For the nine months ended September 30, 1999, the cash used was
for short-term commercial paper investments of $14.5 million and $1.3 million
for property and equipment. For the nine months ending September 30, 1998, $1.6
million was used for property and equipment.
Financing activities used $622,000 in cash in the nine months ended
September 30, 1999 compared to providing $34.3 million in the nine months ended
September 30, 1998. The primary usage of cash for the period ended September 30,
1999, was the repayment of long-term obligations of $1.0 million offset by
$408,000 in new stock issuance for the exercise of stock options. 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 remaining 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 affect 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
10
<PAGE>
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; changes in
management; product lifecycles; 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 and services,
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 into international markets, 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 Form 10-K, filed March 31, 1999. 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) delays in enforcement and
implementation of the Telecommunications Act of 1996; (iii) customer's
acceptance of Local Number Portability Products and other products and services
provided by the company; (iv) delays associated with customers' internal
approval and contracting procedures, procurement practices, and testing and
acceptance process; (v) changes in management; and (vi) 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, 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 in three areas: as a developer and
supplier of telecommunications software, in its internal operations, and the
buying decisions of the Company's customers, which could result in either a
positive or negative impact on the Company's revenue.
The Company formed a Year 2000 project team to assess its state of
readiness with respect to Year 2000 issues and to implement corrective actions
and contingency plans. This project team has completed the process of
identifying,
11
<PAGE>
analyzing, and correcting all items determined to be material to the Company.
Currently the Company is monitoring third party provided software for any
changes to Y2K status, and finalizing contingency plans. The following graph
should be used as an approximate guide of the Company's activities to date in
regard to this problem.
<TABLE>
<CAPTION>
PHASE: Awareness Assessment Renovation Validation Implementation
<S> <C> <C> <C> <C> <C>
Products and Services ----------------------------------------------------------------------------- |
Third Party Suppliers ----------------------------------------------------------------------------- |
Customers ------------------------------------------------------------------------- |
Evolving Systems Internal
IT-Software ------------------------------------------------------------------------- |
IT-Hardware -------------------------------------------------------------------- |
Non-IT Hardware ------------------------------------------------------------------------- |
Suppliers ------------------------------------------------------------------------- |
</TABLE>
The Company has performed all Year 2000 compliance assessment, testing and
remediation using its own personnel, and did not hire third party consultants to
assist with Year 2000 compliance activities.
Products: 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 has tested third-party
software products that are 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's primary products subject to Year 2000 issues are the
Company's Local Number Portability products. Initial testing of these products
was conducted in early 1998, and additional testing, including code scanning and
remediation, was completed in the second quarter of 1999. The Company is
continuing its review of its products and monitoring of third party software
compliance status to ensure ongoing compliance. The Company will continue
testing of its products through the end of 1999 as new releases of the Company's
products are made available to the Company's customers and third party vendors
supply updates to their products.
Custom Software and Services: The Company provides custom software and related
services for a number of customers. These customers have engaged the Company to
perform Year 2000 compliance tests on such software and services. The Company
has successfully completed Year 2000 tests on several software solutions. The
Company expects to continue performing Year 2000 regression testing for such
customers through 1999. The Company's relationship with its customers and the
Company's exposure to liability may be impacted if the Company fails to
adequately address Year 2000 issues in its products and/or custom software
solutions. This could have a material adverse effect on the Company's business,
results of operation and financial condition.
Customers: The Company offers software products and services to
telecommunications carriers and telecommunication companies. The Company has
assisted 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. A disruption of buying patterns could cause a
material adverse effect on the Company's business, results of operations and
financial condition. The Company continues to assess the Year 2000 readiness of
its key customers.
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 have
been replaced within the past three years by new systems that are certified by
their vendors to be date code compliant. 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
initiated correspondence with suppliers in 1998 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. As the Company receives vendor
responses, the Company is developing contingency plans as vendor responses are
being reviewed for adequacy. To the extent that such software and systems do not
comply with Year 2000 requirements, or that the Company's contingency plans are
not effective, 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.
12
<PAGE>
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 in progress to
validate such condition.
Non-IT - Hardware: The Company has completed the assessment, validation,
and repair or replacement of all facilities components that may contain Y2K
impacts. The costs associated with such actions has not had a material effect on
the Company's business, results operations or financial condition.
Suppliers: The Company initiated correspondence with service suppliers to
review what actions need be undertaken to make all embedded systems date code
compliant. Such actions included a review of vendor contracts and formal
communication with suppliers to request certification that products are Year
2000 compliant. This was completed in the second quarter 1999.
The Company's operations are dependent upon third party suppliers of
telecommunications and power services. The Company, at this time, has decided
not to purchase a generator and will be dependent upon third party suppliers.
The Company has created contingency plans in the event of the failure of its
remediation efforts. The contingency plans are drafted and are under review
through the end of the year. The contingency plans are continuously updated as
new developments arise in relation to Y2K compliance and risk management. The
Company will continue the development and testing of the contingency plan as
part of the Company's ongoing Year 2000 compliance effort.
Costs: The costs of the Company's Year 2000 compliance efforts are being funded
with cash flows from operations. To date, these costs have been associated with
the reallocation of internal staff hours to Year 2000 project related efforts
and have not been material. As additional evaluation and testing is performed,
particularly on the Company's products if independent third party vendors are
engaged by the Company, these costs are likely to increase significantly.
Modifications to the Company's products have not been significant but as ongoing
testing is performed, modifications to the Company's products may be required.
The total costs that the Company incurs in connection with the Year 2000
problems will be influenced by the Company's ability to successfully identify
Year 2000 systems' flaws, the nature and amount of programming required to fix
the affected programs, the related labor and/or consulting costs for such
remediation, and the ability of third parties with whom the Company has business
relationships to successfully address their own Year 2000 concerns. Due to the
wide variability of the different issues surrounding Year 2000, the estimate to
analyze, correct, replace component software, test, and re-deploy will be
approximately $1 million dollars. As a result, the Company does not feel that
the total costs will have a material impact on the Company's business, results
of operation, or financial condition.
THE DISCUSSION OF THE COMPANY'S EFFORTS AND MANAGEMENT'S EXPECTATIONS RELATING
TO YEAR 2000 COMPLIANCE CONTAIN FORWARD-LOOKING STATEMENTS AND ARE BASED ON
MANAGEMENT'S BEST ESTIMATES OF FUTURE EVENTS. MANAGEMENT BELIEVES THAT IT IS NOT
POSSIBLE TO DETERMINE WITH COMPLETE CERTAINTY THAT ALL YEAR 2000 PROBLEMS
AFFECTING THE COMPANY HAVE BEEN IDENTIFIED OR CORRECTED. RISKS TO COMPLETING THE
PLAN INCLUDE THE AVAILABILITY OF RESOURCES, THE COMPANY'S ABILITY TO DISCOVER
AND CORRECT THE POTENTIAL YEAR 2000 PROBLEMS WHICH COULD HAVE IMPACT ON THE
COMPANY AND ITS PRODUCTS, THE ABILITY OF THE COMPANY AND ITS SUPPLIERS TO BRING
THEIR SOFTWARE AND SYSTEMS INTO COMPLIANCE AND UNANTICIPATED PROBLEMS IDENTIFIED
IN THE ONGOING COMPLIANCE REVIEW.
These statements regarding year 2000 readiness and the Company's year 2000
program are intended to constitute "Year 2000 Readiness Disclosures" as defined
in the recently enacted Year 2000 Information and Readiness Disclosure Act.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Changes in Securities
None
Item 3. Defaults on Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
13
<PAGE>
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: 11/12/99 /s/ David R. Johnson
--------------------
David R. Johnson
Chief Financial Officer
(Principal Financial and Accounting Officer)
14
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