-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Dv35byH2sismnHkiaWI9rftrLC61lqrHLQ1TewSP2hyn8XasmieNM0Ff5SUoXlCl KfDiSlcCZ8r6IVW0pEVnvA== 0000927356-98-001381.txt : 19980817 0000927356-98-001381.hdr.sgml : 19980817 ACCESSION NUMBER: 0000927356-98-001381 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980630 FILED AS OF DATE: 19980814 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: EVOLVING SYSTEMS INC CENTRAL INDEX KEY: 0001052054 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER PROGRAMMING SERVICES [7371] IRS NUMBER: 841010843 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-24081 FILM NUMBER: 98689632 BUSINESS ADDRESS: STREET 1: 6892 SOUTH YOSEMITE CITY: ENGLEWOOD STATE: CO ZIP: 80112 BUSINESS PHONE: 3038021000 MAIL ADDRESS: STREET 1: 6892 SOUTH YOSEMITE CITY: ENGLEWOOD STATE: CO ZIP: 80112 10-Q 1 FORM 10-Q CONFIDENTIAL PAGE 1 08/13/98 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 ____________ FORM 10-Q (Mark One) X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 1998 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number 0-24081 EVOLVING SYSTEMS, INC. (Exact Name of Registrant as Specified in its Charter) DELAWARE 84-1010843 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 9777 MT. PYRAMID COURT, ENGLEWOOD, COLORADO 80112 (Address of Principal Executive Offices) (Zip Code) (303) 802-1000 (Registrant's Telephone Number, Including Area Code) Indicate by check whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to filed such reports, and (2) has been subject to such filing requirements for the past 90 days. Yes X No _____ ____ As of June 30, 1998, there were outstanding 11,573,890 shares of Registrant's Common Stock (par value $0.001 per share). CONFIDENTIAL PAGE 2 08/13/98 EVOLVING SYSTEMS, INC.
PART 1 FINANCIAL INFORMATION PAGE Item 1. Financial Statements Balance Sheets June 30, 1998 (unaudited) and December 31, 1997................... 3 Statements of Operations for the three-month and six month periods ended June 30, 1998 and 1997 (unaudited)......................................... 4 Condensed Statements of Cash Flow for the six month periods ended June 30, 1998 and 1997 (unaudited).................................................. 5 Statement of Changes in Stockholders Equity for the six month period ended June 30, 1998...................... 6 Notes to Financial Statements........................................... 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..................................................... 8 PART II OTHER INFORMATION................................................. 14 Item 1. Legal Proceedings 14 Item 2. Changes in Securities 14 Item 3. Defaults on Senior Securities 14 Item 4. Submission of Matters to a Vote of Security Holders 14 Item 5. Other Information 14 Item 6. Exhibits and Reports on Form 8-K 14 SIGNATURES....................................................................... 14
CONFIDENTIAL PAGE 3 08/13/98 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS
EVOLVING SYSTEMS, INC. BALANCE SHEETS (IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA) June 30, Dec. 31, 1998 1997 ---------- ----------- (unaudited) ASSETS Current assets: Cash and cash equivalents $30,315 $ 1,171 Certificates of deposit -- 131 Contract receivables, net 11,121 13,344 Unbilled work-in-process 3,838 841 Deferred tax asset 1,769 1,276 Prepaid and other current assets 685 1,077 ------- ------- Total current assets 47,728 17,840 Property and equipment, net 9,079 9,803 Other assets 213 216 ------- ------- Total assets $57,020 $27,859 ======= ======= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current portion of long-term obligations $ 2,525 $ 3,178 Accounts payable 2,108 2,047 Accrued liabilities 1,298 1,195 Unearned revenue and customer deposits 1,801 6,054 ------- ------- Total current liabilities 7,732 12,474 Long-term obligations 660 13,287 Deferred income taxes 414 400 ------- ------- Stockholders' equity: Preferred stock, $.001 par value, 2,000,000 shares authorized, no shares issued -- -- Series A preferred stock, $.001 par value; 0 and 8,160 shares authorized, issued and outstanding at June 30, 1998 and December 31, 1997 -- -- (liquidation preference $6,250 per share) Common stock, $.001 par value; 4,930,000 non-voting shares authorized; 1,620,760 non-voting shares issued and outstanding as of December 31, 1997;25,000,000 voting 12 2 shares authorized; 11,573,890 voting shares issued and outstanding as of June 30, 1998 Additional paid-in-capital 50,480 2,423 Deferred compensation (878) (992) Retained earnings (deficit) (1,400) 265 ------- ------- Total stockholders' equity 48,214 1,698 ------- ------- Total liabilities and stockholders' equity $57,020 $27,859 ======= =======
The accompanying notes are an integral part of the financial statements. CONFIDENTIAL PAGE 4 08/13/98 EVOLVING SYSTEMS, INC. STATEMENTS OF OPERATIONS (IN THOUSANDS EXCEPT PER SHARE DATA) (unaudited)
Three Months Ended June 30, Six Months Ended June 30, -------------------------- ------------------------- Revenue: 1998 1997 1998 1997 License fees and related services $ 2,869 $ 5,370 $ 8,656 $ 7,570 Other services 6,712 4,924 14,054 10,797 ------- ------- ------- ------- Total revenue 9,581 10,294 22,710 18,367 ------- ------- ------- ------- Cost of revenue: License fees and related services 2,484 1,964 4,403 3,519 Other services 4,284 4,267 8,979 8,472 ------- ------- ------- ------- Total cost of revenue 6,768 6,231 13,382 11,991 ------- ------- ------- ------- Gross margin 2,813 4,063 9,328 6,376 Operating expenses: Sales and marketing 1,603 977 2,991 1,595 General and administrative 1,715 2,265 3,853 4,273 Research and development 1,879 364 3,841 1,105 ------- ------- ------- ------- Total operating expenses 5,197 3,606 10,685 6,973 ------- ------- ------- ------- Income (loss) from operations (2,384) 457 (1,357) (597) OTHER EXPENSE, NET (91) (404) (463) (769) ------- ------- ------- ------- Income (loss) before income taxes (2,475) 53 (1,820) (1,366) Provision for (benefit from) income taxes (817) 46 (601) (1,182) ------- ------- ------- ------- Income (loss) before Extraordinary item (1,658) 7 (1,219) (184) Extraordinary item, net of applicable income taxes (446) -- (446) -- ------- ------- ------- ------- Net income (loss) $(2,104) $ 7 $(1,665) $ (184) ======= ======= ======= ======= BASIC EARNINGS PER COMMON SHARE: Income (loss) before extraordinary item $ (.25) $ -- $ (.30) $ (.12) Extraordinary item (.07) (.11) ------- ------- Net income (loss) per common share $ (.32) $ -- $ (.41) $ (.12) ======= ======= ======= ======= DILUTED EARNINGS PER COMMON SHARE: Income (loss) before extraordinary item $ (.25) $ -- $ (.30) $ (.12) Extraordinary item (.07) (.11) ------- ------- Net income (loss) per common share $ (.32) $ -- $ (.41) $ (.12) ======= ======= ======= ======= Basic shares outstanding 6,610 1,554 4,118 1,545 Diluted shares outstanding 6,610 8,837 4,118 1,545
The accompanying notes are an integral part of the financial statements. CONFIDENTIAL PAGE 5 08/13/98 EVOLVING SYSTEMS, INC. CONDENSED STATEMENTS OF CASH FLOW (IN THOUSANDS) (unaudited)
Six Months Ended June 30, ------------------------- 1998 1997 -------- -------- OPERATING ACTIVITIES: Net loss $ (1,665) $ (184) Adjustments to reconcile net (loss) to net cash provided by (used in) operating activities: Provision for uncollectable contract receivables -- 96 Amortization of deferred compensation 114 -- Depreciation and amortization 2,031 1,648 Change in operating assets and liabilities: Contract receivables 2,223 (798) Unbilled work-in-process (2,997) (901) Prepaid and other assets 47 (1,146) Accounts payable 61 (467) Accrued liabilities 103 324 Unearned revenue and customer deposits (4,253) 5,378 -------- -------- Net cash provided by (used in) operating activities (4,331) 3.950 INVESTING ACTIVITIES: Purchases of property and equipment (1,307) (793) -------- -------- Net cash used in investing activities (1,307) (793) FINANCING ACTIVITIES: Repayment of long-term obligations (13,280) (1,360) Sale of stock 48,067 15 -------- -------- Net cash provided by (used in) financing activities 34,782 (1,345) -------- -------- Net increase in cash and cash equivalents 29,144 1,812 Cash and cash equivalents at beginning of period 1,171 3,184 -------- -------- Cash and cash equivalents at end of period $ 30,315 $ 4,996 ======== ========
The accompanying notes are an integral part of the financial statements. CONFIDENTIAL PAGE 6 08/13/98 EVOLVING SYSTEMS, INC. STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (in thousands except share data)
$.001 PAR SERIES A $.01 PAR VOTING NON-VOTING PREFERRED STOCK COMMON STOCK COMMON STOCK ADDITIONAL RETAINED TOTAL ---------------- --------------- -------------- PAID-IN DEFERRED EARNINGS STOCKHOLDERS SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION (DEFICIT) CAPITAL ------ ------ ------ ------ ------ ------ ---------- ------------ --------- ------------ Balance, December 31, 1997.... 8,160 $ 8 $ 0 1,620,760 2 $ 2,423 $ (992) $ 265,076 $ 1,698 ====== ====== ======= ========= ====== ========== ============ ========= ============ Stock option exercises........ 35,130 35 34 34 Amortization of deferred compensation.................. 114 114,000 Issuance of common stock...... 3,798,000 4 48,024 48,027 Conversion of preferred to common........................ (8,160) (8) 6,120,000 6 6 Net loss...................... (1,665) (1,665) Balance, June 30, 1998........ 11,573,890 $ 12 $ 50,480 $ (878) $ (1,399) $ 48,214 ========== ====== ========== ============ ========= ===========
The accompanying notes are an integral part of these financial statements. CONFIDENTIAL PAGE 7 08/13/98 EVOLVING SYSTEMS, INC. NOTES TO FINANCIAL STATEMENTS (Unaudited) (1) BASIS OF PRESENTATION Interim Financial Statements. The accompanying financial statements of Evolving Systems, Inc. (the "Company") have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. However, the Company believes that the disclosures are adequate to make the information presented not misleading. The unaudited financial statements included herein have been prepared on the same basis as the annual financial statements and reflect all adjustments, which include only normal recurring adjustments, necessary for a fair presentation in accordance with generally accepted accounting principles. The results for the period ended June 30, 1998 are not necessarily indicative of the results to be expected for any subsequent quarter or full fiscal year. These financial statements should be read in conjunction with the audited financial statements and the notes thereto for the year ended December 31, 1997 included in the Company's Registration Statement on Form S-1 (No. 333-43973), which was declared effective by the SEC on May 11, 1998. Use of Estimates. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. (2) EARNINGS (LOSS) PER COMMON SHARE The Company was required to adopt Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share," in its financial statements effective retroactively to 1997. Prior period earnings per common share ("EPS") were restated to conform with the new statement. This pronouncement established new standards for computing and presenting EPS on a basis that is more comparable to international standards and provides for the presentation of basic and diluted EPS, replacing the previously required primary and fully-diluted EPS. Basic EPS was computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted EPS was computed using the weighted average number of common shares plus all dilutive potential common shares outstanding during the period unless the effect of the potential common shares is anti-dilutive. The following is the reconciliation of the numerators and denominators of the basic and diluted EPS computations (in thousands, except per share data):
Three Months Ended Six Months Ended June 30, June 30, 1998 1997 1998 1997 Basic earnings per share: Net income (loss) $(2,104) $ 7 $(1,665) $ (184) Weighted average common shares outstanding 6,610 1,554 4,118 1,545 Basic net income (loss) per common share $ (.32) $ .00 $ (.41) $ (.12) Effect of dilutive securities: Options and warrants 1,163 Preferred Stock 6,120 ------ Diluted weighted average common shares outstanding 6,610 8,837 4,118 1,545 Diluted net income (loss) per common share $ (.32) $ .00 $ (.41) $ (.12)
In February 1998, the Company effected a one-for-two reverse stock split. All references in the financial statements to shares, share prices, and per share amounts have been adjusted retroactively for all periods presented to reflect the stock split. (3) INITIAL PUBLIC OFFERING In May 1998, the Company effected an initial public offering on Form S-1. In connection with the offering, the Company issued 3,798,000 shares of common stock, including shares issued to cover the Underwriters' (as hereinafter defined) over-allotment option, and received net proceeds of approximately $48 million. In addition, all of the Preferred Stock was converted into common stock upon the closing of the initial public offering. CONFIDENTIAL PAGE 8 08/13/98 (4) CONTINGENCIES In June, 1998, three class action lawsuits were filed in the U.S. District Court for the District of Colorado against the Company and certain of its officers and directors and, in one case, the Company's Underwriters on behalf of purchasers of the Company's common stock between May 12, 1998 and June 17, 1998. The lawsuits seek an unspecified amount of damages and allege that the defendants disseminated false and misleading statements about the Company's business, finances and future prospects. The Company believes it has meritorious legal defenses with respect to these suits and intends to vigorously defend against these actions. However, the Company is currently unable to (a) determine the ultimate outcome of the complaints, (b) determine whether resolution of this matter will have a material adverse impact on the Company's financial position or results of operations, or (c) reasonably estimate the amount of loss, if any, which may result from resolution of this matter. The Company is, from time to time, subject to certain other claims, assertions or litigation by outside parties as part of its ongoing business operations. The outcome of any such contingencies are not expected to have a material adverse effect on the financial condition, operations or cash flows of the Company. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND --------------------------------------------------------------- RESULTS OF OPERATIONS --------------------- GENERAL - ------- Evolving Systems, Inc. is a leading provider of selected software solutions and services that enable telecommunications carriers to address the technical challenges to their operational support systems created by the industry's rapidly changing competitive and regulatory environment. The Company also provides custom software development services to leading telecommunications companies. The Company adopted the provisions of Statement of Position 97-2, "Software Revenue Recognition," for transactions entered into after January 1, 1998. The Company derives revenue from license fees and services under the terms of both fixed price and time and materials contracts. License fees and related services revenue consists of revenue from contracts that generally provide for both licenses and services or development fees related to the Company's standard software products. Other services revenue consists of revenue from custom programming, systems integration of third-party products, annual maintenance contracts and training. License fees and related services revenue is generally recognized using the percentage-of-completion method of accounting. The percentage-of-completion for each contract is determined based on the ratio of direct labor hours incurred to total estimated direct labor hours. Amounts billed in advance of services being performed are recorded as unearned revenue. Unbilled work in-progress represents revenue earned but not yet billable under contract terms and all such amounts are expected to be billed and collected during the succeeding twelve months. Services revenue provided under fixed price contracts is generally recognized using the percentage-of-completion method of accounting described above. Revenue from other services provided pursuant to time-and-materials contracts is recognized as the services are performed. Annual maintenance revenue is recorded as deferred revenue and is recognized ratably over the service period, which is generally 12 months. Revenue from training services is recognized as the training services are performed. When maintenance or training services are bundled with the original license fee arrangement, their fair value is deferred and recognized during the period such services are provided. The Company may encounter budget and schedule overruns on fixed-price contracts caused by increased material, labor, or overhead costs. Adjustments to cost estimates are made in the periods in which the facts requiring such revisions become known. Estimated losses, if any, are recorded in the period in which current estimates of total contract revenue and contract cost indicate a loss. On May 15, 1998, the Company completed an initial public offering of Common Stock that was managed by Goldman, Sachs & Company, BancAmerica Robertson Stephens, Hambrecht & Quist, and UBS Securities, (the "Underwriters"). On May 11, 1998 the Commission declared effective the Company's Registration Statement on Form S-1 (Registration Statement No. 333-43973), which should be read in conjunction with this document for further information regarding the Company's business, risk factors, and accounting policies. CONFIDENTIAL PAGE 9 08/13/98 RESULTS OF OPERATIONS - --------------------- The following table presents, for the periods indicated, certain items in the Company's unaudited statement of operations reflected as a percentage of total revenue.
Three Months June 30, Six Months Ended June 30, --------------------- ------------------------- (unaudited) --------------------- 1998 1997 1998 1997 ------- ------- ------- ------- Revenue: License fees and related services 30.0% 52.2% 38.1% 41.2% Other services 70.0 47.8 61.9 58.8 ------ ----- ----- ----- Total revenue 100.0 100.0 100.0 100.0 Cost of revenue: License fees and related services 25.9 19.1 19.4 19.2 Other services 44.7 41.4 39.5 46.1 ------ ----- ----- ----- Total cost of revenue 70.6 60.5 58.9 65.3 Gross margin 29.4 39.5 41.1 34.7 Operating expenses: Sales and marketing 16.7 9.5 13.2 8.7 General and administrative 17.9 22.0 16.9 23.2 Research and development 19.6 3.5 16.9 6.0 ------ ----- ----- ----- Total operating expenses 54.2 35.0 47.0 37.9 Income (loss) from operations (24.8) 4.5 (5.9) (3.2) Other expense, net (1.0) (3.9) (2.0) (4.1) Income (loss) before income taxes (25.8) 0.6 (8.0) (7.4) Provision for (benefit from) income taxes (8.5) 0.4 (2.6) (6.4) ------ ----- ----- ----- Income (loss) before extraordinary item (17.3) 0.2 (5.4) (1.0) Extraordinary item (4.7) - (1.9) ------ ----- Net income (loss) (22.0)% 0.2% (7.3)% (1.0)% ====== ===== ===== =====
THE THREE MONTHS ENDED JUNE 30, 1998 COMPARED TO THE THREE MONTHS ENDED JUNE 30, 1997 REVENUE. Total revenue decreased approximately $713,000 or 7% to $9.6 million in the three months-ended June 30,1998 from $10.3 million in the three months ended June 30, 1997. License fees and related services revenue decreased by $2.5 million or 47% to $2.9 million in the three months ended June 30, 1998 from $5.4 million in the three months ended June 30, 1997, reflecting the completion of certain major LNP projects in 1998 and, conversely, the acceleration of the LNP market in mid 1997. Other services revenue increased by $1.8 million or 36% to $6.7 million in the three months ended June 30, 1998 from $4.9 million in the three months ended June 30, 1997, reflecting growth in consulting and custom programming projects with long-standing customers. As a percentage of total revenue other services revenue increased to 70% for the three months ended June 30, 1998 from 48% for the three months ended June 30, 1997. COST OF REVENUE. Total cost of revenue increased by $537,000 or 9% to $6.8 million in the three months ended June 30, 1998 from $6.2 million in the three months ended June 30, 1997. As a percentage of total revenue costs increased from 61% of revenue in the three months ended June 30, 1997 to 71% of revenue due to the decline in revenue in the three months ended June 30, 1998. Cost of license fees and related services increased by $520,000 or 26% to $2.5 million for the three months ended June 30, 1998 from $2.0 million for the three months ended June 30, 1997. As a percentage of total revenue, cost of license fees and related services increased to 26% for the three months ended June 30, 1998 from 19% in the three months ended June 30, 1997. The cost increase in license fees and related services in absolute dollar terms reflects the cost of third party software incorporated in license products as well as increases in personnel assigned to systems integration efforts. Cost of other services was constant at $4.3 million in the three months ended June 30, 1998 and 1997. Other services cost levels remained constant in spite of higher revenues reflecting lower staffing related to such projects and expense controls initiated in late 1997. The Company's expense levels are based in significant part on its expectations regarding future revenues. The Company's revenue is difficult to forecast because the market for the Company's products and services is rapidly evolving, and the Company's sales cycle and the size and timing of significant contracts vary substantially among customers. Accordingly, the Company may be unable to adjust spending in cost of revenue or operating areas in a timely manner to compensate for any unexpected shortfall in revenue. CONFIDENTIAL PAGE 10 08/13/98 SALES AND MARKETING. Sales and marketing expenses increased by $626,000 or 64% to $1.6 million in the three months ended June 30, 1998 from $977,000 in the three months ended June 30, 1997. As a percentage of revenue, sales and marketing increased to 17% of revenue in the three months ended June 30, 1998 from 10% in the three months ended June 30, 1997. This increase reflects both increased sales and marketing staffing and associated costs as well as increased promotional expenses over the prior period. GENERAL AND ADMINISTRATIVE. General and administrative expenses decreased by $550,000 or 24% to $1.7 million in the three months ended June 30, 1998 from $2.3 million in the three months ended June 30, 1997. As a percentage of revenue, general and administrative expenses decreased to 18% in the three months ended June 30, 1998 from 22% in the three months ended June 30, 1997. The decrease in absolute dollars is attributable to elimination of bonuses due to the performance shortfall in the three months ended June 30, 1998 as well as lower equipment costs and spending controls initiated in late 1997. RESEARCH AND DEVELOPMENT. Research and development expenses increased by $1.5 million, or 416%, to $1.9 million in the three months ended June 30, 1998 from $364,000 in the three months ended June 30, 1997. As a percentage of revenue, research and development expenses increased to 20% in the three months ended June 30, 1998 from 4% in the three months ended June 30, 1997, reflecting both absolute dollar increases in spending due to staff increases related to MetOSS product development projects, and percentage increases due to lower revenue levels. OTHER EXPENSE, NET. Other expense, net decreased by $313,000, or 77%, to $91,000 in the three months ended June 30, 1998 from $404,000 in the three months ended June 30, 1997. As a percentage of revenue, other expense decreased to 1% in the three months ended June 30, 1998 from 4% in the three months ended June 30,1997. This expense results principally from interest expense related to funding the Company's operations and the decrease from prior periods reflects the repayment of most outstanding long term debt and line of credit advances following the company's initial public offering in May, 1998 as well as interest income on the Company's cash subsequent to the offering. PROVISION FOR (BENEFIT FROM) INCOME TAXES. The Company recorded an income tax benefit of $817,000 for the three months ended June 30, 1998 compared to a tax provision of $46,000 for the three months ended June 30, 1997. EXTRAORDINARY ITEM. The Company recorded an extraordinary item of $446,000 relating to early retirement penalties and the write off of capitalized debt issue costs resulting from the repayment of debt associated with completion of the Company's initial public offering. The Company recorded a tax benefit of $220,000 relating to the extraordinary item recorded in the three months ended June 30, 1998. THE SIX MONTHS ENDED JUNE 30, 1998 COMPARED TO THE SIX MONTHS ENDED JUNE 30, 1997 REVENUE. Total revenue increased approximately $4.3 million or 23% to $22.7 million in the six months-ended June 30,1998 from $18.4 million in the six months ended June 30, 1997. License fees and related services revenue increased by $1.1 million or 14% to $8.7 million in the six months ended June 30, 1998 from $7.6 million in the six months ended June 30, 1997, reflecting LNP product strength in the first three months of 1998. Other services revenue increased by $3.2 million or 30% to $14.0 million in the six months ended June 30, 1998 from $10.8 million in the six months ended June 30, 1997, reflecting strength in consulting and custom development projects with long-standing customers. As a percentage of total revenue, other services revenue increased to 62% for the six months ended June 30, 1998 from 59% for the six months ended June 30, 1997. COST OF REVENUE. Cost of revenue increased $1.4 million or 12% to $13.4 million in the six months ended June 30, 1998 from $12.0 million in the six months ended June 30, 1997. License fees and related services cost increased by $884,000 or 25% to $4.5 million for the six months ended June 30, 1998 from $3.5 million for the six months ended June 30, 1997. Increased third party software costs as well as increased staffing for product support due to higher LNP revenues in the period is reflected in this increase. Other services cost increased $507,000 or 6% to $9.0 million in the six months ended June 30, 1998 from $8.5 million in the six months ended June 30, 1997. This increase in other services cost was due to higher revenue levels and increased subcontractor costs related to an unusually complex project. SALES AND MARKETING. Sales and marketing expenses increased by $1.4 million or 88% to $3.0 million in the six months ended June 30, 1998 from $1.6 million in the six months ended June 30, 1997. As a percentage of revenue, sales and marketing expenses increased to 13% of revenue in the six months ended June 30, 1998 from 9% in the six months ended June 30, 1997. This increase reflects the absolute dollar spending increase related to personnel increases and promotional expenses. GENERAL AND ADMINISTRATIVE. General and administrative expenses decreased by $420,000 or 10% to $3.9 million in the six months ended June 30, 1998 from $4.3 million in the six months ended June 30, 1997. As a percentage of revenue, general and administrative expenses decreased to 17% in the six months ended June 30, 1998 from 23% in the six months ended June 30, 1997. This decrease in absolute dollars is attributable to lower salary, bonus, and equipment costs; the decline in percentage of revenue is attributable to higher revenue levels. RESEARCH AND DEVELOPMENT. Research and development expenses increased by $2.7 million, or 245%, to $3.8 million in the six months ended June 30, 1998 from $1.1 million in the six months ended June 30, 1997. As a percentage of revenue, research and development expenses increased to 17% in the six months ended June 30, 1998 from 6% in the six months CONFIDENTIAL PAGE 11 08/13/98 ended June 30, 1997, reflecting absolute dollar increases in spending due to staff increases related to MetOSS product development projects. OTHER EXPENSE, NET. Other expense, net decreased by $306,000, or 40%, to $463,000 in the six months ended June 30, 1998 from $769,000 in the six months ended June 30, 1997. As a percentage of revenue, other expense decreased to 2% in the six months ended June 30, 1998 from 4% in the six months ended June 30,1997. This expense is principally interest expense related to funding the Company's operations and reflects the payoff of the majority of outstanding long term debt and line of credit advances following the company's initial public offering in May 1998, as well as interest income on the Company's cash investments subsequent to the offering. PROVISION FOR (BENEFIT FROM) INCOME TAXES. The Company recorded a net income tax benefit of $601,000 for the six months ended June 30, 1998. This compares to a tax benefit of $1.2 million for the six months ended June 30, 1997. EXTRAORDINARY ITEM. The Company recorded an extraordinary item of $446,000 net of taxes relating to early retirement penalties and the write off of capitalized debt issue costs resulting from the repayment of debt associated with completion of the Company's initial public offering during the six months ended June 30, 1998. The Company recorded a tax benefit of $220,000 relating to the extraordinary item recorded in the six months ended June 30, 1998. LIQUIDITY AND CAPITAL RESOURCES. The Company has historically financed its operations through a combination of cash flow from operations and borrowings. On May 15, 1998, the Company completed its initial public offering of common stock and subsequently repaid most outstanding borrowings. At June 30, 1998, the Company's principal sources of liquidity included $30.3 million in cash and cash equivalents, a $10.0 million secured bank line of credit and an equipment term loan agreement of $1.5 million, both of which expire in September 1998. As of June 30, 1998, the Company had no outstanding balance under the line of credit and $660,000 outstanding with respect to the equipment term loan agreement. The Company is required under the credit line to comply with certain financial covenants regarding tangible net worth, performance ratios relating to profitability, debt, asset performance and working capital. At June 30, 1998, the Company was in compliance with such covenants or had obtained waivers. At March 31, 1998, the Company had senior promissory notes payable to stockholders in the amount of $6.8 million bearing semi-annual interest payments at a rate of 9% beginning April 1996, and principal repayments of $1.6 million due semi-annually beginning in 2000. The Company also had notes payable to stockholders in the amount of $5.1 million bearing annual interest payments of 7.25%, with the principal due in 2006. Following the Company's initial public offering in May, 1998, these notes and accrued interest obligations were retired. Net cash used in operating activities was $4.4 million in the six months ended June 30, 1998 compared to a positive contribution of $3.9 million in the six months ended June 30, 1997. The main contributors to the usage of cash by operations in the six months ended June 30, 1998 were an increase in unbilled work-in-process by $3.0 million reflecting milestone extensions which must be met prior to final invoicing and a decline in customer deposits and unearned revenue by $4.2 million, primarily the result of the completion of several large LNP projects. Receivables provided cash of $2.2 million during this period reflecting increased collections on major accounts. In the six months ended June 30, 1997, the cash contribution by operations was largely the result of an increase of $5.4 million in customer deposits and unearned revenue due to large LNP contracts entered into during that period. Net cash used in investing activities during the six months ended June 30, 1998 and June 30, 1997 was $1.3 million and $793,000 respectively in the area of equipment and facilities to support operations. Financing activities provided $34.8 million in cash in the six months ended June 30, 1998 compared to using $1.3 million in the six months ended June 30, 1997. The Company's initial public offering generated approximately $48 million and all outstanding debt of the Company except for capital lease obligations was repaid during the three months ended June 30, 1998. The Company believes that its current cash and short-term investments, together with anticipated cash flow from operations and its existing credit facilities and the net proceeds from the initial public offering will be sufficient to meet its working capital and capital expenditure requirements for at least the next twelve months. Thereafter, the Company may require additional funds to support such activity through public or private equity financing or from other sources. There can be no assurance that additional financing will be available at all or that if available, such financing will be obtainable on terms favorable to the Company and would not be dilutive. FACTORS THAT MIGHT EFFECT OPERATING RESULTS. The Company's operating results have fluctuated significantly in the past and are likely to continue to fluctuate significantly in the future. Fluctuations in operating results may result in volatility in the price of the Company's Common Stock. There can be no assurance that the Company will be profitable in the future or that the Company's level of profitability will not vary significantly between quarters. These quarterly fluctuations may result from a number of factors, including the magnitude, timing and signing of new contracts; the Company's rate of progress under such contracts; the timing of customer and market acceptance of the Company's product and service offerings; actual or anticipated changes in CONFIDENTIAL PAGE 12 08/13/98 government laws and regulations related to the telecommunications market or judicial or administrative actions with respect to such laws or regulations; the nature and pace of enforcement of the Telecommunications Act of 1996; product lifecycles; the Company' success in effecting its planned transition to a product-based business; the mix of products and services sold; changes in demand for the Company's products and services; the timing of third-party contractors' delivery of software and hardware; budgeting cycles of the Company's customers; changes in the renewal rate of support agreements; the timing and amount of expenditures made by the Company for research and development and sales, general and administrative expenses; competition by existing and emerging competitors in the telecommunications software markets; the Company's success in developing and marketing new products, controlling costs, attracting and retaining qualified personnel and expanding its sales and marketing programs; regional office expansion; software defects and other product quality problems; changes in the Company's strategy; the extent of industry consolidation; expansion of the Company's international operations, and general economic conditions. A significant portion of the Company's revenue has been and is expected to continue to be derived from a small number of customers. Accordingly, the loss of any significant customer, delays in delivery or acceptance of any of the Company's products or delays in the performance of services could have a material adverse effect on the Company's business, financial condition and results of operations. Historically, the Company has generally recognized both license fees and service fee revenue under its customer contracts using the percentage-of-completion method. The Company is broadening its strategy to include the development and sale of software products. To the extent that the Company is successful in doing so, the Company expects that it may be able to record future revenue from license fees upon the delivery of a software product to a customer. The Company's ability to recognize revenue on software licenses as packaged software solutions at the time of delivery depends on its ability to engage third parties to implement its software and to separately license the software and separately sell implementation services, as well as technical factors and customer expectations and requirements. There can be no assurance that the Company will be able to achieve or maintain a sales model that allows the Company to record license fees when software products are delivered to customers. Software companies that account for revenue from license fees upon delivery of software products may be exposed to increased risk of quarterly fluctuations. To the extent that this pattern develops at the Company, any failure or delay in the delivery of orders during any given quarter could have a material adverse effect on the Company's business, financial condition and results of operations. The timing of revenue recognition from the Company's contracts has caused, and may continue to cause, material fluctuations in the Company's operating results, particularly on a quarterly basis. The Company's expense levels are based in significant part on its expectations regarding future revenue. The Company's revenue is difficult to forecast because the market for the Company's products and services is rapidly evolving, and the Company's sales cycle and the size and timing of significant contracts vary substantially among customers. Accordingly, the Company may be unable to adjust spending in a timely manner to compensate for any unexpected shortfall in revenue. Any significant shortfall from anticipated levels of demand for the Company's products and services could have a material adverse effect on the Company's business, financial condition and results of operations. Based on all of the foregoing, the Company believes that future revenue, expenses and operating results are likely to vary significantly from quarter to quarter. As a result, quarter-to-quarter comparisons of operating results are not necessarily meaningful or indicative of future performance. Furthermore, the Company believes it is likely that in some future quarter the Company's operating results will be below the expectations of public market analysts or investors. In such event, or in the event that adverse conditions prevail, or are perceived to prevail, with respect to the Company's business or generally, the market price of the Company's Common Stock would likely be materially adversely affected. These results should be read in conjunction with the risk factors defined in the Company's Registration Statement on Form S-1 (No. 333-43973) which was declared effective by the SEC on May 11, 1998. Statements contained in this Form 10-Q with respect to future revenue and expenses are "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. Actual results may differ. Among the factors that could cause actual results to differ are the following: (i) the Company's dependence on the rapidly evolving telecommunications industry, (ii) the customer's acceptance of Local Number Portability Products, (iii) delays associated with customers' internal approval and contracting procedures, procurement practices, and testing and acceptance process, and (iv) rapid technological change and intense competition in the Company's industry. IMPACT OF THE YEAR 2000 ISSUE Many currently installed computer systems and software products are coded to accept only two digit entries in the date code field. These date code fields will need to accept four digit entries to distinguish 21st century dates from 20th century dates. As a result, in less than two years, computer systems and/or software used by many companies may need to be upgraded to comply with such Year 2000 requirements. Significant uncertainty exists in the software industry concerning the potential effects associated with such compliance. The Company is impacted by the Year 2000 issue both internally with regard to its operations and externally with regard to its product and services offerings and the vulnerability of its customer base. The Company is in the process of assessing its state of readiness in all areas costs associated with remediation, risks, and contingency plans. The following graph should be used as an approximate guide of the Company's activities to date in regard to this problem. CONFIDENTIAL PAGE 13 08/13/98 [GRAPH APPEARS HERE] Products and Services: The Company currently offers software products that are designed to be Year 2000 compliant and the Company's current contracts with its customers require that the Company warrant Year 2000 capability. Although the Company has designed its products to be Year 2000 capable and tests third-party software that is incorporated with the Company's products, there can be no assurance that the Company's software products, particularly when such products incorporate third-party software, contain all necessary date code changes. The Company is continuing its review of its products to ensure compliance. The Company's operations may be at risk if its suppliers and other third parties fail to adequately address the problem or if software conversions result in system incompatibilities with these third parties. This issue could result in system failures or generation of erroneous information and could significantly disrupt business activities. Customers: The Company offers software products and services to telecommunications carriers and telecommunication companies. Currently, the Company is assisting several of these customers in the evaluation of their software and systems to be compliant with Year 2000 requirements. As these companies products and services are largely dependent on integrated software and hardware networks as described above, there can be no assurance that assessment and remediation will have been completed by all such customers within the appropriate timeframe. As a result, the Company's business with these customers could be negatively or positively influenced by these customers financial and operational results and consequent decisions regarding the purchase of the Company's products and services. Such a disruption of buying patterns could cause a material adverse effect on the Company's business, results of operations and financial condition. Evolving Systems' Internal Operations: IT - Software: The Company utilizes off-the-shelf and custom software developed internally and by third parties. The Company's ERP (enterprise resource planning) systems as well as its internal communication software has been replaced within the past three years by new systems that are certified by their vendors to be date code compliant. A final, non-compliant subsystem is scheduled to be replaced within the next six months. All such upgrades were undertaken to increase efficiency and effectiveness of the Company's operations and were not approved primarily for the reasons of date code compliance. The Company has initiated correspondence with suppliers and is continuing to review what actions will be required to make all software systems used internally Year 2000 compliant as well as to mitigate its vulnerability to problems with the systems used by its suppliers and other third parties. To the extent that such software and systems do not comply with Year 2000 requirements, there can be no assurance that potential systems interruptions or the cost necessary to update such software will not have a material adverse effect on the Company's business, financial condition and results of operations. IT - Hardware: The Company utilizes off-the-shelf hardware in its processing and network operations. Such equipment either has been certified to be date code compliant or correspondence with suppliers is being initiated to validate such condition. Non-IT - Hardware: The Company will initiate correspondence with suppliers to review what actions will be required to make all embedded systems date code compliant in the facilities it occupies. The costs associated with such actions is not expected to have a material effect on the Company's business, results operations or financial condition. Suppliers: The Company will initiate correspondence with service suppliers to review what actions will be undertaken to make all embedded systems date code compliant. Such actions include a review of vendor contracts and formal communication with suppliers to request certification that products are Year 2000 compliant. The total cost and time associated with the impact of Year 2000 compliance cannot presently be estimated. The costs associated with such actions is not expected to have a material effect on the Company's business, results of operations or financial condition. The Company does not, at this time, have a formal contingency plan in the event of the failure of remediation efforts with regard to its internal operations. Such a plan can only be developed after a full assessment of potential points of failure. Following the completion of the assessment phase in all areas, the Company anticipates the development of such a plan. CONFIDENTIAL Page 14 08/13/98 PART II. OTHER INFORMATION Item 1. Legal Proceedings In June, 1998, three class action lawsuits were filed in the United States District Court of the District Court of Colorado against the Company and certain of its officers and directors. The actions are purportedly brought on behalf of purchasers of the Company's common stock between May 12, 1998 and June 17, 1998. The claims allege violations of Sections 11 and 12 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. The actions seek unspecified compensatory and punitive damages, interest, attorneys' fees and other costs. The Company believes that it has meritorious defenses to both actions and intends to vigorously defend the actions. Item 2. Changes in Securities None Item 3. Defaults on Senior Securities None Item 4. Submission of Matters to a Vote of Security Holders On January 28, 1998, the Company solicited the written consent of its security holders with respect to (a) Election of Directors; (b) One-for-two reverse stock split; (c) Amendments to Articles of Incorporation; (d) Amendment of the Company's Stock Option Plan; (e) Adoption of the Company's Employee Stock Purchase Plan; (f) Adoption of Amended and Restated Bylaws; and (g) Approval of Standard Indemnification Agreement. 8,160 shares of Series A Preferred Stock were voted in favor of such proposal, no shares of Series A Preferred Stock were voted against such proposal. Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 10.27 Financial Data Schedule (b) Reports on Form 8-K None SIGNATURES Pursuant to the requirements of the Securities exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Date: 8/14/98 /s/ Roger A. Barnes ------------------------------ Roger A. Barnes Senior Vice President of Finance, Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer) EX-27 2 FINANCIAL DATA SCHEDULE
5 1,000 6-MOS DEC-31-1998 JAN-01-1998 JUN-30-1998 30,315 0 11,121 0 0 47,728 9,079 0 57,020 7,732 0 0 0 12 48,202 57,020 0 22,710 13,382 24,067 463 0 0 (1,820) (601) (1,219) 0 (446) 0 (1,665) (.41) (.41)
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