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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------
FORM 10-K
[X]Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934
For the fiscal year ended December 31, 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 (IRS Employer Identification Number)
incorporation or organization)
9777 Mt. Pyramid Ct., Englewood, 80112
Colorado (Zip Code)
(Address of principal
executive offices)
(303) 802-1000
(Registrant's telephone number)
Securities registered under Section 12(b) of the Exchange Act: None
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, par value $0.001 per share
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
The approximate aggregate market value of the Common Stock held by non-
affiliates of the registrant, based upon the last sale price of the Common
Stock reported on the National Association of Securities Dealers Automated
Quotation National Market System was $12.50 as of March 1, 2000.
The number of shares of Common Stock outstanding was 12,494,121 as of
March 1, 2000.
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part III (Items 10, 11, 12 and 13) is
incorporated by reference to portions of the registrant's definitive proxy
statement for the 2000 Annual Meeting of Stockholders which will be filed with
the Securities and Exchange Commission within 120 days after the close of the
1999 year.
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EVOLVING SYSTEMS, INC.
Annual Report on Form 10-K
December 31, 1999
Table of Contents
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PART I
Item 1 Business....................................................... 3
Item 2 Properties..................................................... 14
Item 3 Legal Proceedings.............................................. 15
Item 4 Submission of Matters to a Vote of Security Holders............ 15
PART II
Market for Registrant's Common Equity and Related Stockholder
Item 5 Matters........................................................ 16
Item 6 Selected Financial Data........................................ 17
Management's Discussion and Analysis of Financial Condition and
Item 7 Results of Operations.......................................... 18
Item 8 Consolidated Financial Statements and Supplementary Data....... 24
Changes in and Disagreements with Accountants on Accounting and
Item 9 Financial Disclosure........................................... 24
PART III
Item 10 Directors and Executive Officers of the Registrant............. 25
Item 11 Executive Compensation......................................... 25
Security Ownership of Certain Beneficial Owners and
Item 12 Management..................................................... 25
Item 13 Certain Relationships and Related Transactions................. 25
PART IV
Exhibits, Financial Statement Schedules and Reports on Form 8-
Item 14 K.............................................................. 26
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Except for the historical information contained herein, the following
discussion contains forward-looking statements that involve risks and
uncertainties. The Company's actual results could differ materially from those
discussed here. Factors that could cause or contribute to such differences
include, but are not limited to, those discussed in this section, in the
sections entitled "Management's Discussion And Analysis Of Financial Condition
And Results of Operations" and "Risk Factors."
PART I
Item 1. Business
Introduction
Evolving Systems is a software, consulting and integration company
enabling next generation telecommunications companies. Evolving Systems helps
address the technical challenges relating to their Operations Support Systems
(OSS) and Business Support Systems (BSS) created by the industry's rapidly
changing technology, competitive pressures and regulatory environment. The
Company has significant technical expertise and business acumen in each of
these domains.
From its inception in 1985 through 1996, the Company focused on providing
custom software development services to a limited number of telecommunications
companies. Beginning in 1996, the Company made a strategic decision to expand
its focus to include development of Local Number Portability (LNP) software
products. The Company is using its technical strengths to position itself both
as a leading custom software developer as well as a provider of next-generation
(NextGen) OSS and Network Element (NE) solutions.
The Company's LNP software solution, enabling carriers to meet the
requirement that customers retain their local phone numbers when changing
service providers, has been selected for use by a majority of the Regional Bell
Operating Companies (RBOCs) and two leading local and long distance carriers.
The Company believes that the implementation of LNP will require significant
changes in a broad range of carriers' software and systems that perform mission
critical functions such as ordering, provisioning, service assurance and
billing, collectively known as OSS.
The Company developed and continues to maintain the software currently in
use by all Number Portability Administration Centers (NPACs) in the United
States and Canada. The software receives ported telephone number information as
changes occur, and distributes the data to all subscribing carriers in the
region. The software is provided under contract to NeuStar Corporation,
formerly a division of Lockheed Martin IMS.
The Company provides a wide range of custom solutions to incumbent local
exchange carriers (ILECs) and competitive local exchange carriers (CLECs) for
the provisioning and fulfillment of customer orders. These solutions focus on
the flow-through provisioning of Advanced Intelligent Network (AIN) services
within a carrier's network environment.
As part of its systems integration focus the Company provides billing
solutions to IP technology-based carriers utilizing software products form
third parties. In addition, the Company uses workflow technology from third
parties in conjunction with systems integration techniques to provide solutions
to carriers' needs for improved efficiency, effectiveness and reduced cycle
times in order management, provisioning and other service fulfillment
functional areas.
The Company developed and continues to maintain and enhance software for
wireless data network elements which are owned and marketed by Lucent
Technologies (Lucent).
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Industry Background
The Telecommunications Industry
Historically, telecommunications carriers have operated in a highly
regulated environment, with local and long distance telephone service providers
operating as near monopolies with little competition. More recently, however,
the U.S. and many foreign governments have begun to deregulate the
telecommunications industry in order to reduce prices and improve
telecommunications services through increased competition.
Deregulation and the widespread adoption of new telecommunications
technologies, such as fiber optics, packet-data networks, digital wireless
telephony and Internet-based services, have significantly increased the number
of telecommunications carriers and created an increasingly competitive market.
New entrants to the telecommunications service market include CLECs, alternate
access providers, internet service providers (ISPs) and wireless service
providers. To be competitive in this new environment, telecommunications
service providers are seeking to rapidly enter new markets by offering new or
differentiated services in a cost-effective manner. These new carriers must
build their OSS and NE infrastructure to quickly introduce and support these
services.
Competition and Deregulation
The U.S. long distance market was opened to competition beginning in the
early 1970s. More recently, the Telecommunications Act of 1996 (the Act)
provides for the introduction of competition in local telephone service,
allowing long distance, wireless and other carriers to enter local telephone
markets. The Act, among other things, requires RBOCs and other ILECs to offer
LNP, which allows customers to retain their local phone numbers regardless of
the carrier providing local telephone service. The Act also requires that
carriers unbundle local services and facilities, which requires an interface to
be made available to their new competitors for ordering, service provisioning
maintenance and billing systems.
These new competitive and regulatory pressures have created significant
technological challenges for existing and new carriers. Existing carriers must
develop new systems that are interoperable with their legacy systems to enable
them to respond to increasing competitive challenges. In addition, new entrants
to local telephone markets require solutions that do not depend on an existing
OSS infrastructure and that can be deployed quickly and cost-effectively. Thus,
the Company believes that carriers' OSS are evolving from back-office legacy
systems to strategic business systems that play an increasingly important role
in enhancing competitiveness as well as enabling compliance with the
requirements of the Act.
Operations Support Systems
OSS encompass a broad array of software and systems that perform critical
functions for telecommunications carriers, including ordering, provisioning,
service assurance and billing. Ordering systems allow carriers to collect
customer information, retrieve current service information, capture and
validate new service requests, verify the availability of selected services and
transmit completed orders to one or more provisioning OSS. Carriers use
provisioning systems to install services for new customers and to change or add
services for existing customers. Service assurance systems allow carriers to
perform the testing, monitoring and reporting necessary to maintain network
availability and feed operational data to other business systems. Carriers use
billing systems to collate, manage and report billing information. Some
industry trade press also include customer care systems in the OSS market
segment.
Historically, as existing carriers have added new services, such as
wireless or Internet-based services, they have developed multiple, distinct
OSS. These legacy, proprietary OSS have typically been mainframe-based systems
that in many cases utilize incompatible software and technologies, making
communication among systems difficult. These OSS are further strained by the
many incremental changes that have been made in order to accommodate new
technologies, such as client/server technology and advancements in data
networking, and the proliferation of value-added services, such as call
waiting, call forwarding and voice mail.
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Despite these difficulties, carriers are unable to completely replace
existing OSS due to the large investments and vast amounts of historical data
contained in these systems. As a result, carriers continue to make incremental
modifications to these OSS, further increasing their complexity and
interoperability difficulties.
LNP Challenges to Current OSS
The LNP requirements of the Act pose significant technological challenges
to existing carriers' OSS, which are already strained by the changes caused by
increasing competition, new technologies and the introduction of value-added
services. LNP invalidates a fundamental design assumption of many existing OSS,
which is the association between a customer's telephone number and the
geographic location of a carrier's particular physical switch. Provisioning
systems now must be able to receive and distribute on a real-time basis certain
customer data in order to assure proper call handling, routing and completion.
If the LNP data from ported numbers are not properly distributed to all
involved carriers, any call to and from that number will not be routed
correctly, causing service problems for customers. Moreover, carriers that have
not implemented LNP may incur substantial call termination or "dip" charges if
they direct calls to locations where LNP has been mandated.
After altering provisioning systems, carriers must then implement changes
throughout many of their other OSS. These OSS are "hard-coded" in that each
telephone number corresponds to a physical switch for the ordering, service
assurance and billing systems. The implementation of LNP also requires new
systems to pool, allocate and assign telephone numbers. Changes will be
required to existing billing systems, which currently associate a telephone
number with a fixed geographic location. As a result of these challenges, the
Company believes a significant market opportunity exists for providing
solutions to carriers that must address these OSS problems.
New Technologies and Experience
New Network Technologies. The wireless carriers continue to deploy networks
using new technologies such as Code Division Multiple Access (CDMA), Time
Division Multiple Access (TDMA) and Global System for Mobile Communications
(GSM). They require the ability to transfer packet data using these protocols
and this environment creates a continuing opportunity for the Company.
IP Telephony. Historically, telephone companies built separate network
infrastructures to offer new technology options requiring technology-specific
OSS to support these unique networks. The isolated networks separate voice from
data traffic and force the customers to maintain multiple subscriptions with
the carrier. Network technology options that combine network traffic are
developing today at an ever-increasing pace due to the heavy investments in
research and development. CLECs and ISPs are developing convergent networks
that combine voice and data on the same network. Virtual Private Networks (VPN)
is one technology that is rapidly being accepted to combine the voice and data
networks. The VPN technology digitizes voice into packets for transfer on data
networks. IP Telephony is often referred to as next generation or "NextGen"
telephony.
Experienced and Reliable Implementation Provider. To provide necessary
support services for these changes in the industry, the company believes
carriers will need vendors with significant communications software, OSS, and
NE related domain expertise. Because of competitive pressure and short time
frames, these carriers will look for solutions, including integration, and not
just products. ILECs need such vendors in order to integrate their multiple
legacy systems. CLECs and ISPs that do not have the personnel with the required
expertise will need vendors to provide such services and expertise.
Evolving Systems Strategy
Recognizing the opportunity created by the ongoing deregulation of local
telephone service, the Company has capitalized on its historic strength as a
leading architect and developer of solutions for technically
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challenging OSS requirements. The Company positions itself as a leading
provider of next generation OSS solutions for the telecommunications industry.
As the industry expands to include ISPs and cable companies, Evolving Systems
has positioned its software to enable those potential carriers with LNP
capabilities. The Company's heritage of custom development for service
activation, wireless technology and LNP provides a base of domain expertise
necessary to continue its leadership position in the industry. Account Managers
and Service Directors utilize this knowledge to develop new business with
existing customers and to attract new customers needing the Company's
technological expertise.
The Company expects to combine its heritage for custom services with
product components to offer NextGen solutions tailored to each carrier.
Evolving Systems' resources are organized to pursue a customer-focused
"solution" strategy. Customer-facing employees utilize the Company's domain
expertise and requirements definition skills to identify an opportunity. Once
the opportunity is validated, a solution is created and tailored to the
customer's buying needs. Sometimes the solution will be totally custom
designed, but more often it will be a variation to the Company's standard
products or the integration of "off the shelf" products of third parties. The
Company plans to build, and/or partner with strategic alliances to build a full
suite of solutions integrating its domain expertise, product components, custom
development, integration and support services with strategic partners in
several business areas. Coupling this approach with an expanded sales force,
targeted focus on new products and expanded services offerings, the Company
plans to expand its customer base in several areas:
Product--The Company develops and packages products for the
telecommunications market. These products are designed for integration into the
customer's environment through adapters. The Company uses an end-to-end process
for managing product lifecycles. The Company's products are licensed under
perpetual licenses and may be licensed separately or bundled as a complete
solution. The Company provides a 90-day warranty against defects, 24X7 help
desk support and problem resolution as part of the warranty and offers extended
warranty support services on an optional annual support agreement.
Custom Software--The Company provides custom software development services
spanning the complete system development lifecycle from feasibility and
requirements planning through development and production rollout. By offering
these custom development services to leading telecommunications service
providers for over a decade, the Company has developed a broad-based
telecommunications domain expertise that it believes provides it with a
competitive advantage.
Systems Integration--The Company has strategic partnerships in place to
perform systems integration services for leading infrastructure providers. The
Company also provides systems integration services for third-party software
products. As an example, the Company has a relationship with TIBCO Software
Inc. to integrate its workflow product for carriers. Additionally, the Company
has a relationship with EHPT where the Company sells, installs and integrates
EHPT OSS/BSS products. The Company provides a range of systems integration
services, including system design, database and network design, network
configuration and other system development areas of expertise.
Customer Support--The Company provides a broad array of customer support
services, including 24X7 help desk support, problem resolution, software
maintenance and scheduled software upgrades, complete training and
documentation for products and services, and quality assurance. The Company's
typical software maintenance agreement has a 12-month term.
Evolving Systems Business Structure
The Company is organized into eight main business groups that build on its
core competencies and domain expertise to form an end-to-end solution for each
customer's specific requirements. The business groups combine domain expertise
with product components and professional services to create next generation OSS
solutions for the carrier. Of the eight business groups described below, four
are product groups and four are services related groups:
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LNP Products Group. The Company's current LNP products enable carriers to
accommodate customer requests to change service providers while retaining the
same phone number, and to exchange call routing data to carriers' networks via
the NPAC. The Company currently offers four LNP products, which began release
in the first half of 1997. The Company's LNP products are licensed under
perpetual licenses and may be licensed separately or bundled as a complete
solution. The LNP group's product offerings in this area include OrderPath(R)
(a Local Service Order Administration component), NumberManager(TM) (a Local
Service Management System component), NodeMaster(R) (optional interface
component from NumberManager(TM) to multiple Service Control Points) and also
Data Server(TM) (a database tool currently under development for independent
data analysis). The group is also responsible for ongoing maintenance of these
products and has been responsible for the development and support of
integration software needed to integrate the products with customers' legacy
systems.
Customers typically engage the Company to provide installation,
integration and testing of the LNP products in connection with these licenses
as stated below. Customers also rely on the Company for ongoing support and
enhancement of the solution. General software upgrades and enhancements for all
products are planned.
The Company intends to offer its LNP products through Application Services
Providers (ASP). Customers that do not wish to incur the capital and operating
expense of an in-house solution can now choose to subscribe with the Company
for use of LNP products. The customer will be charged a monthly subscription
fee and a separate fee based on usage levels.
LNP Integration Group. This group is comprised of staff experienced in
requirements definition, solution synthesis, implementation and integration of
the company's overall LNP solution. This group is a specialized systems
integration group with substantial telecommunications domain knowledge that
offers rapid LNP implementation capabilities to LNP customers.
NPAC Business Group. The Company developed and continues to maintain the
software currently in use by all NPACs in the United States and Canada. The
software receives ported telephone number information as changes occur and
distributes the data to all subscribing carriers in the region. The software is
provided under contract to Neustar Corporation.
Wireless Technology Business Group. This business group provides custom
software products for Lucent, a leading equipment supplier. The infrastructure
products enable Cellular Digital Packet Data (CDPD), CDMA, and Over-the-Air-
Service Provisioning (OTASP) in wireless network environments. The Company
provides full lifecycle support for these products including the initial
development and ongoing maintenance releases. The Wireless Technologies
business group maintains a service bureau offering for the billing of wireless
data.
Service Activation and Fulfillment Business Group. The Service Activation
business group provides a wide range of custom solutions to ILECs and CLECs for
the provisioning and fulfillment of customer orders. The solutions focus on the
flow-through provisioning of Advanced Intelligent Network (AIN) services within
a carrier's network environment. The Company is investigating the viability of
packaging components of the solution developed in the Service Activation
business group for sale as products to the general marketplace. The products
would provide interfaces to available order management OSS and network elements
for seamless integration.
Workflow-Enabled Group. This group has its origin in 1999 as a result of a
relationship established with InConcert, which is owned by TIBCO Software, Inc.
The InConcert product, a workflow solution tool, is used by Evolving Systems as
part of an overall solution in selected functional areas within the
telecommunications industry. The strategy for this solution area is to focus on
the broadly defined fulfillment process domain for carriers (e.g. order
management, provisioning, activation, etc.). The intent is to also leverage the
process domain experience the Company has from its custom work in provisioning
and activation.
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IP Telephony Solutions Group. This group began in the 4th quarter of 1999 and
its focus is delivering IP billing solutions to next generation
telecommunications carriers. This group is staffed with specialists in billing
processes and the IP domain with specific training in the EHPT product suite.
The Company expects this group to grow substantially in the next year.
Knowledge and Training Services Group. This group provides training and
documentation support to customers using Evolving Systems products and for
custom designed systems utilized by network infrastructure customers. They are
also skilled in working with third parties to design training programs for
products which Evolving Systems may integrate for customers.
Marketing and Sales
The primary objectives of the Company's marketing efforts are to build
Evolving Systems' expanded capabilities image, generate market awareness and
produce qualified leads. The Company's marketing efforts include direct sales
to targeted accounts, participation in selected trade shows, a strong website
presence, print and electronic advertising and story placement in telecom
industry trade media, presentations at industry conferences and forums, press
releases to the industry, and certain other marketing initiatives.
The Company's sales activities are conducted through a direct sales force
and the services support organization, both of which are complemented by other
sales channels. The Company intends to rely on resellers and alternate channels
to further penetrate the LNP market. The Company also assigns a dedicated
account and business manager to each major customer to ensure that both the
sales relationship and the business relationship are managed well. The sales
closing cycle can be quite long in the telecommunications business due to both
the complexity of products and integration issues that make major systems
decisions difficult. Typically, the sales cycle takes three months to one year.
The alternate channels, such as strategic distribution partners, help to
identify and qualify leads. The Company plans to increase the focus on
resellers and alternate sales channels in 2000 to further penetrate the LNP
market. The Company believes that a limited window of opportunity exists to
capture a larger market share of these customers. The Company's marketing and
sales efforts have been focused primarily on facility-based local exchange,
interexchange and wireless service providers in the United States, and this
group has comprised the majority of the Company's customers. In 2000, the
Company will continue efforts among these markets and expand its focus to
include non-facilities-based service providers, ISPs and VPN providers with
additional product and service offerings beyond LNP.
The Company believes that significant demand for new OSS products and
services exists outside of the U.S. due to increased deregulation and resulting
competition. The Company intends to expand it sales and marketing efforts
internationally through a series of partnerships with specific third-party
systems integrators and software suppliers, as well as the extension of its
relationships with existing customers as they expand into international
markets.
Research and Development
The Company's research and development efforts are focused on identifying
market requirements and performing design and development functions. These
activities follow the Company's product development process that governs the
product lifecycle from concept through product launch and subsequent retirement
from the marketplace, all through the use of cross-functional teams. This
process provides the Company's senior management with a series of decision
milestones that allows the evaluation of ongoing projects on a regular basis.
Normally, the Company does not fund significant development efforts without
first having a customer to buy the resulting product.
Competition
The market for telecommunications software is intensely competitive and is
subject to rapid technological change, evolving industry standards and
regulatory developments. The Company faces continuous demand for
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improved product performance, new product features and reduced prices, as
well as intense pressure to accelerate the release of new products and product
enhancements. The Company's existing and potential competitors include many
large domestic and international companies, including certain customers of the
Company, that have substantially greater financial, manufacturing,
technological, marketing, distribution and other resources, larger installed
customer bases and longer-standing relationships with telecommunications
customers than the Company. Although the Company concentrates on providing
software and services for the telecommunications industry, the market for
telecommunications software is extremely large and the Company currently holds
only a very small portion of the market share outside of the LNP segment. The
Company differentiates itself from competitors through its combination of
products, services and strategic alliances. The Company consults, develops
software, integrates third party software and interconnects customers existing
operating systems. Very few competitors can offer all of these capabilities and
depth of knowledge.
The principal competitors of the Company's LNP products include DSET,
Telcordia (formerly known as Bellcore), Lucent, Nortel Networks (Nortel), and
Tekelec, Inc. (Tekelec). The Company expects competition to increase in the
future from existing suppliers and from other companies that may enter the
Company's existing or future markets with solutions which may be less costly,
provide higher performance or additional features or be introduced earlier than
the Company's solutions.
Many telecommunications companies have large internal development
organizations which develop software solutions and provide services similar to
the Company's products and services. In addition, customers who have purchased
custom software solutions from the Company are not precluded from competing
with the Company. ILECs that have implemented LNP solutions are well suited to
provide LNP services for smaller CLECs within their regions. Recent independent
market research data indicate that more telecommunications companies are
outsourcing their software solutions due to time to market considerations.
The Company believes that its ability to compete successfully depends on a
wide range of internal and externally controlled factors. The Company plans to
compete by providing quality solutions that are tailored specifically to the
customer. The company is organized to provide core products and complimentary
services that provide a total solution for the application area. The Company
then creates a long-term relationship with the customer by providing ongoing
support, extensions of the original solution, and new related solutions.
Intellectual Property
The Company relies on a combination of copyright, trademark and trade
secret laws, as well as confidentiality agreements and licensing arrangements,
to establish and protect its proprietary right. The Company presently has no
patents, but has patent applications pending in the U.S. on elements of its
three LNP products: NumberManager, OrderPath and NodeMaster and an Internet
call processing engine.
Employees
As of December 31, 1999, the Company employed 302 people, of which 69%
were involved in service provision, consulting practices and product
development. Additionally, 10% of staff are in marketing and sales, and 21% in
general administration.
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RISK FACTORS
Fluctuations in Quarterly Results of Operations
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. 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 products 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 nature and pace of enforcement of the Act;
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, controlling cost, 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 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.
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.
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.
Dependence Upon Telecommunications Industry; Regulatory Uncertainties
The market for the Company's products was created and has primarily been
driven by the adoption of regulations under the Act requiring RBOCs to
implement LNP as a condition to being permitted to provide long distance
services. Therefore any changes to such regulations, or the adoption of new
regulations by federal or state regulatory authorities under the Act, or any
legal challenges to the Act, could have a material adverse effect upon the
market for the Company's products and services. Recently, for example, the FCC
delayed implementation of the Act with respect to wireless carriers until
November, 2002. These delays have had, and continue to have, an impact on the
Company's revenue from its LNP products and services. Additional delays in the
deadlines imposed by the Act or the FCC, or any invalidation, repeal or
modification in the requirements imposed by the Act or the FCC, could have a
material adverse effect on the Company's business, financial condition and
results of operations. Moreover, customers may require, or the Company
otherwise may deem it necessary or advisable, that the Company modify its
products or services to address actual or anticipated changes in the regulatory
environment. Any other delay in implementation of the Act, or other regulatory
changes, could materially adversely affect the Company's business, financial
condition and results of operations.
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Reliance on Significant Customers
Historically, a substantial portion of the Company's revenue has been
derived from a limited number of customers. During the years ending December
31, 1997, 1998 and 1999, the Company recognized approximately 89%, 87% and 84%
of total revenue from six, six and five customers, respectively, all in the
telecommunications industry. The Company expects to continue to depend on large
contracts with a small number of significant customers, which can cause its
revenue and earnings to fluctuate between quarters based on the timing of
contracts and installation of the Company's products by these customers. None
of the Company's major customers has any obligation to purchase additional
products or services. Consequently, the failure by the Company to maintain
existing relationships or develop relationships with significant new customers
would have a material adverse effect on the Company's business, financial
condition and results of operations. Additionally, business or marketplace
consolidations affecting one or more of the Company's major customers has
caused delays in customer contracts and could result in the loss of that
customer, which also could have a material adverse effect on the Company's
business, financial condition and results of operations.
Lengthy Implementation Process; Customer Acceptance of Company Solutions
Implementation of the Company's solutions is a relatively complex and
lengthy process that involves significant allocation of resources by the
Company in order to adapt and customize such solutions for each customer's
unique environment. Moreover, certain of the Company's customers may require
rapid deployment of the Company's software solutions, resulting in pressure on
the Company to meet demanding delivery and implementation schedules. Delays in
implementation may result in customer dissatisfaction and/or damage to the
Company's reputation and could have a material adverse effect on the Company's
business, financial condition and results of operations.
The majority of the Company's existing contracts provide for acceptance
testing by the customer before the contract is considered complete.
Unanticipated difficulties or delays in the customer acceptance process could
result in higher costs and delayed payments. Moreover, if the Company fails to
satisfy acceptance criteria within prescribed times, the customer may be
entitled to cancel its contract and receive a refund of all or a portion of
amounts previously paid or other amounts as liquidated damages, which could
exceed related contract revenue and which could result in a future charge to
earnings. Any failure or delay in achieving final acceptance of the Company's
software and services could have a material adverse effect on the Company's
business, financial condition and results of operations. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
Lengthy Sales Cycle / Consolidations in the Industry
The Company's software products and services are generally used by large
telecommunications service providers for enterprise-wide, mission-critical
purposes, involving significant capital expenditures and lengthy implementation
plans. Prospective customers typically commit significant resources to the
technical evaluation of the Company's products and services and require the
Company to expend substantial time, effort and money providing education
regarding the Company's solutions. This evaluation process often results in an
extensive and lengthy sales cycle, typically ranging between three and 12
months, making it difficult for the Company to forecast the timing and
magnitude of sales contracts. Delays associated with customers' internal
approval and contracting procedures, procurement practices, and testing and
acceptance process are common. For example, customers' budgetary constraints
and internal acceptance reviews may cause potential customers to delay or
forego a purchase. The delay or failure to complete one or more large contracts
could have a material adverse effect on the Company's business, financial
condition or results of operations and cause the Company's operating results to
vary significantly from quarter to quarter.
The telecommunications industry is currently experiencing significant
reorganization and consolidation. Mergers and acquisitions of large
telecommunications companies, as well as the formation of new alliances, has
resulted in a constantly changing marketplace for the Company's products and
services. Delays associated with these changes are common. The delay or failure
to complete one or more large contracts could have a
11
<PAGE>
material adverse effect on the Company's business, financial condition or
results of operations and cause the Company's operating results to vary
significantly from quarter to quarter.
Fixed-Price Contracts
The Company historically derived a majority of its revenue from contracts
that were billed on a time-and-materials basis. Beginning in mid-1996, a
majority of the Company's revenue has been derived from contracts that were
billed on a fixed-price basis. The Company in the past has incurred budget
overruns on certain fixed-price contracts, resulting in lower than anticipated
margins, and there can be no assurance that the Company will not incur such
budget overruns in the future. If the Company incurs such budget overruns, the
Company's gross margins and results of operations may be materially adversely
affected. To the extent that the Company continues to provide custom software
development or consulting services, it anticipates that customers will continue
to request that the Company provide software and implementation services as a
total solution on a fixed-price basis. These contracts specify certain
obligations and deliverables to be met by the Company regardless of actual
costs incurred by the Company. There can be no assurance that the Company can
successfully complete these contracts on budget, and the Company's inability to
do so could have a material adverse effect on its business, financial condition
and results of operations. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
Rapid Technological Change; Risks Associates with New Versions and New
Products; Risks of Software Defects
The market for the Company's products and services is subject to rapid
technological changes, evolving industry standards, changes in carrier
requirements and preferences and frequent new product introductions and
enhancements. The introduction of products that incorporate new technologies
and emergence of new industry standards can render existing products obsolete
and unmarketable. To compete successfully, the Company must continue to design,
develop and sell enhancements to existing products and new products that
provide higher levels of performance and reliability in a timely manner, take
advantage of technological advancements and changes in industry standards and
respond to new customer requirements. There can be no assurance that the
Company will successfully identify new product opportunities or will achieve
market acceptance of new products brought to market. Products developed by
others may render the Company's products obsolete or noncompetitive. Any
failure by the Company to anticipate or respond adequately to changes in
technology and customer preferences, any failure of the Company's products to
perform satisfactorily or any significant delay in product development or
introductions could have a material adverse effect on its business, financial
condition and results of operations.
The Company intends to issue interim and new releases of its family of
software products periodically. As a result of the complexities inherent in
software development, major new product enhancements and new products can
require long development and testing periods before they are commercially
released. There can be no assurance that delays will not occur in the future.
Competition; Risks Associated with Recruiting and Retaining Personnel
The Company's primary markets are intensely competitive and are subject to
rapid technological changes, evolving industry standards and regulatory
developments. The Company faces continuous demand for improved product
performance, new product features and reduced prices, as well as intense
pressure to accelerate the release of new products and product enhancements.
The Company's existing and potential competitors include many large domestic
and international companies, including certain of the Company's customers, that
have substantially greater financial, manufacturing, technological, marketing,
distribution and other resources, larger installed customer bases and longer-
standing relationships with customers than the Company. The Company's principal
competitors in the LNP market include DSET, Telcordia, Lucent, Nortel and
Tekelec. One of the Company's principal customers, Lucent, competes with the
Company with respect to certain of the Company's products and services that it
offers in competition with the Company. In addition, NeuStar has retained
rights to
12
<PAGE>
the NPAC software developed for NeuStar by the Company, and NeuStar
potentially could compete with the Company with respect to LNP products and
related services. There also can be no assurance that other customers will not
offer competitive products or services in the future. The Company expects
competition to increase in the future from ASPs, existing competitors and from
other companies that may enter the Company's existing or future markets with
solutions which may be less costly, provide higher performance or additional
features or be introduced earlier than the Company's solutions. Many
telecommunications companies have large internal development organizations
which develop software solutions and provide services similar to the Company's
products and services. Moreover, customers who have purchased custom software
solutions from the Company are not precluded from competing with the Company.
The Company believes that its ability to compete successfully depends on
numerous factors, both within and outside of its control, including
responsiveness to service providers' needs, quality and reliability of the
Company's and its competitors' products and services, price, project management
capabilities, technical subject matter expertise, quality of customer service
and support, the emergence of new industry standards, the development of
technical innovations, the attraction and retention of qualified personnel,
regulatory changes and general market and economic conditions. A variety of
potential actions by the Company's competitors, including a reduction of
product prices or increased promotion, announcement or accelerated introduction
of new or enhanced products, or cooperative relationships among competitors,
could have a material adverse effect on the Company's business, financial
condition and results of operations. There can be no assurance that the Company
will be able to compete successfully with existing or new competitors or will
properly identify and address the demands of new markets. The failure by the
Company to adapt to emerging market demands, respond to regulatory and
technological changes or compete successfully with existing and new competitors
would have a material adverse effect on the Company's business, financial
condition and results of operations.
The Company's ability to manage future expansion, if any, effectively will
require it to attract, train, motivate and manage new employees successfully,
to integrate new management and employees into its overall operations and to
continue to improve its operations, financial and management systems. The
Company anticipates that it will need to hire additional development personnel.
Competition for development and other technical personnel is intense, and there
can be no assurance that the Company will be able to retain personnel or to
hire additional personnel on a timely basis, if at all. Because of the
complexity of the Company's software solutions, a significant time lag exists
between the hiring date of technical and sales personnel and the time at which
they become fully productive. The Company has at times experienced and
continues to experience difficulty in recruiting and retaining such personnel.
Any failure by the Company to retain personnel or to hire qualified personnel
on a timely basis could materially adversely affect the Company's business,
financial condition and results of operations.
The Company is continuing its implementation of new financial and project
accounting software packages. The Company's ability to implement these new
systems is likely to place substantial demands on certain of the Company's
managerial resources. In addition, if the Company is unable to implement these
software packages effectively, the Company's ability to accurately forecast and
manage its business may be adversely affected. The Company's failure to manage
any expansion effectively, including any failure to integrate new management
and employees or failure to continue to implement and improve financial,
operations and management controls, systems and procedures, could have a
material adverse effect on the Company's business, financial condition and
results of operations.
Product Liability
The Company's agreements with its customers typically contain provisions
designed to limit the Company's exposure to potential liability for damages
arising out of the use of or defects in the Company's products. The nature and
extent of such limitations, however, tend to vary from customer to customer and
it is possible that such limitations of liability provisions may not be
effective as a result of federal, state or local laws or ordinances or
unfavorable judicial decisions. In addition, the Company currently has errors
and omissions insurance which, subject to customary exclusions, covers claims
resulting form failure of the
13
<PAGE>
Company's software products or services to perform the function or to serve
the purpose intended. To the extent that any successful product liability claim
is not covered by such insurance, the Company's business, financial condition
and results of operations may be materially adversely affected, particularly
since the Company's software products may be used in critical business
applications. Defending such a suit, regardless of its merits, could involve
substantial expense and require the time and attention of key management
personnel, either of which could have a material adverse effect on the
Company's business, financial condition and results of operations. In addition,
the Company's business reputation could be adversely affected by product
liability claims, regardless of their merit or the eventual outcome of such
claims.
Year 2000 Capability
To date, the Company has not encountered any significant problems with
either the software sold to customers or to internal systems run by the
Company. The Company had developed a detailed contingency plan and worked
closely with customers and vendors to avoid Y2K problems. In 1999, expenses
related to this effort were approximately $1,000,000.
Protection of Intellectual Property; Risks of Infringement
The Company's success and ability to compete are dependent to a
significant degree on its proprietary technology. The Company relies on a
combination of copyright, trademark and trade secret laws, as well as
confidentiality agreements and licensing arrangements, to establish and protect
its proprietary rights. The Company presently has no patents, but has patent
applications pending in the U.S. on elements of its three LNP products,
NumberManager, OrderPath and NodeMaster, and an internet call processing
engine. In addition, the Company has registered or filed for registration of
certain of its trademarks. Despite these precautions, it may be possible for a
third party to copy or otherwise obtain and use the Company's products or
technology without authorization or to develop similar technology independently
through reverse engineering or other means. In addition, the laws of some
foreign countries do not adequately protect the Company's proprietary rights.
There can be no assurance that the Company's means of protecting its
proprietary rights in the U. S. or abroad will be adequate or that others will
not independently develop technologies that are similar or superior to the
Company's technology, duplicate the Company's technology or design around any
patent of the Company. There can also be no assurance that the Company will not
inadvertently infringe upon the intellectual property rights of a third party.
Moreover, litigation may be necessary in the future to enforce the Company's
intellectual property rights, to determine the validity and scope of the
proprietary rights of others or to defend against claims of infringement or
invalidity. Such litigation could result in substantial costs and diversion of
management time and resources and could have a material adverse effect on the
Company's business, financial condition and results of operations.
Possible Volatility of Stock Price
The trading price of the Company's Common Stock has been and may continue
to be subject to wide fluctuations in response to quarterly variations in
operating results, announcements of technological innovations or new products
by the Company or its competitors, changes in financial estimates by securities
analysts, the operating and stock price performance of other companies that
investors may deem comparable to the Company, general stock market and economic
considerations and other events or factors. In addition, the stock market has
experienced volatility that has particularly affected the market prices of
equity securities of many technology companies and that often has been
unrelated to the operating performance of such companies. These broad market
fluctuations may adversely affect the trading price of the Company's Common
Stock. As a result of the foregoing factors, there can be no assurance that the
Company's Common Stock will trade at or higher than its current price.
Item 2. Properties
The Company leases office space at three locations in the Denver, Colorado
metropolitan area, including two in the Englewood area (Meridian and
Southgate), and one in the Boulder area (Louisville), and in Santa
14
<PAGE>
Maria, California. The Company also leases sales offices in New Jersey, St.
Louis and Vienna, Virginia. The Company's leases in the Denver, Colorado
metropolitan area and California are shown below:
<TABLE>
<CAPTION>
Location Square Footage Lease Expiration
-------- -------------- ----------------
<S> <C> <C>
Meridian.................................. 120,281 11/30/2016
Southgate................................. 68,566 12/31/2000
Santa Maria............................... 6,600 8/31/2001
Louisville................................ 10,992 10/31/2002
</TABLE>
The Company no longer has operations in its Southgate location and
subleases the Southgate facility for the remainder of its lease commitment.
Item 3. Legal Proceedings
In June 1998, four securities class action complaints were filed against
the Company and certain of its current and former officers and directors in the
U.S. District Court for the District of Colorado alleging violations of the
federal securities laws. The complaints were consolidated. The plaintiffs
purported to represent a class of persons who purchased the Company's
securities during the period of May 12, 1998 through July 23, 1998. The
complaints alleged that the Company and certain of its officers misled the
investing public regarding the financial prospects of the Company. The Company
denied these allegations. 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 $719,000 in
legal costs associated with the lawsuit.
The Company is currently involved in a dispute with an employee concerning
amounts allegedly owed to the employee in connection with his employment. The
Company believes the employee's claims are without merit and the parties are
currently seeking to resolve the dispute through mediation. Although it is too
early to evaluate the outcome of this dispute, in the event the parties are
unable to reach a mutually agreeable resolution and the employee subsequently
succeeds in his claim, the outcome could have a material adverse effect on the
Company's business, financial condition and results of operation.
From time to time the Company is involved in various legal proceedings
arising in the normal course of business operations. Management does not expect
that any such proceedings will have a material adverse effect on the Company's
financial position or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
During the fourth quarter of 1999, no matters were submitted to a vote of
the Company's stockholders.
15
<PAGE>
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholders Matters
The Company's Common Stock began trading publicly through the NASDAQ
National Market under the symbol "EVOL" on May 12, 1998. Prior to that date,
there was no public market for the Common Stock. The closing price of the
Company's Common Stock as reported on the NASDAQ National Market as of March 1,
2000 was $12.50 per share. The following table sets forth for the periods
indicated the high and low closing sale quotations for the Common Stock as
reported on the NASDAQ National Market. The prices reported do not include
retail mark-ups, mark downs or commissions.
<TABLE>
<CAPTION>
High Low
------ -----
<S> <C> <C>
For the Fiscal Year Ended December 31, 1999:
First Quarter............................................. $ 8.75 $3.63
Second Quarter............................................ $ 6.13 $3.88
Third Quarter............................................. $ 7.13 $3.75
Fourth Quarter............................................ $10.50 $5.00
</TABLE>
As of March 1, 2000, there were approximately 196 holders of record of the
Company's Common Stock.
The Company has not declared or paid a cash dividend on its Common Stock.
The Company currently intends to retain any future earnings, if any, to finance
the growth and development of its business and, therefore, does not anticipate
paying cash dividends in the foreseeable future.
Use of Initial Public Offering Proceeds
The Company used the net proceeds of its IPO for repayment of its
obligations under its Subordinated Notes and Stockholder Notes, working capital
and other corporate purpose. The respective principal amounts (exclusive of
$56,517 in accrued interest) outstanding under the Subordinated Notes and
Stockholder Notes were $6,792,885 and $5,059,539 and bore interest at the rates
of 9% (with deferred interest accrued at the rate of 12%) and 7.25%,
respectively, with respective maturity dates of June 1, 2004 and January 2,
2006. The Company also used proceeds to pay prepayment penalties to the holders
of the Notes in the amount of $446,000, net of taxes. The Company also used
proceeds to fund the general business operations including research and
development expenses related to its LNP products. The balance of the proceeds
were invested in investment grade, short-term investments bearing various
interest rates.
16
<PAGE>
Item 6. Selected Financial Data
The selected financial data set forth below for each of the years in the
five-year period ended December 31, 1999, have been derived from the Company's
consolidated financial statements and should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations", the financial statements and the notes thereto and other financial
information included elsewhere in this annual report on Form 10-K.
<TABLE>
<CAPTION>
1999 1998 1997 1996 1995
------- ------- ------- ------- -------
In thousands, except per share amounts
<S> <C> <C> <C> <C> <C>
Revenue.......................... $40,487 $37,238 $42,720 $36,918 $45,355
Cost of Revenue.................. 26,935 27,104 25,224 24,531 26,589
Sales and Marketing.............. 4,516 5,739 5,065 2,913 3,405
General and Administrative....... 9,705 8,566 8,635 8,587 7,725
Research and Development......... 1,064 7,197 2,914 641 821
Income (loss) from Operations.... (1,732) (11,368) 882 246 6,815
Other Income (Expense)........... (2,415) (60) (1,395) (1,422) (689)
Provision for (benefit from)
Income Taxes.................... -- (601) (791) 81 --
Net Income (loss) (1)(2)......... (4,148) (11,273) 278 (1,257) 6,126
Diluted Earning (loss) Per
Share........................... (0.34) (1.43) 0.03 (0.82) 4.00
Working Capital.................. 28,904 31,009 5,366 6,390 3,174
Total Assets..................... 49,628 47,479 27,859 24,356 19,203
Long Term Debt, net of current
portion......................... 170 825 16,465 18,096 6,059
Shareholder Equity............... 36,541 39,362 1,698 996 9,173
Dividends Paid................... 0 0 0 0 0
</TABLE>
- --------
(1) Prior to January 6, 1996, the Company was an S corporation for federal and
state income tax purposes, and accordingly, the Company's income was taxed
directly to the Company's stockholders at that time. Net income (loss) for
1996 and 1995 do not reflect the estimated federal and state income taxes
that would have been payable if the Company had not been an S corporation
prior to January 6, 1996.
(2) Included in net loss for 1998 is an extraordinary loss on early
extinguishment of debt of approximately $446,000, net of $220,000 in income
tax benefit. See note 3 of Notes to Financial Statements.
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<PAGE>
The following table presents, for the periods indicated, certain items
contained in the Company's statement of operations reflected as a percentage of
total revenue:
<TABLE>
<CAPTION>
Year Ended
December 31,
-------------------
1997 1998 1999
----- ----- -----
<S> <C> <C> <C>
Revenue:
License fees and related services....................... 46.9% 27.3% 20.1%
Other services.......................................... 53.1 72.7 79.9
----- ----- -----
Total revenue......................................... 100.0 100.0 100.0
----- ----- -----
Cost of revenue:
License fees and related services....................... 14.8 22.2 20.3
Other services.......................................... 44.2 50.6 46.2
----- ----- -----
Total cost of revenue................................. 59.0 72.8 66.5
----- ----- -----
Gross margin.............................................. 41.0 27.2 33.5
Operating expenses:
Sales and marketing..................................... 11.9 15.4 11.2
General and administrative.............................. 20.2 23.0 24.0
Research and development................................ 6.8 19.3 2.6
----- ----- -----
Total operating expenses.............................. 38.9 57.7 37.8
----- ----- -----
Operating income.......................................... 2.1 (30.5) (4.3)
Other income (expense), net............................... (3.3) (0.2) (6.0)
----- ----- -----
Income (loss) before income taxes......................... (1.2) (30.7) (10.3)
Provision for (benefit from) income taxes................. (1.9) (1.6) 0.0
----- ----- -----
Net income (loss) before extraordinary item............... 0.7 (29.1) (10.3)
----- ----- -----
Extraordinary item, net of taxes.......................... -- 1.2 --
----- ----- -----
Net income (loss)......................................... 0.7 (30.3) (10.3)
----- ----- -----
</TABLE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This section contains forward-looking statements which involve risks and
uncertainties. The Company's actual results could differ materially from those
anticipated in these forward-looking statements as a result of certain factors,
including those set forth in this section and in the section entitled "Risk
Factors."
Introduction
Evolving Systems, Inc., formed in 1985, began its first year as a publicly
traded company on May 12, 1998. The Company's core business is designing and
integrating software systems for the telecommunications industry. Software
projects are bid at either a fixed price or as time and materials custom
software projects. From the Company's inception in 1985 through 1996, the
Company focused on providing custom software development services, primarily to
two large customers. Beginning in 1996, the Company broadened its focus to
include proprietary software products in response to declining demand from key
customers for custom software development services that reflected the changing
industry patterns for software procurement. In addition, the Company
aggressively sought new customers for its custom software development business.
The Company had an excellent market for its LNP products in 1997 as a
result of the mandated requirements for LNP capabilities in the Act. License
fees and related services revenues for 1997 were over $20,000,000. Other
services of the business also increased due to considerable integration support
needed to implement LNP. This market demand did not carry forward into 1998 for
those LNP products. The Company refocused its LNP products sales efforts to
other market segments such as wireless and CLECs but these
18
<PAGE>
segments are much smaller than the wire line portion of the
telecommunications market and FCC approved delays in implementation of LNP for
the wireless industry had an impact on sales of LNP products to wireless
carriers. The end result has been a substantial decline in license fee and
related services in 1998 when compared to 1997 and 1999 is still below 1997
levels.
Revenue Recognition
For contracts entered into subsequent to January 1, 1998, the Company
recognizes revenue in accordance with the provisions of Statement of Position
97-2, "Software Revenue Recognition". 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 involving the Company's LNP software products and related services.
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 generated from fixed price
contracts that provide for both licenses and services. Revenue under these
arrangements, where the services are essential to the functionality of the
delivered software, 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 the terms of the fixed price contracts and
all such amounts are expected to be billed and collected during the succeeding
12 months.
In arrangements where the services are not essential to the functionality
of the delivered software, the Company recognizes license revenue when a
license agreement has been signed, delivery has occurred, the fee is fixed or
determinable and collectibility is probable. Where applicable, fees from
multiple element arrangements are unbundled and recorded as revenue as the
elements are delivered to the extent that vendor specific objective evidence of
fair value exists. If vendor specific objective evidence of fair value does not
exist, fees from such arrangements are deferred until the earlier of the date
that vendor specific objective evidence of fair value does exist or all of the
elements are delivered.
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
periods 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 costs indicate a
loss.
For contracts entered into prior to January 1, 1998, the Company
recognized revenue in accordance with Statement of Position 91-1, "Software
Revenue Recognition." The Company's revenue recognition was substantively the
same as that discussed above.
19
<PAGE>
RESULTS OF OPERATIONS--YEAR ENDED DECEMBER 31, 1999
COMPARED TO THE YEAR ENDED DECEMBER 31, 1998
Revenue. Total revenue increased 9% from $37.2 million in 1998 to $40.5
million in 1999. License fees and related services revenue declined 20%
although the Company added new customers in fourth quarter of 1999, primarily
because the demand for LNP systems declined as the wire line portion of the
telecommunications industry substantially completed implementation of LNP in
1998. Other services revenue, consisting primarily of custom system development
revenue, increased 19% from $27.1 million in 1998 to $32.3 million in 1999 as
the Company focused on other services to counteract the software revenue
shortfall. As a percentage of revenue, license fees and related services
revenue declined from 27% in 1998 to 20% in 1999. Other services revenue
increased from 73% in 1998 to 80% in 1999.
Cost of Revenue. Cost of revenue consists primarily of personnel costs,
equipment depreciation, facilities costs and the cost of third party software.
Cost of license fees and related services decreased by $54,000, or 1%, even
though the related revenue declined by 20% for the year ended December 31,
1999. Cost of revenue was favorably impacted as a result of lower cost of sales
for certain arrangements where services were minimal. This favorable impact was
offset as the Company maintained a relatively consistent labor base and
facilities compared to the prior year. As a result of the consistent cost base
and declining revenues, the gross margin on license fees and related services
declined to a negative 1% for the year ended December 31, 1999 compared to 19%
for the year ended December 31, 1998. In the fourth quarter of 1998, the
Company recorded $302,000 in additional costs in connection with a contract for
which all revenue had previously been recorded. The cost of revenue for other
services decreased 1% in 1999 even though revenue increased 19%. The gross
margin for other services improved from 30% to 42% for the years ending
December 31, 1998 and December 31, 1999, respectively, as staff utilization
rates improved.
Sales and Marketing. Sales and marketing expenses consist primarily of
compensation costs (including commissions), travel expenses, field sales office
expenses and marketing communication expenses. Sales and marketing expenses
decreased by $1.2 million, or 21%, to $4.5 million for the year ended December
31, 1999 from $5.7 million for the year ended December 31, 1998. The decrease
was primarily due to the Company's refocus of sales plans that reduced
promotion expenses. In the second half of 1999, the Company increased the sales
staff, causing the 4th quarter 1999 expenses to increase substantially.
General and Administrative. General and administrative expenses consist
principally of compensation costs for administration, facilities, finance,
legal, human resources, quality assurance and general management personnel.
General and administrative expenses increased by $1.1 million or 13% to $9.7
million for the year ending December 31, 1999 from $8.6 million for the year
ended December 31, 1998. The increase in cost was attributable to increased
real estate rents, property taxes and insurance premium costs.
Research and Development. Research and development expenses consist primarily
of compensation costs, equipment and software development tools. Research and
development expenses decreased 85%, or $6.1 million to $1.1 million in the year
ended December 31, 1999, from $7.2 million in the year ended December 31, 1998.
As a percentage of revenue, research and development decreased from 19% in 1998
to 3% in 1999. This decrease resulted from the Company's change in product
development strategy of next generation software products as well as
significant research and development cost being recorded in 1998 to complete
the LNP product line.
Other Income (expense), Net. Other expense, net of other income, includes
interest expense on the Company's debt financing and capital leases and
interest income on cash. The net expense increased to $2.4 million in the year
ended December 31,1999, from $60,000 in the year ended December 31, 1998 as a
result of the $3.2 million settlement of the shareholder lawsuit including
$719,000 in associated legal fees. (See Item 3, Legal Proceedings)
20
<PAGE>
Extraordinary Item. The Company recorded an extraordinary item of $445,702
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 in the year ended
December 31, 1998. The Company recorded a tax benefit of $220,000 relating to
the extraordinary item.
Provision for (benefit from) Income Taxes. The Company has recorded a partial
valuation allowance against its carryforward tax benefits to the extent that it
believes that it is more likely than not that all of such benefits will not be
realized in the foreseeable future. The Company's assessment of this valuation
allowance was made using all available evidence, both positive and negative. In
particular, the Company considered both its historical results and its
projections of profitability for only reasonably foreseeable future periods.
The Company recorded no income tax benefit related to 1999 operating losses as
management deems it inappropriate to book such benefits until projected
operating results reflect greater certainty of profitability and the ability to
realize such benefits. The Company's realization of its recorded net deferred
tax assets is dependent on future taxable income and therefore, the Company is
not assured that such benefits will be realized.
RESULTS OF OPERATIONS--YEAR ENDED DECEMBER 31, 1998
COMPARED TO THE YEAR ENDED DECEMBER 31, 1997
Revenue. Total revenue decreased 13% from $42.7 million in 1997 to $37.2
million in 1998. License fees and related services revenue declined 49% because
the demand for LNP systems declined as the wire line portion of the
telecommunications industry substantially completed implementation of LNP in
1998. Other services revenue, consisting primarily of custom system development
revenue, increased 19% from $22.7 million in 1997 to $27.0 million on 1998 as
the Company focused on other services to counteract the software revenue
shortfall. As a percentage of revenue, license fees and related services
revenue declined from 47% in 1997 to 27% in 1998. Other services revenue
increased from 53% in 1997 to 73% in 1998.
Cost of Revenue. Cost of revenue consists primarily of personnel costs,
equipment depreciation, facilities costs and the cost of third party software.
Cost of license fees and related services increased by $1.9 million, or 30%
even though the related revenue declined by 49% for the year ended December 31,
1998 as the Company incurred considerable labor expenses due to
underutilization of personnel assigned to LNP projects. As a result, the gross
margin on license fees and related services declined to 19% for the year ended
December 31, 1998 compared to 68% for the year ended December 31, 1997. In the
fourth quarter of 1998, the company recorded additional costs in connection
with a contract for which all revenue had previously been recorded. The cost of
revenue for other services decreased .2% in 1998 even though revenue increased
19%. The gross margin for other services improved from 17% to 30% for the years
ending December 31, 1997 and December 31, 1998, respectively, as staff
utilization rates improved.
Sales and Marketing. Sales and marketing expenses consist primarily of
compensation costs (including commissions), travel expenses, field sales office
expenses and marketing communication expenses. Sales and marketing expenses
increased by $295,000, or 6%, to $5.4 million for the year ended December 31,
1998 from $5.1 million for the year ended December 31, 1997. The increase was
primarily due to the Company's continued active sales efforts for its next
generation products.
General and Administrative. General and administrative expenses consist
principally of compensation costs for administration, facilities, finance,
legal, human resources, quality assurance and general management personnel.
General and administrative expenses increased to 23% of revenue from 20% of
revenue for the years ending December 31, 1998 and December 31, 1997,
respectively. The increase in cost was attributable to turnover in staffing at
all levels of the Company resulting in increased severance and recruiting
costs. In absolute dollars, general and administrative expense remained flat
from 1997 to 1998.
21
<PAGE>
In October 1998, Mr. Abramson, the CEO of the Company, resigned and was
replaced by Mr. Hallenbeck, the former CEO and co-founder of the Company.
Shortly thereafter, the CFO resigned and was replaced by a new hire from
outside of the Company and several other management changes occurred through
out late 1998. As a result of these management changes an expense of $378,981
in severance costs.
Research and Development. Research and development expenses consist primarily
of compensation costs, equipment and software development tools. Research and
development expenses increased 147%, or $4.3 million in the year ended December
31, 1998, from $2.9 million in the year ended December 31, 1997. As a
percentage of revenue, research and development increased from 7% in 1997 to
19% in 1998. This increase resulted from the Company's continued commitment to
the development of next generation software products as well as significant
research and development cost being recorded as cost of sales in 1997.
Other Income (expense), Net. Other expense, net of other income, includes
interest expense on the Company's debt financing and capital leases and
interest income on cash. The net expense declined 96% from $1.4 million in the
year ended December 31,1997, to $60,000 in the year ended December 31, 1998 as
a result of debt being retired from the proceeds of the initial public offering
of common stock in the second quarter of 1998, and the increase in interest
income as a result of investing those proceeds.
Extraordinary Item. The Company recorded an extraordinary item of $445,702
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. The Company recorded
a tax benefit of $220,000 relating to the extraordinary item. A similar charge
was not recorded in 1997.
Provision for (benefit from) Income Taxes. The Company has recorded a partial
valuation allowance against its carryforward tax benefits to the extent that it
believes that it is more likely than not all of such benefits will not be
realized in the foreseeable future. The Company's assessment of this valuation
allowance was made using all available evidence, both positive and negative. In
particular, the Company considered both its historical results and its
projections of profitable for only reasonably foreseeable future periods. The
Company's realization of its recorded net deferred tax assets is dependent on
future taxable income and therefore, the Company is not assured that such
benefits will be realized.
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically financed its operations through a combination
of cash flow from operations and borrowings. On May 12, 1998, the Company
completed its initial public offering of common stock and subsequently repaid
most outstanding borrowings. At December 31, 1999, the Company's principal
sources of liquidity included $4.3 million in cash and cash equivalents, $18.0
million in short term investments, and a $5.0 million secured bank line of
credit, which expires in September 2000. As of December 31, 1999, the Company
had no outstanding balance under the line of credit and the Company was in
compliance with all related covenants.
Net cash provided by operating activities was $5.9 million in the year ended
December 31, 1999 compared to a cash usage of $14.4 million in the year ended
December 31, 1998. The main contributors to cash from operations in the year
ended December 31, 1999 were funding deposits from customers on new projects
and a decrease in contract receivables net of a large increase in unbilled work
in progress due to an earlier cutoff for receivable billings in 1999 as part of
the Y2K preparedness program.
Net cash used in investing activities during the years ended December 31,
1999 and December 31, 1998 was $13.2 million and $9.1 million, respectively, to
fund purchases of short term investments and purchases of equipment to support
operations. The Company purchased $11.1 million, net of sales, in short-term
investments as part of treasury management to increase interest income in the
year ended December 31, 1999.
22
<PAGE>
Financing activities used $155,000 in cash in the year ended December 31,
1999 compared to providing $34.0 million in the year ended December 31, 1998.
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 1998. The Company continued to retire outstanding equipment
leases in 1999.
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.
Impact of Inflation. Inflation has not had a significant effect on the
Company's operations during the past three years ended December 31, 1999.
Impact of the Year 2000 Issue. To date, the Company has not been
significantly adversely affected by the Year 2000 computer issues. The Company
formed a Year 2000 project team early in 1999 and implemented a comprehensive
project plan to identify internal and external information technology and non-
information technology systems which required modification or upgrade to be
made Year 2000 ready. As part of the plan, the Company analyzed and tested its
software products and corrected for Year 2000 issues prior to December 31,
1999. All products functioned across the millennium crossover without incident.
The Company developed and tested contingency plans which identified workarounds
in the event of malfunction of a system designated as a priority. These
contingency plans were in place, but none was required to be enacted.
Furthermore, there were no significant Year 2000 issues with the Company's
internal software, hardware, or infrastructure.
The Company recently received a request from one of its customers
concerning patent claims made against the customer by Bruce Dickens. Mr.
Dickens asserts a patent to a "windowing" technique that was used by many
companies to resolve Year 2000 issues. The Company believes that it has
adequate defenses to any claims from its customer.
Costs: Funding of all Year 2000 efforts was expensed as occurred. The Company
has spent approximately $1 million dollars. The Company believes that any
additional resources needed to address Year 2000 issues will not be material.
However, there any be no assurance that currently unidentified Year 2000
issues, if any, will not arise; that these issues will not have a material
adverse effect on the Company; or, that additional resources needed to address
Year 2000 issues will not be material.
Recent Accounting Pronouncements
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes methods of
accounting for derivative financial instruments and hedging activities related
to those instruments as well as other hedging activities. SFAS No. 133, as
amended, is effective for fiscal years beginning after June 15, 2000. To date,
we have not entered into any derivative financial instruments or hedging
activities.
In December 1999, the SEC issued Staff Accounting Bulletin No. 101 (SAB
101), "Revenue Recognition in Financial Statements." SAB 101 provides specific
guidance, among other things, as to the recognition of revenue related to up-
front non-refundable fees and services charges received in connection with a
contractual arrangement. We have applied the provisions of SAB 101 for the year
ended December 31, 1999. The adoption of SAB 101 did not have a material impact
on our financial condition or results of operations.
23
<PAGE>
Item 8. Consolidated Financial Statements and Supplementary Data
The consolidated financial statements and related notes thereto required
by this item are listed and set forth herein beginning on page F-1.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
24
<PAGE>
PART III
Item 10. Directors and Executive Officers of the Registrant
Incorporated by reference to the section of the Company's 2000 Proxy
Statement, anticipated to be filed within 120 days of December 31, 1999,
entitled "Proposal 1--Election of Directors," and the section entitled
"Management."
Item 11. Executive Compensation
Incorporated by reference to the section of the Company's 2000 Proxy
Statement, anticipated to be filed within 120 days of December 31, 1999,
entitled "Executive Compensation."
Item 12. Security Ownership of Certain Beneficial Owners and Management
Incorporated by reference to the section of the Company's 2000 Proxy
Statement, anticipated to be filed within 120 days of December 31, 1999,
entitled "Security Ownership of Certain Beneficial Owners and Management."
Item 13. Certain Relationships and Related Transactions
Incorporated by reference to the section of the Company's 2000 Proxy
Statement, anticipated to be filed within 120 days of December 31, 1999,
entitled "Certain Relationships and Related Transactions."
25
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) The following documents are filed as part of this Annual Report on
Form 10-K.
1. Consolidated Financial Statements: The consolidated financial
statements of Evolving Systems, Inc. are included as Appendix F of this
report. See Index to Consolidated Financial Statements on page F-1.
2. Financial Statement Schedules.
3. Exhibits.
<TABLE>
<CAPTION>
Exhibit
Number Description of Document
------- -----------------------
<C> <S>
3.1+ Restated Certificate of Incorporation.
3.2+ Amended and Restated Bylaws.
4.1+ Reference is made to Exhibits 3.1 and 3.2.
4.2+ Specimen stock certificate representing shares of Common Stock.
10.1+ Indemnification Agreement, entered into by the Registrant and each of
its directors and executive officers, dated as of January 1, 1998.
10.2+* Amended and Restated Stock Option Plan.
10.3+* Employee Stock Purchase Plan.
10.10+ Software Development Agreement, by and between the Registrant and
American Telephone and Telegraph Company, dated as of May 1, 1993.
(The division of American Telephone & Telegraph Company responsible
for this Agreement has split off from AT&T and is now known as Lucent
Technologies, Inc.).
23.1 Consent of PricewaterhouseCoopers LLP, Independent Accountants.
24.1 Power of Attorney. Reference is made to page 24.
27.1 Financial Data Schedule.
</TABLE>
- --------
+ Incorporated by reference to the Registrant's Registration Statement on Form
S-1 No. 333-43973.
* Indicates each management contract or compensatory plan or arrangement
required to be filed as an exhibit to this Form 10-K.
(b) Reports on Form 8-K.
The Company filed a current report on Form 8-K dated November 3, 1999
describing the appointment of James M. Ross to President and Chief Operating
Officer and also naming him as a director of the Company.
The Company filed a current report on Form 8-K dated July 8, 1999
describing the adoption of a Rights Plan.
26
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, on the 20th day of
March, 2000.
Evolving Systems, Inc.
By: /s/ George A. Hallenbeck
George A. Hallenbeck
Chief Executive Officer
(Principal Executive Officer)
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints George A. Hallenbeck and Anita T. Moseley, or
any of them, his or her attorney-in-fact, each with the power of substitution,
for him or her in any and all capacities, to sign any amendments to this
Report, and to file the same, with exhibits thereto and other documents in
connections therewith, with the Securities and Exchange Commission, hereby
ratifying and confirming all that each of said attorneys-in-fact, or his or her
substitute or substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ George A. Hallenbeck Chief Executive Officer, March , 2000
______________________________________ Chairman of the Board of
George A. Hallenbeck Directors (Principal
Executive Officer)
/s/ James M. Ross President, Chief Operating March , 2000
______________________________________ Officer, Director
James M. Ross
/s/ David R. Johnson Senior Vice President, March , 2000
______________________________________ Chief Financial Officer
David R. Johnson (Principal Financial and
Accounting Officer)
/s/ David J. Molny Vice President, Chief March , 2000
______________________________________ Technical Officer,
David J. Molny Director
/s/ Harry B. Fair Director March , 2000
______________________________________
Harry B. Fair
/s/ Donald R. Dixon Director March , 2000
______________________________________
Donald R. Dixon
/s/ Robert J. Loarie Director March , 2000
______________________________________
Robert J. Loarie
</TABLE>
27
<PAGE>
EVOLVING SYSTEMS, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Index to Financial Statements
Report of PricewaterhouseCoopers LLP..................................... F-2
Balance Sheets at December 31, 1998 and 1999............................. F-3
Statements of Operations for the years ended December 31, 1997, 1998 and
1999.................................................................... F-4
Statement of Changes in Stockholders' Equity for the years ended December
31, 1997, 1998 and 1999................................................. F-5
Statement of Cash Flows for the years ended December 31, 1997, 1998 and
1999.................................................................... F-6
Notes to Financial Statements............................................ F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of Evolving Systems, Inc.
In our opinion, the accompanying balance sheets and the related statements
of operations, statement of changes in stockholders' equity and statement of
cash flows present fairly, in all material respects, the financial position of
Evolving Systems, Inc. at December 31, 1999 and 1998 and the results of its
operations and its cash flows for the three years in the period ended December
31, 1999, in conformity with accounting principles generally accepted in the
United States. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with auditing standards generally accepted in the
United States which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
Broomfield, Colorado
March 1, 2000
F-2
<PAGE>
EVOLVING SYSTEMS, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
December 31, December 31,
1998 1999
------------ ------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents........................ $ 11,706,563 $ 4,265,956
Short-term investments--unrestricted............. 6,949,604 12,086,926
Short-term investments--restricted............... -- 5,920,111
Contract receivables, net of allowance of
$308,110 and $39,006 at December 31, 1998 and
1999, respectively.............................. 14,239,396 9,623,555
Unbilled work in-progress........................ 3,374,469 8,349,436
Prepaid and other current assets................. 2,031,228 1,574,906
------------ ------------
Total current assets........................... 38,301,260 41,820,890
Property and equipment, net........................ 7,630,899 6,259,939
Deferred tax assets................................ 1,547,007 1,547,007
------------ ------------
$ 47,479,166 $ 49,627,836
------------ ------------
Liabilities and Stockholder's Equity
Current liabilities:
Current portion of long-term obligations......... $ 1,211,294 $ 640,010
Accounts payable and accrued liabilities......... 3,001,707 2,998,514
Unearned revenue and customer deposits........... 3,078,741 9,278,058
------------ ------------
Total current liabilities...................... 7,291,742 12,916,582
Long-term obligations.............................. 824,968 169,960
Commitments and contingencies (Note 3).............
Stockholders' equity:
Preferred stock, $.001 par value: 2,000,000
shares authorized, no shares issued............. -- --
Common stock, $.001 par value: 25,000,000 voting
shares authorized; 11,888,021 and 12,446,965
shares issued and outstanding as of December 31,
1998 and December 31, 1999, respectively........ 11,888 12,447
Additional paid-in capital......................... 50,703,085 51,774,076
Deferred compensation.............................. (344,469) (89,454)
Accumulated deficit................................ (11,008,048) (15,155,775)
------------ ------------
Total stockholders' equity..................... 39,362,456 36,541,294
------------ ------------
$ 47,479,166 $ 49,627,836
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
EVOLVING SYSTEMS, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------
1997 1998 1999
----------- ------------ -----------
<S> <C> <C> <C>
Revenue:
License fees and related services.... $20,033,964 $ 10,183,533 $ 8,137,972
Other services....................... 22,686,329 27,054,063 32,349,270
----------- ------------ -----------
Total revenue...................... 42,720,293 37,237,596 40,487,242
Cost of revenue:
License fees and related services.... 6,338,475 8,270,718 8,216,897
Other services....................... 18,885,428 18,833,172 18,718,018
----------- ------------ -----------
Total cost of revenue.............. 25,223,903 27,103,890 26,934,915
----------- ------------ -----------
Gross margin......................... 17,496,390 10,133,706 13,552,327
Operating expenses:
Sales and marketing.................. 5,064,654 5,738,827 4,515,561
General and administrative........... 8,635,424 8,565,620 9,704,785
Research and development............. 2,914,312 7,197,309 1,064,392
----------- ------------ -----------
Total operating expenses........... 16,614,390 21,501,756 15,284,738
----------- ------------ -----------
Income (loss) from operations.......... 882,000 (11,368,050) (1,732,411)
Other income (expense):
Interest income...................... 175,384 935,053 907,197
Interest expense, including related
party interest of $989,378, $0 and
$0 for the years ended December 31,
1997, 1998 and 1999................. (1,570,535) (994,989) (171,814)
Litigation settlement and expenses... -- -- (3,150,699)
----------- ------------ -----------
Total.............................. (1,395,151) (59,936) (2,415,316)
----------- ------------ -----------
Loss before income taxes............... (513,151) (11,427,986) (4,147,727)
Benefit from income taxes.............. (791,650) (600,564) 0
----------- ------------ -----------
Income (loss) before extraordinary
item.................................. 278,499 (10,827,422) (4,147,727)
----------- ------------ -----------
Extraordinary item, net of taxes....... -- 445,702 --
----------- ------------ -----------
Net income (loss)...................... $ 278,499 $(11,273,124) $(4,147,727)
----------- ------------ -----------
Income (loss) per common share before
extraordinary item.................... $ .18 $ (1.37) $ (0.34)
Extraordinary item..................... -- (0.06) --
----------- ------------ -----------
Net income (loss) per common share..... $ .18 $ (1.43) $ (0.34)
Weighted average common shares
outstanding........................... 1,557,236 7,887,000 12,137,783
Diluted income (loss) per common share
before extraordinary item............. $ .03 $ (1.37) $ (0.34)
Extraordinary item..................... -- (0.06) --
----------- ------------ -----------
Diluted net income (loss) per common
share................................. $ . 03 $ (1.43) $ (0.34)
Diluted weighted average common shares
outstanding........................... 8,222,312 7,887,000 12,137,783
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
EVOLVING SYSTEMS, INC.
STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Series A $.01 Par $.001 Par Additional Retained Total
Preferred Stock Common Stock Common Stock Paid-in Deferred Earnings Stockholder's
----------------- ------------- ------------------ Capital Compensation (Deficit) Equity
<S> <C> <C> <C> <C> <C> <C> ----------- ------------ ------------ -------------
<CAPTION>
Shares Amount Shares Amount Shares Amount
-------- ------- ------ ------ ---------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance,
December 31,
1996........... 8,160 $ 8 -- $ -- 1,535,786 $ 1,536 $ 1,007,632 $ -- $ (13,423) $ 995,753
Stock option
exercises...... 84,974 85 67,894 67,979
Compensation
related to
stock options.. 1,347,534 (1,347,534)
Amortization of
deferred
compensation... 355,346 355,346
Net income...... 278,499 278,499
-------- ------- ----- ----- ---------- ------- ----------- ----------- ------------ ------------
Balance,
December 31,
1997........... 8,160 8 -- -- 1,620,760 1,621 2,423,060 (992,188) 265,076 1,697,577
Issuance of
shares in
initial public
offering, net,
and conversion
of preferred
stock.......... (8,160) (8) 9,918,000 9,918 47,946,839 47,956,749
Stock option
exercises...... 283,118 283 226,211 226,494
Compensation
related to
stock options.. 65,421 65,421
Amortization of
deferred
compensation... (231,056) 647,719 416,663
Common Stock
issued pursuant
to the Employee
Stock Purchase
Plan........... 66,143 66 272,610 272,676
Net loss........ (11,273,124) (11,273,124)
-------- ------- ----- ----- ---------- ------- ----------- ----------- ------------ ------------
Balance,
December 31,
1998........... -- -- -- -- 11,888,021 11,888 50,703,085 (344,469) (11,008,048) 39,362,456
Stock option
exercises...... 464,567 465 698,164 698,629
Compensation
related to
stock options..
Amortization of
deferred
compensation... 255,015 255,015
Common Stock
issued pursuant
to the Employee
Stock Purchase
Plan........... 94,377 94 372,827 372,921
Net loss........ (4,147,727) (4,147,727)
-------- ------- ----- ----- ---------- ------- ----------- ----------- ------------ ------------
Balance,
December 31,
1999........... -- $ -- -- $ -- 12,446,965 $12,447 $51,774,076 $ (89,454) $(15,155,775) $ 36,541,294
======== ======= ===== ===== ========== ======= =========== =========== ============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
EVOLVING SYSTEMS, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------
1997 1998 1999
----------- ------------ -----------
<S> <C> <C> <C>
Operating activities:
Net income (loss)..................... $ 278,499 $(11,273,124) $(4,147,727)
Adjustments to reconcile net income
(loss) to net cash provided by (used
in) operating activities:
Provision for uncollectible
accounts........................... 456,600 (211,890) --
Amortization of deferred
compensation....................... 355,346 416,663 255,015
Depreciation and amortization....... 4,004,225 4,379,307 3,511,132
Loss on disposal of property and
equipment.......................... 159,304 132,984 13,049
Benefit from deferred income taxes.. (957,138) (671,218) --
Change in operating assets and
liabilities:
Contract receivables................ (4,237,934) (683,567) 4,884,945
Unbilled work in-progress........... (73,135) (2,533,477) (5,244,071)
Prepaid and other assets............ (609,014) (737,218) 456,322
Accounts payable and accrued
liabilities........................ (1,113,448) (240,652) (3,193)
Unearned revenue and customer
deposits........................... 5,388,594 (2,975,680) 6,199,317
----------- ------------ -----------
Net cash provided by (used in)
operating activities............. 3,651,899 (14,397,872) 5,924,789
----------- ------------ -----------
Investing activities:
Purchases of property and equipment... (2,966,966) (2,300,743) (2,153,221)
Proceeds from sale of property and
equipment............................ 45,346 25,604 --
Purchases of short-term investments... -- (6,818,617) (45,885,623)
Sales of short-term investments....... 25,688 -- 34,828,190
----------- ------------ -----------
Net cash used in investing
activities....................... (2,895,932) (9,093,756) (13,210,654)
----------- ------------ -----------
Financing activities:
Proceeds from long-term obligations... 200,000 -- --
Repayments of long-term obligations... (3,037,403) (14,428,387) (1,226,292)
Borrowings from line of credit........ -- 6,686,000 --
Repayments of line of credit.......... -- (6,686,000) --
Proceeds from issuance of common
stock, net........................... 67,979 48,455,919 1,071,550
----------- ------------ -----------
Net cash provided by (used in)
financing activities............. (2,769,424) 34,027,532 (154,742)
----------- ------------ -----------
Net increase (decrease) in cash and
cash equivalents..................... (2,013,457) 10,535,904 (7,440,607)
Cash and cash equivalents at beginning
of period............................ 3,184,116 1,170,659 11,706,563
----------- ------------ -----------
Cash and cash equivalents at end of
period............................... $ 1,170,659 $ 11,706,563 $ 4,265,956
=========== ============ ===========
Supplemental disclosure of other cash
and non-cash investing and financing
transactions
Interest paid......................... $ 1,566,184 $ 920,450 $ 171,814
Income taxes paid..................... 289,867 -- --
Assets acquired under capital lease... 1 ,205,714 86,839 --
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
EVOLVING SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
1. Organization and Summary of Significant Accounting Policies
Organization
The Company designs, develops, markets and supports OSS products and
solutions for the telecommunications industry and provides a broad range of
both fixed price and time and materials software solutions. The Company
provides these systems and software products through a combination of its own
proprietary software integrated with software packages purchased from other
companies to form complete software solutions for its customers.
Initial Public Offering
In May 1998, the Company completed an initial public offering (IPO). Of
the 5.3 million shares of common stock sold to the public at $14.00 per share,
the Company issued 3.8 million shares and selling shareholders sold 1.5 million
shares. The Company realized approximately $48 million from the offering after
deducting expenses of the offering of approximately $5.2 million.
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 and
disclosure of contingent assets and liabilities at the date of the financial
statements as well as the reported amounts of revenue and expenses during the
reporting period. Significant estimates have been made by management with
respect to the collectibility of accounts receivable and the estimates to
complete long-term contracts. Actual results could differ from these estimates.
Revenue Recognition
For contracts entered into subsequent to January 1, 1998, the Company
recognizes revenue in accordance with the provisions of Statement of Position
97-2, "Software Revenue Recognition". 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 involving the Company's LNP software products and related services.
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 generated from fixed price
contracts that provide for both licenses and services. Revenue under these
arrangements, where the services are essential to the functionality of the
delivered software, 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 the terms of the fixed price contracts and
all such amounts are expected to be billed and collected during the succeeding
12 months.
In arrangements where the services are not essential to the functionality
of the delivered software, the Company recognizes license revenue when a
license agreement has been signed, delivery has occurred, the fee is fixed or
determinable and collectibility is probable. Where applicable, fees from
multiple element arrangements are unbundled and recorded as revenue as the
elements are delivered to the extent that vendor specific objective evidence of
fair value exists. If vendor specific objective evidence of fair value does not
exist, fees from such arrangements are deferred until the earlier of the date
that vendor specific objective evidence of fair value does exist or all of the
elements are delivered.
F-7
<PAGE>
EVOLVING SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
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 periods 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 costs
indicate a loss.
For contracts entered into prior to January 1, 1998, the Company
recognized revenue in accordance with Statement of Position 91-1, "Software
Revenue Recognition." The Company's revenue recognition was substantively the
same as that discussed above.
Software Research and Development Costs
Expenditures for software research and development are expensed as
incurred. Such costs are required to be expensed until the point that
technological feasibility of the product is established after which time such
costs are capitalized until general availability of the product. The period
between achieving technological feasibility and the general availability of
such software has historically been short. Consequently, costs otherwise
capitalizable after technological feasibility is achieved are expensed because
they are insignificant.
Cash and Cash Equivalents
All highly liquid investments and investments with a maturity of three
months or less when purchased are considered to be cash equivalents. All cash
equivalents are carried at cost, which approximates fair value. Short-term
investments consist of high grade commercial paper, maturing within one year.
Such short-term investments are classified as held-to-maturity and accordingly
carried at amortized cost.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of cash and cash equivalents,
short term investments and accounts receivable. The Company has cash
investment policies that limit investments to investment grade securities and
certificates of deposit. The Company performs ongoing evaluations of its
customers' financial condition and, generally, requires no collateral from its
customers. During the years ending December 31, 1997, 1998 and 1999, the
Company recognized approximately 89%, 87% and 84% of total revenue from six,
six and five customers, respectively, all in the telecommunications industry.
As of December 31, 1998 and 1999, these customers accounted for 92% and 78% of
contract receivables, respectively.
Fair Value of Financial Instruments
For certain of the Company's financial instruments, including cash and cash
equivalents, certificates of deposit, contract receivables, accounts payable
and accrued expenses, management believes that the carrying amounts
approximate fair value due to their short maturities. Additionally, based on
borrowing rates currently available to the Company for debt agreements with
similar terms and average maturities, management believes the carrying amount
of the notes payable to the bank approximates fair market value.
F-8
<PAGE>
EVOLVING SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Property and Equipment
Property and equipment are stated at cost and are depreciated over their
estimated useful lives, generally four to seven years or the lease term, if
shorter, using the straight-line method. Leasehold improvements are stated at
cost and are depreciated over the life of the leases using the straight-line
method.
Stock-based Compensation
The Company applies Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" (APB No. 25), in accounting for
stock based compensation arrangements. The Company has included the pro-forma
disclosures required under SFAS No. 123 in Note 4.
Income Taxes
Deferred tax assets and liabilities are recorded for the estimated future
tax effects of temporary differences between the tax bases of assets and
liabilities and amounts reported in the accompanying balance sheets, as well as
operating loss and tax credit carryforwards. Deferred tax assets may be reduced
by a valuation allowance if based on the weight of available evidence it is
more likely than not that these benefits will not be realized.
Earnings Per Common Share
Basic earnings per share (EPS) is computed by dividing net income by the
weighted average number of shares outstanding during the period. Diluted EPS is
computed using the weighted average number of shares outstanding plus all
dilutive potential common shares outstanding.
The following is the reconciliation of the numerators and denominators of
the basic and diluted EPS computations for the years ended December 31:
<TABLE>
<CAPTION>
1997 1998 1999
---------- ------------ -----------
<S> <C> <C> <C>
Basic Earnings Per Share
Net income (loss)...................... $ 278,499 $(11,273,124) $(4,147,727)
Basic weighted average common shares
outstanding........................... 1,557,236 7,887,000 12,137,783
Basic earnings per common share........ $ .18 $ (1.43) $ (.34)
---------- ------------ -----------
Diluted Earnings per Share
Net income (loss)...................... $ 278,499 $(11,273,124) $(4,147,727)
---------- ------------ -----------
Basic weighted average number of shares
outstanding........................... 1,557,236 7,887,000 12,137,783
Effect of Dilutive Securities
Options and warrants................... 545,076 -- --
Conversion of preferred shares......... 6,120,000 -- --
---------- ------------ -----------
Diluted weighted average common shares
outstanding........................... 8,222,312 7,887,000 12,137,783
---------- ------------ -----------
Diluted earnings per share............. $ .03 $ (1.43) $ (.34)
========== ============ ===========
</TABLE>
All options and warrants outstanding during 1998 and 1999 were excluded
from computation of diluted EPS because of their anti-dilutive effect on the
net loss per share.
F-9
<PAGE>
EVOLVING SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
2. Balance Sheet Components
Certain balance sheet components are as follows:
<TABLE>
<CAPTION>
December 31,
--------------------------
1998 1999
------------ ------------
<S> <C> <C>
Property and equipment:
Computer equipment and purchased software.... $ 18,614,794 $ 20,112,423
Furniture, fixtures and leasehold
improvements................................ 4,228,237 4,321,859
------------ ------------
22,843,031 24,434,282
Less accumulated depreciation.................. (15,212,132) (18,174,343)
------------ ------------
$ 7,630,899 $ 6,259,939
============ ============
</TABLE>
Included in property and equipment at December 31, 1998 and 1999 are
assets under capital lease of $10,308,106 and $2,786,429, respectively. Related
accumulated depreciation is $8,239,850 and $2,400,813 as of December 31, 1998
and 1999, respectively.
<TABLE>
<S> <C> <C>
Accounts payable and accrued liabilities:
Accounts payable.................................... $ 616,217 $ 730,286
Accrued compensation and related expenses........... 725,949 1,216,310
Other............................................... 1,659,541 1,051,918
---------- ----------
$3,001,707 $2,998,514
========== ==========
</TABLE>
3. Long-term Obligations, Including Related Party Obligations and Commitments
Long-term obligations, including capitalized lease obligations, consist of
the following:
<TABLE>
<CAPTION>
December 31,
----------------------
1998 1999
----------- ---------
<S> <C> <C>
Notes payable to a bank under line of credit and
term debt facility............................... $ 250,000 $ --
Capital lease obligations......................... 1,786,262 809,970
Line of credit.................................... -- --
----------- ---------
Total............................................. 2,036,262 809,970
Less current portion.............................. (1,211,294) (640,010)
----------- ---------
Long-term portion................................. $ 824,968 $ 169,960
=========== =========
</TABLE>
Line of Credit to Bank
Under a borrowing arrangement with a bank, the Company has a revolving
line of credit with $5,000,000 of maximum available credit at December 31, 1999
which bears interest at the bank's prime rate. The line of credit is
collateralized by short-term commercial paper investments of $5,920,111. No
borrowings were outstanding under the line of credit at December 31, 1998 or
1999.
The Company also had a term debt facility under which the Company could
draw up to a maximum of $5,000,000. The term debt facility expired September
16, 1999 and there were no borrowings against the facility at the time of
termination.
F-10
<PAGE>
EVOLVING SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
The Company had no additional debt covenants or debt facilities as of
December 31, 1999.
Extraordinary Item
In connection with the early retirement in 1998 of notes payable to
stockholders and senior subordinated promissory notes payable to stockholders,
the Company recorded an extraordinary loss of $445,702, net of $220,000 in tax
benefit. The extraordinary loss is comprised of the prepayment penalties and
the write-off of capitalized debt issuance costs.
Lease Commitments
The Company leases its office and operating facilities and various
equipment under non-cancelable operating leases. Rent expense was $3,746,954,
$3,804,613 and $1,916,912 for the years ended December 31, 1997, 1998 and 1999,
respectively. Rent expense is net of sublease rental income of $1,276,419,
$515,638 and $1,110,826 for the years ending December 31, 1997, 1998, and 1999,
respectively. In connection with its obligations under certain of its office
facility leases, the Company has letters of credit totaling $664,216 and
$100,000 outstanding at December 31, 1998 and 1999, respectively.
Future minimum non-cancelable commitments as of December 31, 1999 for
capital leases and non-cancelable operating leases with initial terms in excess
of one year are as follows:
<TABLE>
<CAPTION>
Operating Leases Capital Leases
---------------- --------------
<S> <C> <C>
2000....................................... $ 2,696,994 $ 718,067
2001....................................... 1,688,544 168,542
2002....................................... 1,616,883 --
2003....................................... 1,468,241 --
2004....................................... 1,460,445 --
Thereafter................................. 16,104,001 --
----------- ---------
25,035,108 886,609
Less: sublease income...................... 1,006,750 --
-----------
Minimum lease payments..................... $24,028,358 886,609
===========
Less amounts representing interest......... -- (76,639)
---------
809,970
Less current maturities.................... -- (640,010)
---------
$ 169,960
=========
</TABLE>
4. Stock Options and Employee Stock Purchase Plan
Stock Options
On January 19, 1996, the Company's board of directors approved a stock
option plan. Under the stock option plan, 4,350,000 shares of the Company's
common stock are reserved for issuance, of which 528,302 shares are available
for grant as of December 31, 1999. The Company has also reserved 910,633 shares
of common stock for the issuance of warrants. Options issued under the stock
option plan shall be at the discretion of the Board of Directors, including the
provisions of each stock option granted, which need not be identical. Options
generally vest over four years and expire no more than ten years from the date
of grant. Certain options were automatically vested upon the effectiveness of
the IPO. On December 30, 1997 the Board of Directors approved the repricing of
all options granted from September 1, 1997 through December 30, 1997 to
F-11
<PAGE>
EVOLVING SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
a new exercise price of $9.50. On September 25, 1998, 61,734 stock options for
non-officer employees were repriced to $2.75, the fair market value at that
date. On November 5, 1998, 238,250 options for officers were repriced to $2.75,
a price above the fair value at that date but equal to the price set for non-
officer employees. No compensation expense was recorded, as the options were
repriced to an exercise price greater than or equal to fair market.
Generally, stock options are granted with an exercise price not less than
fair value of common stock as determined by the Board of Directors at the date
of grant, and accordingly no compensation cost was recognized prior to 1997.
During the year ended December 31, 1997, the Company recorded $1,347,534 as
deferred compensation, representing the excess of the deemed fair value of the
Company's common stock over the exercise price of options granted during 1997.
Such deferred compensation cost is being amortized over the vesting period of
the options. Of the total amount, $416,663 and $255,015 were recognized as
expense during the years ended December 31, 1998 and 1999, respectively.
Based on calculations using the minimum value and Black-Scholes option-
pricing models, the weighted average grant date fair value of options and
warrants was $1.29, $1.76 and $3.40 in 1997, 1998 and 1999, respectively. The
fair value has been estimated using the minimum value and Black-Scholes option-
pricing models with the following assumptions used for grants in 1997, 1998 and
1999, respectively: no dividend yield for all periods; an expected life of 3
years for all periods; volatility of 0%, 104% and 91%; and weighted average
risk free interest rates of 6.3%, 4.7%, and 5.8%.
The pro forma impact on the Company's net income (loss) and net income (loss)
per share had compensation cost been recorded at the date of grant based on the
method prescribed by SFAS No. 123 is shown below:
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, 1998 December 31, 1999
----------------- -----------------
<S> <C> <C>
Net income (loss):
As reported.......................... $(11,273,124) $(4,147,727)
SFAS No. 123 Pro forma............... $(11,889,569) $(4,669,255)
Net income (loss) per common share:
As reported.......................... $ (1.43) $ (.34)
SFAS No. 123 Pro forma............... $ (1.51) $ (.38)
Diluted net income (loss) per common
share:
As reported.......................... $ (1.43) $ (.34)
SFAS No. 123 Pro forma............... $ (1.51) $ (.38)
</TABLE>
F-12
<PAGE>
EVOLVING SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
The status of total stock options and warrants outstanding and exercisable
under the Plan as of December 31, 1999 follows:
<TABLE>
<CAPTION>
Stock Options and
Stock Options and Warrants Outstanding Warrants Exercisable
------------------------------------------ ------------------------
Weighted Average
Remaining Weighted Weighted
Range of Number Contractual Average Number Average
Exercise Prices of Shares Life (years) Exercise Price of Shares Exercise Price
--------------- --------- ---------------- -------------- --------- --------------
<S> <C> <C> <C> <C> <C> <C>
Options................. $0.80 212,408 7.05 $0.80 131,744 $0.80
$2.00-$3.57 1,390,144 8.78 $2.68 428,530 $2.71
$4.13-$6.00 1,252,969 9.67 $5.41 29,287 $5.02
$6.25-$9.44 102,500 9.88 $8.02 -- --
$9.50-$10.00 29,003 9.82 $9.61 784 $9.76
--------- ---- ----- ------- -----
2,987,024 9.08 $3.94 590,345 $2.41
--------- ---- ----- ------- -----
Warrants................ $0.80 910,633 3.40 $0.80 910,633 $0.80
</TABLE>
The following is a summary of stock option activity:
<TABLE>
<CAPTION>
Weighted Weighted
Number of Shares Average Options and Average
-------------------- Exercise Warrants Exercise
Options Warrants Price Exercisable Price
---------- -------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
Options and warrants
outstanding, December 31,
1996...................... 824,932 910,633 $0.80 1,106,482 $0.80
Options granted.......... 1,449,439 -- 6.19
Less options forfeited... (301,996) -- 0.93
Less options exercised... (84,974) -- 0.80
---------- ------- -----
Options and warrants out-
standing December 31,
1997...................... 1,887,401 910,633 3.58 1,249,894 $0.80
Options granted.......... 2,349,723 -- 4.16
Less options forfeited... (1,609,055) -- 8.49
Less options exercised... (283,118) -- 0.80
---------- ------- -----
Options and warrants out-
standing December 31,
1998...................... 2,344,951 910,633 1.85 1,293,130 $0.85
Options granted.......... 1,485,875 -- 5.63
Less options forfeited... (379,235) -- (3.09)
Less options exercised... (464,567) -- (1.50)
---------- ------- -----
Options and warrants out-
standing December 31,
1999...................... 2,987,024 910,633 3.21 1,500,978 $1.43
========== ======= =====
</TABLE>
Included in total options and warrants exercisable at December 31, 1997,
1998 and 1999, are 910,633 warrants issued in connection with a 1996 debt
financing. The warrants are exercisable at $.80 per share and expire May 31,
2003. Subsequent to December 31, 1999, the Company granted options to purchase
121,500 shares of common stock at a weighted average exercise price of $9.16
per share.
Employee Stock Purchase Plan
Under the Employee Stock Purchase Plan, the Company is authorized to issue
up to 350,000 shares of common stock to its full-time employees, nearly all of
whom are eligible to participate. Under the terms of the plan, employees may
elect to have up to 15% of their gross salaries withheld by payroll deduction
to purchase the Company's common stock. The purchase price of the stock is 85%
of the lower of market price at the beginning or end of each six-month
participation period. Under the plan employees purchased 66,143 and 94,377
shares in 1998 and 1999, respectively.
F-13
<PAGE>
EVOLVING SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
The fair value of each stock purchase plan grant was estimated on the
date of grant using the Black-Scholes model with the following assumptions for
1998 and 1999 respectively: no dividend yield for all periods; an expected
life of .14 years and .5 years, and .49 years and .5 years; volatility of 104%
and 91%; and a risk free interest rate of 5.5% and 5.62%.
5. Income Taxes
The provision for (benefit from) income taxes consists of the following:
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------
1997 1998 1999
--------- --------- ----
<S> <C> <C> <C>
Current:
Federal......................................... $ 165,758 $(156,797) $--
State........................................... (270) 7,451 --
Deferred:
Federal......................................... (953,612) (611,834) --
State........................................... (3,526) (59,384) --
--------- --------- ----
Total......................................... $(791,650) $(820,564) $--
========= ========= ====
</TABLE>
Of the total 1998 benefit from income taxes, $220,000 is reflected in the
extraordinary item on the income statement.
Components of the Company's deferred tax assets and liabilities are as
follows as of December 31:
<TABLE>
<CAPTION>
1998 1999
----------- -----------
<S> <C> <C>
Deferred tax assets:
Deferred revenue............................... $ 84,130 $ 112,105
Research and development credit carryforwards.. 1,050,000 1,701,244
Minimum tax credit carryforwards............... 13,112 --
Allowance for doubtful accounts................ 114,932 14,549
Net operating loss carryforwards............... 4,284,971 5,966,596
Other.......................................... 37,897 48,125
----------- -----------
Total deferred tax assets.................... $ 5,585,042 $ 7,842,619
----------- -----------
Deferred tax liabilities:
Accumulated depreciation....................... (215,158) (413,237)
----------- -----------
Total deferred tax liabilities............... (215,158) (413,237)
----------- -----------
Net deferred tax asset before valuation
allowance....................................... 5,369,884 7,429,382
Valuation allowance.............................. (3,822,877) (5,882,375)
----------- -----------
Net deferred tax asset........................... $ 1,547,007 $ 1,547,007
=========== ===========
</TABLE>
F-14
<PAGE>
EVOLVING SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
The provision for (benefit from) income taxes differs from the amounts
computed by applying the federal statutory rate to loss before income taxes and
extraordinary item. The amounts are reconciled as follows for the years ended
December 31:
<TABLE>
<CAPTION>
1997 1998 1999
--------- ----------- -----------
<S> <C> <C> <C>
Federal income taxes benefit at
statutory rate...................... $(174,471) $(3,885,515) $(1,410,227)
State income tax, net of federal
benefit............................. (3,704) (390,335) (128,160)
Increase in valuation allowance...... -- 3,822,877 2,059,498
Research and development tax
credits............................. (750,000) (300,000) (300,000)
Amortization of deferred
compensation........................ 120,818 141,665 (135,599)
Other................................ 15,707 10,744 (85,512)
--------- ----------- -----------
Provision for (benefit from) income
taxes............................... $(791,650) $ (600,564) $ --
========= =========== ===========
</TABLE>
The tax effect of $220,000 related to the extraordinary item in 1998
approximates the federal statutory rate.
As of December 31, 1999, the Company has research and development tax
credit carryforwards for federal income tax purposes of $1,701,244, which begin
to expire in 2011. Additionally, the Company has net operating loss
carryforwards of $16,258,022 which expire beginning in 2018.
The Company has recorded a partial valuation allowance against its
carryforward tax benefits to the extent that it believes that it is more likely
than not all of such benefits will not be realized in the foreseeable future.
The Company's assessment of this valuation allowance was made using all
available evidence, both positive and negative. In particular, the Company
considered both its historical results and its projections of profitability for
only the reasonably foreseeable future periods. The Company's realization of
its recorded net deferred tax assets is dependent on future taxable income and
therefore, the Company is not assured that such benefits will be realized.
6. Benefit Plans
The Company has established a 401(k) Plan that is available to all
employees 21 years of age or older with one quarter year service to the
Company. Employees may contribute up to 15% of gross compensation not to exceed
the maximum statutory contribution amount. The Company may make discretionary
matching contributions and has done so. All employee contributions are fully
vested immediately and employer contribution vest 100% after completion of
three years service. During 1997, 1998 and 1999, the Company contributed
$1,017,896, $1,244,842 and $1,250,480 respectively, under the 401(k) Plan.
7. Legal Proceedings
In June 1998, four securities class action complaints were filed against
the Company and certain of its current and former officers and directors in the
Federal Court for the District of Colorado alleging violations of the federal
securities laws. The complaints were consolidated. The plaintiffs purported to
represent a class of persons who purchased the Company's securities during the
period of May 12, 1998 through July 23, 1998. The complaints alleged that the
Company and certain of its officers misled the investing public regarding the
financial prospects of the Company. The Company denied these allegations. 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 $719,000 in legal costs associated
with the lawsuit.
F-15
<PAGE>
EVOLVING SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
The Company is currently involved in a dispute with an employee concerning
amounts allegedly owed to the employee in connection with his employment. The
Company believes the employee's claims are without merit and the parties are
currently seeking to resolve the dispute through mediation. Although it is too
early to evaluate the outcome of this dispute, in the event the parties are
unable to reach a mutually agreeable resolution and the employee subsequently
succeeds in his claim, the outcome could have a material adverse effect on the
Company's business, financial condition and results of operation.
From time to time the Company is involved in various legal proceedings
arising in the normal course of business operations. Management does not expect
that any such proceedings will have a material adverse effect on the Company's
financial position or results of operations.
F-16
<PAGE>
Exhibit 23.1 Consent of Independent Accountants
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-8 (No. 333-82473) of Evolving Systems, Inc. of our report
dated March 1, 2000 relating to the financial statements, which appears in this
Annual Report on Form 10-K.
/s/ PricewaterhouseCoopers LLP
- -------------------------------
PricewaterhouseCoopers LLP
Broomfield, Colorado
March 20, 2000
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM INCOME
STATEMENTS, BALANCE SHEETS AND STATEMENTS OF CASH FLOWS AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> DEC-31-1999 DEC-31-1998
<PERIOD-START> JAN-01-1999 JAN-01-1998
<PERIOD-END> DEC-31-1999 DEC-31-1998
<CASH> 4,265,956 11,706,563
<SECURITIES> 18,007,037 6,949,604
<RECEIVABLES> 9,623,555 14,239,396
<ALLOWANCES> 0 0
<INVENTORY> 0 0
<CURRENT-ASSETS> 41,820,890 38,301,260
<PP&E> 6,259,939 7,630,899
<DEPRECIATION> 3,511,132 4,379,307
<TOTAL-ASSETS> 49,627,836 47,479,166
<CURRENT-LIABILITIES> 12,916,582 7,291,742
<BONDS> 0 0
0 0
0 0
<COMMON> 12,447 11,888
<OTHER-SE> 36,528,847 39,350,568
<TOTAL-LIABILITY-AND-EQUITY> 49,627,836 47,479,166
<SALES> 0 0
<TOTAL-REVENUES> 40,487,242 37,237,596
<CGS> 26,934,915 27,103,890
<TOTAL-COSTS> 42,219,653 48,605,646
<OTHER-EXPENSES> 3,150,699 0
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 171,814 994,989
<INCOME-PRETAX> (4,147,727) (11,427,986)
<INCOME-TAX> 0 (600,564)
<INCOME-CONTINUING> 0 0
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 445,702
<CHANGES> 0 0
<NET-INCOME> (4,147,727) (11,273,124)
<EPS-BASIC> (.34) (1.43)
<EPS-DILUTED> (.34) (1.43)
</TABLE>
