<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
____________
(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, 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 June 30, 1999, there were outstanding 12,143,511 shares of
Registrant's Common Stock (par value $0.001 per share).
1
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EVOLVING SYSTEMS, INC.
<TABLE>
<CAPTION>
PART 1 FINANCIAL INFORMATION PAGE
<S> <C>
Item 1. Financial Statements
Balance Sheets
June 30, 1999 (unaudited) and December 31, 1998......................................... 3
Statements of Operations
for the three-month and six-month periods ended June 30,
1999 and 1998 (unaudited)............................................................... 4
Condensed Statements of Cash Flow
for the six-month periods ended June 30, 1999 and
1998 (unaudited)......................................................................... 5
Notes to Financial Statements................................................................... 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........................................................................... 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>
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>
June 30, Dec. 31,
1999 1998
-------- --------
(unaudited)
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 4,351 $ 11,707
Short-term investments 9,417 6,950
Contract receivables, net 15,830 14,239
Unbilled work-in-process 2,599 3,374
Prepaid and other current assets 800 2,031
-------- --------
Total current assets 32,997 38,301
Property and equipment, net 7,061 7,631
Deferred tax assets 1,547 1,547
Other assets -------- --------
Total assets $ 41,605 $ 47,479
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term obligations $ 795 $ 1,211
Accounts payable and accrued liabilities 2,370 3,002
Unearned revenue and customer deposits 3,273 3,079
-------- --------
Total current liabilities 6,438 7,292
Long-term obligations 464 825
Stockholders' equity:
Preferred stock, $.001 par value, 2,000,000 shares authorized,
no shares issued - -
Common stock, $.001 par value; 25,000,000 shares authorized; 12,143,511 and 12 12
11,888,021 shares issued and outstanding as of June 30, 1999 and December
31, 1998 respectively.
Additional paid-in-capital 50,929 50,703
Deferred compensation (209) (345)
Retained earnings (deficit) (16,029) (11,008)
-------- --------
Total stockholders' equity 34,703 39,362
-------- --------
Total liabilities and stockholders' equity $ 41,605 $ 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 June 30, Six Months Ended June 30,
--------------------------- -------------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenue:
License fees and related services $ 605 $ 2,869 $ 1,304 $ 8,656
Other services 9,200 6,712 17,361 14,054
------- ------- ------- -------
Total revenue 9,805 9,581 18,665 22,710
------- ------- ------- -------
Cost of revenue:
License fees and related services 2,056 2,484 4,069 4,403
Other services 5,100 4,284 9,875 8,979
------- ------- ------- -------
Total cost of revenue 7,156 6,768 13,944 13,382
------- ------- ------- -------
Gross margin 2,649 2,813 4,721 9,328
Operating expenses:
Sales and marketing 911 1,603 1,583 2,991
General and administrative 2,391 1,715 4,815 3,853
Research and development 0 1,879 393 3,841
------- ------- ------- -------
Total operating expenses 3,302 5,197 6,791 10,685
------- ------- ------- -------
Income (loss) from operations (653) (2,384) (2,070) (1,357)
Other expense, net 121 (91) (2,951) (463)
------- ------- ------- -------
Income (loss) before income taxes (532) (2,475) (5,021) (1,820)
Provision for (benefit from) income taxes -- (817) -- (601)
------- ------- ------- -------
Income (loss) before Extraordinary item (532) (1,658) -- (1,219)
Extraordinary item, net of applicable income taxes -- (446) -- (446)
------- ------- ------- -------
Net income (loss) $ (532) $(2,104) (5,021) $(1,665)
======= ======= ======= =======
Basic and diluted earnings per common share:
Net loss before extraordinary item $ (.04) $ (.25) $ (.42) $ (.30)
Extraordinary item -- (.07) -- (.11)
------- ------- ------- -------
Net loss per common share $ (.04) $ (.32) $ (.42) $ (.41)
======= ======= ======= =======
Basic & diluted shares outstanding 12,127 6,610 12,097 4,118
</TABLE>
The accompanying notes are an integral part of the financial statements.
4
<PAGE>
EVOLVING SYSTEMS, INC.
CONDENSED STATEMENTS OF CASH FLOW
(IN THOUSANDS)
(unaudited)
<TABLE>
<CAPTION>
Six Months Ended June 30,
-------------------------
1999 1998
---- ----
<S> <C> <C>
Operating activities:
Net loss $(5,021) $(1,665)
Adjustments to reconcile net loss to net cash used in operating activities:
Amortization of deferred compensation 136 114
Depreciation and amortization 1,462 2,031
Change in operating assets and liabilities:
Contract receivables (1,591) 2,223
Unbilled work-in-progress 775 (2,997)
Prepaid and other assets 1,231 47
Accounts payable and accrued liabilities (632) 164
Unearned revenue and customer deposits 194 (4,253)
------- -------
Net cash used in operating activities (3,446) (4,331)
Investing activities:
Purchases of property and equipment (892) (1,307)
Purchase of short-term investments (2,467) -------
Net cash used in investing activities (3,359) (1,307)
Financing activities:
Repayment of long-term obligations (777) (13,280)
Sale of Stock 226 48,067
------- -------
Net cash provided by (used in) financing activities (551) 34,787
------- -------
Net increase (decrease) in cash and cash equivalents (7,356) 29,144
Cash and cash equivalents at beginning of period 11,707 1,171
------- -------
Cash and cash equivalents at end of period $ 4,351 $30,315
======= =======
</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 June 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 with the SEC 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
The Company was required to adopt Statement of Financial Accounting
Standards ("SFAS") No. 128, "Earnings Per Share," in its financial statements.
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.
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' 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) 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 one case, the Company's Underwriters on behalf of
purchasers of the Company's common stock between May 12, 1998 and July 23, 1998.
The parties reached a settlement of a $2.5 million payment, on April 12, 1999.
Settlement is subject to court approval, scheduled in October of 1999. 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 critical 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,
Voice over IP technology 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).
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 Ended June 30, Six Months Ended June 30,
-------------------------- -------------------------
(unaudited)
-----------
1999 1998 1999 1998
------------ ----------- ----------- -----------
<S> <C> <C> <C> <C>
Revenue:
License fees and related services 6.2% 30.0% 7.0% 38.1%
Other services 93.8 70.0 93.0 61.9
------------ ----------- ----------- -----------
Total revenue 100.0 100.0 100.0 100.0
Cost of revenue:
License fees and related services 21.0 25.9 21.8 19.4
Other services 52.0 44.7 52.9 39.5
------------ ----------- ----------- -----------
Total cost of revenue 73.0 70.6 74.7 58.9
Gross margin 27.0 29.4 25.3 41.1
Operating expenses:
Sales and marketing 9.3 16.7 8.5 13.2
General and administrative 24.4 17.9 25.8 16.9
Research and development 0.0 19.6 2.1 16.9
------------ ----------- ----------- -----------
Total operating expenses 33.7 54.2 36.4 47.0
Loss from operations (6.7) (24.8) (11.1) (5.9)
Other income (expense), net 1.2 (1.0) (15.8) (2.0)
Loss before income taxes (5.4) (25.8) (26.9) (8.0)
Benefit from income taxes (0.0) (8.5) 0.0 (2.6)
------------ ----------- ----------- -----------
Loss before extraordinary item (5.4) (17.3) (26.9) (5.4)
Extraordinary item 0.0 (4.7) 0.0 (1.9)
------------ ----------- ----------- -----------
Net loss (5.4)% (22.00)% (26.9)% (7.3)%
============ =========== =========== ===========
</TABLE>
The three months ended June 30, 1999 compared to the three months ended June 30,
1998
Revenue. Total revenue increased approximately $224,000 or 2% to $9.8 million in
the three months ended June 30,1999 from $9.6 million in the three months ended
June 30, 1998. License fees and related services revenue decreased by $2.3
million or 79% to $605,000 in the three months ended June 30, 1999 from $2.9
million in the three months ended June 30, 1998, reflecting the completion of
certain major LNP projects in 1998. Other services revenue increased by $2.5
million or 37% to $9.2 million in the three months ended June 30, 1999 from $6.7
million in the three months ended June 30, 1998, reflecting growth in consulting
and custom programming projects with long-standing customers. As a percentage of
total revenue, other services revenue increased to 94% for the three months
ended June 30, 1999 from 70% for the three months ended June 30, 1998.
Cost of revenue. Total cost of revenue increased by $388,000 or 6% to $7.2
million in the three months ended June 30, 1999 from $6.8 million in the three
months ended June 30, 1998. As a percentage of total revenue, costs increased
from 71% of revenue in the three months ended June 30, 1998 to 73% of revenue
due to the decline in sales of higher margin LNP products in the three months
ended June 30, 1999. Cost of license fees and related services decreased by
$428,000 or 17% to $2.1 million for the three months ended June 30, 1999 from
$2.5 million for the three months ended June 30, 1998. As a percentage of total
revenue, cost of license fees and related services decreased to 21% for the
three months ended June 30, 1999 from 26% in the three months ended June 30,
1998. The cost decrease in license fees and related services in absolute dollar
terms reflects decreases in personnel assigned to LNP systems support. Cost of
other services increased in the three months ended June 30, 1999 due to
increased business activity but the increase in costs of 17% was approximately
half of the 37% increase in related revenue for the quarter ending June 30,
1999, because of increasing gross margins. Because the Company has excess
resources assigned to license fee products, these products produce a negative
gross margin.
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 by $692,000 or 43%
to $911,000 in the three months ended June 30, 1999 from $1.6 million in the
three months ended June 30, 1998. As a percentage of revenue, sales and
marketing decreased to 9% of revenue in the three months ended June 30, 1999
from 17% in the three months ended June 30, 1998. This decrease reflects both
decreased sales and marketing staffing and associated costs as well as decreased
promotional expenses over the prior period as the Company has refocused its
strategy.
General and administrative. General and administrative expenses increased by
$676,000 or 39% to $2.4 million in the three months ended June 30, 1999 from
$1.7 million in the three months ended June 30, 1998. As a percentage of
revenue, general and administrative expenses increased to 24% in the three
months ended June 30, 1999 from 18% in the three months ended June 30, 1998. The
increase in absolute dollars is attributable to bonus payments, increased
liability insurance premiums and real estate property taxes in the three months
ended June 30, 1999.
Research and development. Research and development expenses decreased by $1.9
million, or 100%, to $ 0 in the three months ended June 30, 1999 from $1.9
million in the three months ended June 30, 1998. As a percentage of revenue,
research and development expenses decreased to 0% in the three months ended June
30, 1999 from 20% in the three months ended June 30, 1998, reflecting staff
decreases in LNP development and a change in the Company strategy for
development. During the first and second quarters of 1999, the Company
contracted with EHPT to develop the VoIP Call Agent whereby EHPT was to
reimburse Evolving Systems for much of its development costs; however, costs
exceeded revenue on this project. As a result, cost related to this development
are accounted for in cost of other services revenue. In addition, LNP related
development cost is accounted for in cost of services revenue as the cost of
enhancements are being partially covered by existing LNP customers. As a result,
approximately $650,000 of expenses related to development costs are accounted
for in the cost of revenue for the quarter ending June 30, 1999.
Other income (expense), net. Other income, net increased by $212,000, or 233%,
to $121,000 in the three months ended June 30, 1999 from an expense of $(91,000)
in the three months ended June 30, 1998. As a percentage of revenue, other
income (expense) increased to 1% of income in the three months ended June 30,
1999 from (1%) of income in the three months ended June 30,1998. This
income/expense change results from a decline in interest expense as debt was
retired subsequent to the IPO in May, 1998 as well as interest income on the
Company's cash subsequent to the offering.
Benefit from income taxes. The Company recorded an income tax benefit of
$817,000 for the three months ended June 30, 1998 but did not record any tax
benefit for the period ending June 30, 1999. The Company deems it inappropriate
to book such benefits until the market for the Company's products and services
stabilizes and projected operating results reflect greater certainty of
probability to realize such benefits.
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 Company did not record an extraordinary item for the three
months ended June 30, 1999.
The six months ended June 30, 1999 compared to the six months ended June 30,
1998
Revenue. Total revenue decreased approximately $4 million or 18% to $18.7
million in the six months ended June 30,1999 from $22.7 million in the six
months ended June 30, 1998. License fees and related services revenue decreased
by $7.4 million or 85% to $1.3 million in the six months ended June 30, 1999
from $8.7 million in the six months ended June 30, 1998, reflecting LNP product
strength in the first three months of 1998 and the decline in demand since then.
Other services revenue increased by $3.3 million or 24% to $17.4 million in the
six months ended June 30, 1999 from $14.1 million in the six months ended June
30, 1998, reflecting strength in consulting and custom development projects with
long-standing customers. As a percentage of total revenue, other services
revenue increased to 93% for the six months ended June 30, 1999 from 62% for the
six months ended June 30, 1998.
Cost of revenue. Cost of revenue increased $562,000 or 4% to $13.9 million in
the six months ended June 30, 1999 from $13.4 million in the six months ended
June 30, 1998. License fees and related services cost decreased by $334,000 or
8% to $4.1 million for the six months ended June 30, 1999 from $4.4 million for
the six months ended June 30, 1998, due to decreased staffing for product
support due to fewer product enhancements in the period and moving staff to
higher margin projects. The effect of this staff movement is to reduce the
negative gross margin on license fee business. Other services cost increased
$896,000 or 10% to $9.9 million in the six months ended June 30, 1999 from $9.0
million in the six months ended June 30, 1998. This increase in other services
cost was due to higher revenue levels.
Sales and marketing. Sales and marketing expenses decreased by $1.4 million or
47% to $1.6 million in the six months ended June 30, 1999 from $3.0 million in
the six months ended June 30, 1998. As a percentage of revenue, sales and
marketing expenses decreased to 9% of revenue in the six months ended June 30,
1999 from 13% in the six months ended June 30, 1998. This decrease reflects the
personnel decreases and decreases in advertising and promotional activities due
to strategic partnering activities and refocus of marketing efforts.
General and administrative. General and administrative expenses increased by
$962,000 or 25% to $4.8 million in the six months ended June 30, 1999 from $3.9
million in the six months ended June 30, 1998. As a percentage of revenue,
general and administrative expenses increased to 26% in the six months ended
June 30, 1999 from 17% in the six months ended
9
<PAGE>
June 30, 1998. This increase is a result of higher insurance expense, real
estate property taxes, legal fees and lower revenue levels used in the
percentage calculation.
Research and development. Research and development expenses decreased by $3.4
million, or 90%, to $393,000 in the six months ended June 30, 1999 from $3.8
million in the six months ended June 30, 1998. As a percentage of revenue,
research and development expenses decreased to 2% in the six months ended June
30, 1999 from 17% in the six months ended June 30, 1998, reflecting the change
in company strategy to develop new products through funding arrangements with
strategic partners. Research and development projects are funded by strategic
partners and the Company records the cost in cost of revenue as the Company
records revenue related to these projects.
Other income (expense), net. Other income (expense), net decreased by $(2.5)
million or 537%, to $(3.0) million in the six months ended June 30, 1999 from an
expense of $(463,000) in the six months ended June 30, 1998. As a percentage of
revenue, other income (expense) increased to (16%) of income in the three months
ended June 30, 1999 from (2%) of expense in the six months ended June 30,1998.
This income/expense change results from a decline in interest expense as debt
was retired subsequent to the IPO in May, 1998 as well as interest income on the
Company's proceeds from the offering and a one-time charge of $3.3 million for
the settlement of the shareholder suit filed in 1998.
Benefit from income taxes. The Company recorded an income tax benefit of
$601,000 for the six months ended June 30, 1998 but did not record any tax
benefit for the period ending June 30, 1999. The Company deems it inappropriate
to book such benefits until the market for the Company's products and services
stabilizes and projected operating results reflect greater certainty of
probability to realize such benefits.
Extraordinary item. The Company did not record any extraordinary item in the six
months ended June 30, 1999. 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 1999. 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 had
no outstanding balances under its bank loan agreements as of June 30, 1999. 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, 1999,
the Company was in compliance with such covenants.
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 $3.4 million in the six months
ended June 30, 1999 compared to a usage of $4.3 million in the six months ended
June 30, 1998. The main contributor to the usage of cash by operations in the
six months ended June 30, 1999 was funding the $3.3 million lawsuit settlement
and associated costs. Contract receivables used cash of $1.6 million during this
period which was offset by depreciation and amortization of $1.5 million. In the
six months ended June 30, 1998, the cash usage by operations was largely the net
result of an increase in $4.3 in unearned revenue offset by an increase in
customer deposits due to large LNP contracts entered into during that period.
Net cash used in investing activities during the six months ended June
30, 1999 increased $2.1 million or 157% to $3.4 million for the six month period
ending June 30, 1999. Most of this cash was used to purchase investment grade
debt securities as part of normal treasury operations. For the period ending
June 30, 1998 cash usage in investing activities was $1.3 million and used to
purchase equipment and facilities to support operations.
Financing activities used $551,000 in cash in the six months ended June
30, 1999 compared to cash provided of $34.8 million in the six months ended June
30, 1998. The Company's initial public offering generated approximately $48
million and all outstanding debt of the Company of $13 million, except for
capital lease obligations, was repaid during the six months ended June 30, 1998.
During the six months ended June 30, 1999, cash was used for the repayment of
long-term obligations.
The Company believes that its current cash and short-term investments,
together with anticipated cash flow from operations and its existing credit
facilities 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
10
<PAGE>
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 government laws and regulations related to the
telecommunications market or judicial or administrative actions with respect to
such laws or regulations; the impact of Year 2000 on customers' purchasing; the
nature and pace of enforcement of the Telecommunications Act of 1996; product
lifecycles; the Company' success in effecting 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, sales, and 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 has broadened 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.
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.
11
<PAGE>
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
inventorying items that will be affected by Year 2000, assigning priorities to
identified items, assessing the Year 2000 compliance of items determined to be
material to the Company. Currently the Company is repairing or replacing
material items that are found not be Year 2000 compliant, testing Company
developed software and third party provided software, and designing contingency
plans. The Company expects the Year 2000 projects to be successfully completed
during the remainder of 1999. The following graph should be used as an
approximate guide of the Company's activities to date in regard to this problem.
<TABLE>
<CAPTION>
<S> <C>
PHASE: Awareness Assessment Renovation Validation Implementation
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 there are no plans to 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, has been 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 anticipates ongoing
testing of its products through the third quarter 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. 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. A disruption of buying patterns could cause a
material adverse effect on the Company's business, results of operations and
financial condition. The Company is currently assessing 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 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. As the Company
12
<PAGE>
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.
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 has initiated 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. 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 is in the process of creating contingency plans in the event of the
failure of its remediation efforts. A full assessment of the potential points of
failure is ongoing. While the original target completion was expected to be June
30, 1999, it has been extended to be completed in the third quarter so that the
Company's contingency plans can be coordinated with the Company's customers. The
Company will continue the development and testing of the contingency plan as
part of the Company's ongoing Year 2000 compliance effort. The testing of the
contingency plans is expected to be completed by September 30, 1999.
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 in the
range of $1 to $1.5 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
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 one case, the Company's Underwriters on
behalf of purchasers of
13
<PAGE>
the Company's common stock between May 12, 1998 and July 23, 1998. The parties
reached a settlement, subject to court approval, on April 12, 1999. Settlement
is subject to court approval, scheduled in October of 1999.
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. Changes in Securities
None
Item 3. Defaults on Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
27 Financial Data Schedule
(b) Reports on Form 8-K
Amendment of Employee Stock Purchase Plan and Stock Option Plan
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: 8/12/99 /s/ David R. Johnson
---------------------------------------
David R. Johnson
Senior Vice President of Finance,
Chief Financial Officer and Treasurer
(Principal Financial and Accounting
Officer)
14
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