-----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, SLt1wSZZYmZSll0ujAtA4swhe+Uh//Rkzwn9BbzI6M8CDE9rzW8jEommSoSQYMu9 U3JQnSmCUR+k74AxpvVtAQ== 0000927356-99-000828.txt : 19990510 0000927356-99-000828.hdr.sgml : 19990510 ACCESSION NUMBER: 0000927356-99-000828 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990331 FILED AS OF DATE: 19990507 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: 99614312 BUSINESS ADDRESS: STREET 1: 9777 MT PYRAMID COURT CITY: ENGLEWOOD STATE: CO ZIP: 80112 BUSINESS PHONE: 3038021000 MAIL ADDRESS: STREET 1: 9777 MT PYRAMID COURT CITY: ENGLEWOOD STATE: CO ZIP: 80112 10-Q 1 FORM 10-Q 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 March 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 (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 March 31, 1999, there were outstanding 12,086,746 shares of Registrant's Common Stock (par value $0.001 per share). Page 2 EVOLVING SYSTEMS, INC. PART 1 FINANCIAL INFORMATION PAGE Item 1. Financial Statements Balance Sheets March 31,1999 (unaudited) and December 31, 1998.............................................................. 3 Statements of Operations for the three-month period ended March 31, 1999 and 1998 (unaudited)......................................... 4 Condensed Statements of Cash Flow for the three month period ended March 31, 1999 and 1998 (unaudited)......................................... 5 Notes to Financial Statements........................................................................................ 5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations................................ 7 PART II OTHER INFORMATION.................................................................................................... 13 Item 1. Legal Proceedings.................................................................................................... 13 Item 2. Changes in Securities................................................................................................ 13 Item 3. Defaults on Senior Securities........................................................................................ 13 Item 4. Submission of Matters to a Vote of Security Holders.................................................................. 13 Item 5. Other Information.................................................................................................... 13 Item 6. Exhibits and Reports on Form 8-K..................................................................................... 13 SIGNATURES................................................................................................................... 13
Page 3 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS EVOLVING SYSTEMS, INC. BALANCE SHEETS (IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
March 31, Dec. 31, 1999 1998 ----------- ------------ (unaudited) ASSETS Current assets: Cash and cash equivalents $ 7,422 $ 11,707 Short-term investments 10,415 6,950 Contract receivables, net 13,621 14,239 Unbilled work-in-process 3,908 3,374 Prepaid and other current assets 976 2,031 -------- -------- Total current assets 36,342 38,301 Property and equipment, net 7,251 7,631 Deferred tax asset 1,547 1,547 -------- -------- Total assets $ 45,140 $ 47,479 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current portion of long-term obligations $ 974 1,211 Accounts payable and accrued liabilities 5,600 3,002 Unearned revenue and customer deposits 2,816 3,079 -------- -------- Total current liabilities 9,390 7,292 Long-term obligations 643 825 Deferred income taxes 0 0 -------- -------- Total liabilities 10,033 8,117 Stockholders' equity: Preferred stock, $.001 par value, 2,000,000 shares authorized, no shares issued ---- ---- Common stock, 12 12 $.001 par value; 25,000,000 shares authorized, 12,086,746 and 11,888,021 shares issued and outstanding as of March 31, 1999 and December 31, 1998, respectively Additional paid-in-capital 50,864 50,703 Deferred compensation (270) (345) Retained deficit (15,499) (11,008) -------- -------- Total stockholders' equity 35,107 39,362 -------- -------- Total liabilities and stockholders' equity $ 45,140 47,479 ======== ========
The accompanying notes are an integral part of the financial statements. Page 4 EVOLVING SYSTEMS, INC. STATEMENTS OF OPERATIONS (IN THOUSANDS EXCEPT PER SHARE DATA) (unaudited)
Three Months Ended March 31, ---------------------------- Revenue: 1999 1998 ------- ------- License fees and related services $ 699 5,787 Other services 8,160 7,341 ------- ------- Total revenue 8,859 13,128 ------- ------- Cost of revenue: License fees and related services 2,012 1,919 Other services 4,776 4,694 ------- ------- Total cost of revenue 6,788 6,613 ------- ------- Gross margin 2,071 6,515 Operating expenses: Sales and marketing 672 1,388 General and administrative 2,423 2,137 Research and development 394 1,962 ------- ------- Total operating expenses 3,489 5,487 ------- ------- Income (loss) from operations (1,418) 1,028 Litigation settlement and expenses 3,251 0 Other (income) expense, net (178) 372 ------- ------- Income (loss) before income taxes (4,491) 656 Provision for (benefit from) income taxes 0 216 ------- ------- Net income (loss) $(4,491) $ 440 ======= ======= Basic earnings per common share: Net income (loss) per common share $(.37) $.27 ======= ======= Diluted earnings per common share: Net income (loss) per common share $(.37) $.05 ======= ======= Basic shares outstanding 12,068 1,630 Diluted shares outstanding 12,068 9,671
The accompanying notes are an integral part of the financial statements. Page 5 EVOLVING SYSTEMS, INC. CONDENSED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (unaudited)
Three Months Ended March 31, ------------------------------ 1999 1998 ------- ------- Operating activities: Net income (loss) $(4,491) $ 440 Adjustments to reconcile net income (loss) to net cash used in operating activities: Amortization of deferred compensation 75 75 Depreciation and amortization 966 1,119 Provision for deferred income taxes - 147 Change in operating assets and liabilities: Contract receivables 618 4,303 Unbilled work-in-process (534) (3,977) Prepaid and other assets 1,055 (431) Accounts payable and accrued liabilities 2,598 336 Unearned revenue and customer deposits (263) (4,093) ------- ------- Net cash provided by (used in) operating activities 24 (2,081) Investing activities: Purchases of property and equipment (586) (544) Purchases of short term investments (3,465) 0 ------- ------- Net cash used in investing activities (4,051) (544) Financing activities: Borrowings (repayment) of long-term obligations (419) 3,990 Proceeds from stock options exercises 161 0 ------- ------ Net cash provided by (used in) financing activities (258) 3,990 ------- ------ Net increase (decrease) in cash and cash equivalents (4,285) 1,365 Cash and cash equivalents at beginning of period 11,707 1,171 ------- ------ Cash and cash equivalents at end of period $ 7,422 $2,536 ======= ======
The accompanying notes are an integral part of the financial statements. 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 March 31, 1999 are not necessarily indicative of the results to be expected for any subsequent quarter or full fiscal year. These financial statements should be read in conjunction with the audited financial statements and the notes thereto for the year ended December 31, 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, and the Company's Form 10-K for the year ended December 31, 1998. Page 6 Use of Estimates. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. (2) Earnings (Loss) Per Common Share Basic EPS was computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted EPS was computed using the weighted average number of common shares plus all dilutive potential common shares outstanding during the period unless the effect of the potential common shares is anti-dilutive. 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 March 31, 1999 1998 Basic earnings per share: Net income (loss) $(4,491) $ 440 Weighted average common shares outstanding 12,068 1,630 Basic net income (loss) per common share $ (.37) $ .27 Effect of dilutive securities: Options and warrants - 1,921 Preferred stock - 6,120 ------- ------ Diluted weighted average common shares outstanding 12,068 9,671 Diluted net income (loss) per common share $ (.37) $ .05
In February 1998, the Company effected a one-for-two reverse stock split. All references in the financial statements to shares, share prices, and per share amounts have been adjusted retroactively for all periods presented to reflect the stock split. (3) Initial Public Offering In May 1998, the Company effected an initial public offering on Form S-1. In connection with the offering, the Company issued 3,798,000 shares of common stock, including shares issued to cover the underwriters' over-allotment option, and received net proceeds of approximately $48 million. In addition, all Preferred Stock was converted into common stock upon the closing of the initial public offering. (4) Contingencies, Litigation Settlement and Legal Fees In June, 1998, four class action lawsuits were filed in the U.S. District Court for the District of Colorado against the Company and certain of its officers and directors and, in two cases, the Company's underwriters of the Company's initial public offering on behalf of purchasers of the Company's common stock between May 12, 1998 and June 17, 1998. In October 1998, these cases were consolidated, class action status was certified, and the class period was extended to July 23, 1998. The plaintiffs alleged that the defendants misled investors concerning the Company's business, finances and future prospects and the Company has denied these allegations. The parties reached an out-of-court- settlement of the lawsuit on April 12, 1999, which is pending court approval. 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. Page 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND --------------------------------------------------------------- RESULTS OF OPERATIONS --------------------- GENERAL - ------- Evolving Systems provides the telecommunications industry with solutions containing software products and systems integration for a full range of business and operational support systems and network element software. 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 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 11, 1998 the Commission declared effective the Company's Registration Statement on Form S-1 (Registration Statement No. 333-43973), which should be read in conjunction with this document for further information regarding the Company's business, risk factors, and accounting policies. Page 8 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 Ended March 31, ---------------------------- (unaudited) ----------- Revenue: 1999 1998 ------ ----- License fees and related services 7.9% 44.1% Other services 92.1 55.9 ------ ----- Total revenue 100.0 100.0 Cost of revenue: License fees and related services 22.7 14.6 Other services 53.9 35.8 ------ ----- Total cost of revenue 76.6 50.4 Gross margin 23.4 49.6 Operating expenses: Sales and marketing 7.6 10.6 General and administrative 27.4 16.3 Research and development 4.4 14.9 ------ ----- Total operating expense 39.4 41.8 Income (loss) from operations (16.0) 7.8 Litigation settlement and expense 36.7 0 Other income, net (2.0) (2.8) ------ ----- Income (loss) before income taxes (50.7) 5.0 Provision for (benefit from) income taxes 0.0 1.6 ------ ----- Net income (loss) (50.7)% 3.4% ====== =====
The three months ended March 31, 1999 compared to the three months ended March 31, 1998 Revenue. Total revenue decreased approximately $4.3 million or 33% to $8.9 million in the three months-ended March 31,1999 from $13.1 million in the three months ended March 31, 1998. License fees and related services revenue decreased by $5.1 million or 88% to $699,000 in the three months ended March 31, 1999 from $5.8 million in the three months ended March 31, 1998, reflecting the completion of certain major LNP projects in 1998 and decreased demand for LNP in the three months ending March 31, 1999 due to easing of regulatory requirements for LNP in the wireless sector. Other services revenue increased by $819,000 or 11% to $8.2 million in the three months ended March 31, 1999 from $7.3 million in the three months ended March 31, 1998, reflecting growth in consulting and custom programming projects with long-standing customers in 1999. As a percentage of total revenue other services revenue increased to 92% for the three months ended March 31, 1999 from 56% for the three months ended March 31, 1998. Cost of revenue. Total cost of revenue increased by $175,000 or 3% to $6.8 million in the three months ended March 31, 1999 from $6.6 million in the three months ended March 31, 1998. As a percentage of total revenue, costs increased from 50.4% of revenue in the three months ended March 31, 1998 to 76.6% of revenue due to the decline in revenue in the three months ended March 31, 1999. Cost of license fees and related services increased by $93,000 or 5% to $2.0 million for the three months ended March 31, 1999 from $1.9 million for the three months ended March 31, 1998. As a percentage of total revenue, cost of license fees and related services increased to 22.7% for the three months ended March 31, 1999 from 14.6% in the three months ended March 31, 1998. The decline in costs of license fees and related services in absolute dollar terms reflects the decreases in personnel assigned to LNP product development and reassignment of this staff to custom programming and systems integration efforts. Cost of other services increased by $82,000 or 2% to $4.8 million for the three months ended March 31, 1999 from $4.7 million for the three months ended March 31, 1998. Other services cost levels were favorably impacted by efficiencies and expense controls initiated in late 1998. The Company experienced a reduced total gross margin in the three months ended March 31, 1999 due to the shortfall in product related revenues previously discussed and a largely fixed cost of goods based on staffing. The Company's expense levels are based in significant part on its expectations regarding future revenues. The Company's revenue is difficult to forecast because the market for the Company's products and services is rapidly evolving, and the Company's sales cycle and the size and timing of significant contracts vary substantially among customers. Page 9 Sales and marketing. Sales and marketing expenses decreased by $716,000 or 52% to $672,000 in the three months ended March 31, 1999 from $1.4 million in the three months ended March 31, 1998. As a percentage of revenue, sales and marketing decreased to 7.6% of revenue in the three months ended March 31, 1999 from 10.6% in the three months ended March 31, 1998. This percentage decrease reflects decreased sales commissions and staffing costs over the prior period. General and administrative. General and administrative expenses increased by $287,000 or 13.4% to $2.4 million in the three months ended March 31, 1999 from $2.1 million in the three months ended March 31, 1998. As a percentage of revenue, general and administrative expenses increased to 27.4% in the three months ended March 31, 1999 from 16.3% in the three months ended March 31, 1998. The increase in absolute dollars is attributable to increased legal expense and other outside consultant services in the three months ended March 31, 1999. Research and development. Research and development expenses decreased by $1.6 million, or 80%, to $394,000 in the three months ended March 31, 1999 from $2.0 million in the three months ended March 31, 1998. As a percentage of revenue, research and development expenses decreased to 4.4% in the three months ended March 30, 1999 from 14.9% in the three months ended March 31, 1998, reflecting both decreases in spending due to staff decreases related to LNP product development projects as staff was reassigned to services projects and much of the remaining staff cost is now classified as cost of revenues for maintenance contracts. Other (income) expense, net. Other (income) expense, net reflected increased income by $550,000, or 149%, to $178,000 in the three months ended March 31, 1999 from $372,000 expense in the three months ended March 31, 1998. Interest expense declined $336,000 or 87% to $51,000 in the three months ended March 31, 1999 from $387,000 in the three months ended March 31, 1998. This expense results principally from interest expense on the Company's outstanding debt 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. Litigation settlement and expense. The Company reached a settlement with the plaintiffs that is awaiting final approval by the Court. The aggregate settlement amount is $10,000,000 and the Company's insurance limit is $7,500,000. The Company paid $2,500,000 in cash in April, 1999 to the settlement escrow account and has expensed another $800,000 in legal and related expenses. These expenses were recognized in the quarter ending March 31, 1999 as the closure of a contingent liability resulting from that period. Provision for (benefit from) Income Taxes. The Company recorded no income tax benefit relating to its operating loss of $4.5 million for the three months ended March 31, 1999 compared to a tax provision of $216,000 for the three months ended March 31, 1998. The Company deems it inappropriate to book such benefits until the market for the Company's products and services stabilizes and projected operating results reflect greater certainty of profitability to realize such benefits. 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 March 31, 1999, the Company's principal sources of liquidity included $7.4 million in cash and cash equivalents, $10.4 million in short term investments, a $10.0 million secured bank line of credit and an equipment term loan agreement of $1.5 million, both of which expire in September 1999. As of March 31, 1999, the Company had no outstanding balance under the line of credit and no balance 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 March 31, 1999, the Company was in compliance with such covenants. At March 31, 1998, the Company had senior promissory notes payable to stockholders in the amount of $6.8 million bearing semi-annual interest payments at a rate of 9% beginning April 1996, and principal repayments of $1.6 million due semi-annually beginning in 2000. The Company also had notes payable to stockholders in the amount of $5.1 million bearing annual interest payments of 7.25%, with the principal due in 2006. Following the Company's initial public offering in May, 1998, these notes and accrued interest obligations were retired. Net cash provided by operating activities was $24,000 in the three months ended March 31, 1999 compared to a usage of $2.1 million in the three months ended March 31, 1998. The main contributors to the provision of cash by operations in the three months ended March 31, 1999 were a decrease in prepaid and other assets of $1 million, partially offset by a decrease in customer deposits and unearned revenue by $263,000 and an increase in accounts payable and accrued liabilities of $2.6 million, primarily caused by the $2.5 million accrual of the litigation settlement. Receivables provided cash of $618,000 during this period reflecting increased collections on major accounts. In the three months ended March 31, 1998, the cash usage by operations was largely the result of a decrease of $4.0 million in customer deposits and unearned revenue due to large LNP contracts progressing and recognizing revenue during that period. Net cash used in investing activities during the three months ended March 31, 1999 and March 31, 1998 was $4.0 million and $.5 million respectively in the area of equipment and facilities to support operations. Page 10 Financing activities used $258,000 in cash in the three months ended March 31, 1999 for the repayment of capital leases compared to providing $4.0 million through borrowing from the line of credit in the three months ended March 31, 1998. The Company's initial public offering generated approximately $48 million and all outstanding debt of the Company except for capital lease obligations were repaid subsequent to March 31, 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 affect operating results. The Company's operating results have fluctuated significantly in the past and are likely to continue to fluctuate significantly in the future. Fluctuations in operating results have may continue to result in volatility in the price of the Company's Common Stock. There can be no assurance that the Company will be profitable in the future or that the Company's level of profitability will not vary significantly between quarters. These quarterly fluctuations may result from a number of factors, including the magnitude, timing and signing of new contracts; the Company's rate of progress under such contracts; the timing of customer and market acceptance of the Company's product and service offerings; actual or anticipated changes in government laws and regulations related to the telecommunications market or judicial or administrative actions with respect to such laws or regulations; the nature and pace of enforcement of the Telecommunications Act of 1996; impact of Year 2000 issues; changes in management; product lifecycles; the Company' success in building 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 into international markets, and general economic conditions. A significant portion of the Company's revenue has been and is expected to continue to be derived from a small number of customers. Accordingly, the loss of any significant customer, delays in delivery or acceptance of any of the Company's products or delays in the performance of services could have a material adverse effect on the Company's business, financial condition and results of operations. Historically, the Company has generally recognized both license fees and service fee revenue under its customer contracts using the percentage-of-completion method. The Company is broadening its strategy to include the development and sale of its software products and third party 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. Furthermore, 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, and the Company's Form 10-K for the year ended December 31, 1998. Statements contained in this Form 10-Q with respect to future revenue and expenses Page 11 are "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. Actual results may differ. Among the factors that could cause actual results to differ are the following: (i) the Company's dependence on the rapidly evolving telecommunications industry, (ii) delays in enforcement and implementation of the Telecommunications Act of 1996; (iii) customer's acceptance of Local Number Portability Products, (iv) delays associated with customers' internal approval and contracting procedures, procurement practices, and testing and acceptance process including but not limited to, delays associated with Year 2000 issues; (v) changes in management; and (vi) rapid technological change and intense competition in the Company's industry. Impact of the Year 2000 Issue Many currently installed computer systems and software products are coded to accept only two digit entries in the date code field. These date code fields will need to accept four digit entries to distinguish 21st century dates from 20th century dates. As a result, computer systems and/or software used by many companies may need to be upgraded to comply with such Year 2000 requirements. Significant uncertainty exists in the software industry concerning the potential effects associated with such compliance. The Company is impacted by the Year 2000 in three areas: as a developer and supplier of telecommunications software, in its internal operations, and the buying decisions of the Company's customers, which could result in either a positive or negative impact on the Company's revenue. The Company has formed a Year 2000 project team to assess its state of readiness with respect to Year 2000 issues and to implement corrective actions and contingency plans. This project team has completed the process of inventorying items that will be affected by Year 2000, assigning priorities to identified items, assessing the Year 2000 compliance of items determined to be material to the Company, Currently the Company is repairing or replacing materials items that are found not be Year 2000 compliant, testing Company developed software and third party provided software, and designing contingency plans. The Company expects the Year 2000 projects to be successfully completed during the remainder of 1999. The following graph should be used as an approximate guide of the Company's activities to date in regard to this problem.
PHASE: Awareness Assessment Renovation Validation Implementation Products and Services |----------------------------------------X Third Party Suppliers |---------------------------------------X Customers |----------------------X Evolving Systems Internal: IT-Software |-----------------------------------------------------------------X IT-Hardware |--------------------------------X Non-IT Hardware |------------------------------------------------------------------X Suppliers |---------------------------------------------------------------X
The Company is currently performing Year 2000 compliance assessment and testing using its own personnel, and there are no plans to hire third party consultants to assist with Year 2000 compliance activities. Products: The Company currently offers software products that are designed to be Year 2000 compliant and the Company's current contracts with its customers require that the Company warrant Year 2000 capability. Although the Company has designed its products to be Year 2000 capable and has tested third-party software 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 and anticipates ongoing testing of its products through the third quarter of 1999 as new releases of the Company's products are made available to the Company's customers. The Company's primary products subject to Year 2000 issues are the Company's Local Number Portability products. Testing of these products was conducted in early 1998, and additional testing is ongoing. Custom Software and Services: The Company provides custom software and related services for a number of customers. These customers have engaged the Company to perform Year 2000 compliance tests on such software and services. The Company has successfully completed Year 2000 tests on several software solutions. The Company expects to continue performing Year 2000 tests for such customers through 1999. The Company's relationship with its customers and the Company's exposure to liability may be impacted if the Company fails to adequately address Year 2000 issues in its products and/or custom software solutions. This could have a material adverse effect on the Company's business, results of operation and financial condition. Customers: The Company offers software products and services to telecommunications carriers and telecommunication companies. Currently, the Company is assisting several of these customers in the evaluation of their Page 12 software and systems to be compliant with Year 2000 requirements. As these companies products and services are largely dependent on integrated software and hardware networks as described above, there can be no assurance that assessment and remediation will have been completed by all such customers within the appropriate timeframe. As a result, the Company's business with these customers could be negatively or positively influenced by these customers financial and operational results and consequent decisions regarding the purchase of the Company's products and services. A disruption of buying patterns could cause a material adverse effect on the Company's business, results of operations and financial condition. The Company is currently assessing the Year 2000 readiness of its key customers. Evolving Systems' Internal Operations: IT - Software: The Company utilizes off-the-shelf and custom software developed internally and by third parties. The Company's ERP (enterprise resource planning) systems as well as its internal communication software have been replaced within the past three years by new systems that are certified by their vendors to be date code compliant. All such upgrades were undertaken to increase efficiency and effectiveness of the Company's operations and were not approved primarily for the reasons of date code compliance. The Company has initiated correspondence with suppliers and is continuing to review what actions will be required to make all software systems used internally Year 2000 compliant as well as to mitigate its vulnerability to problems with the systems used by its suppliers and other third parties. As the Company receives vendor responses, the Company is developing contingency plans as vendor responses are being reviewed for adequacy. To the extent that such software and systems do not comply with Year 2000 requirements, or that the Company's contingency plans are not effective, there can be no assurance that potential systems interruptions or the cost necessary to update such software will not have a material adverse effect on the Company's business, financial condition and results of operations. IT - Hardware: The Company utilizes off-the-shelf hardware in its processing and network operations. Such equipment either has been certified to be date code compliant or correspondence with suppliers is in progress to validate such condition. Non-IT - Hardware: The Company 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 has initiated correspondence with service suppliers to review what actions will be undertaken to make all embedded systems date code compliant. Such actions include a review of vendor contracts and formal communication with suppliers to request certification that products are Year 2000 compliant. It is estimated that this review will be completed by June 30, 1999. The Company, at this time, is in the process of creating contingency plans in the event of the failure of its remediation efforts. A full assessment of the potential points of failure is ongoing and is expected to be completed by June 30, 1999. Following the completion of the assessment phase in all areas, the Company will continue the development and testing of the contingency plan as part of the Company's ongoing Year 2000 compliance effort. The testing of the contingency plans is expected to be completed by September 30, 1999. Costs: The costs of the Company's Year 2000 compliance efforts are being funded with cash flows from operations. To date, these costs have been associated with the reallocation of internal staff hours to Year 2000 project related efforts and have not been material. As additional evaluation and testing is performed, particularly on the Company's products if independent third party vendors are engaged by the Company, these costs are likely to increase significantly. As ongoing testing is performed, modifications to the Company's products may be required. The total costs that the Company incurs in connection with the Year 2000 problems will be influenced by the Company's ability to successfully identify Year 2000 systems' flaws, the nature and amount of programming required to fix the affected programs, the related labor and/or consulting costs for such remediation, and the ability of third parties with whom the Company has business relationships to successfully address their own Year 2000 concerns. Due to the wide variability of the different issues surrounding Year 2000, the estimate to analyze, correct, replace component software, test, and redeploy will be in the range of $1 to $2 million dollars. As a result, the Company does not feel that the total costs will have a material impact on the Company's business, results of operation, or financial condition. THE DISCUSSION OF THE COMPANY'S EFFORTS AND MANAGEMENT'S EXPECTATIONS RELATING TO YEAR 2000 COMPLIANCE CONTAIN FORWARD-LOOKING STATEMENTS AND ARE BASED ON MANAGEMENT'S BEST ESTIMATES OF FUTURE EVENTS. MANAGEMENT BELIEVES THAT IT IS NOT POSSIBLE TO DETERMINE WITH COMPLETE CERTAINTY THAT ALL YEAR 2000 PROBLEMS AFFECTING THE COMPANY HAVE BEEN IDENTIFIED OR CORRECTED. RISKS TO COMPLETING THE PLAN INCLUDE THE AVAILABILITY OF RESOURCES, THE COMPANY'S ABILITY TO DISCOVER AND CORRECT THE POTENTIAL YEAR 2000 PROBLEMS WHICH COULD HAVE IMPACT ON THE COMPANY AND ITS PRODUCTS, THE ABILITY OF THE COMPANY AND ITS SUPPLIERS TO BRING THEIR SOFTWARE AND SYSTEMS INTO COMPLIANCE AND UNANTICIPATED PROBLEMS IDENTIFIED IN THE ONGOING COMPLIANCE REVIEW. These statements regarding year 2000 readiness and the Company's year 2000 program are intended to constitute "Year 2000 Readiness Disclosures" as defined in the recently enacted Year 2000 Information and Readiness Disclosure Act. Page 13 PART II. OTHER INFORMATION Item 1. Legal Proceedings Beginning on June 22, 1998, four securities class action complaints were filed in the United states District Court for the District of Colorado against the Company, certain of its current and former officers and directors, and the underwriters of the Company's initial public offering. The complaints subsequently were consolidated. The actions were brought on behalf of a class of persons who purchased the Company's securities during the period of May 12, 1998 through July 23, 1998. The complaints allege that defendants misled investors concerning the business and financial prospects of the Company. On April 12, 1999, parties reached an agreement to settle the consolidated class actions. The aggregate settlement amount is $10,000,000 in cash. The settlement will be funded by insurance proceeds and by the Company, with the Company paying $2,500,000, plus legal fees and other expenses incurred by the Company in connection with the lawsuit. The $2,500,000 payment, legal fees and other expenses will be paid out of the Company's cash balances. The settlement is subject to approval by the Court. 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 April 6, 1999, the Company solicited the written consent of its security holders with respect to (a) Election of Directors; (b) Amendment of the Company's Stock Option Plan; (c) Amendment to the Company's Employee Stock Purchase Plan; and (d) Ratification of PricewaterhouseCoopers LLP as the independent auditors of the Company 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: 5/7/1999 s/ David R. Johnson --------------------------------- David R. Johnson Senior Vice President of Finance, Chief Financial Officer, Treasurer and Assistant Secretary (Principal Financial and Accounting Officer) EX-27 2 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM INCOME STATEMENT, BALANCE STATEMENT, STATEMENT OF CASH FLOWS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 3-MOS DEC-31-1999 JAN-01-1999 MAR-31-1999 17,837 0 13,621 0 0 36,342 7,251 0 45,140 9,390 0 0 0 12 35,095 45,140 0 8,859 6,788 10,277 3,073 0 0 (4,491) 0 (4,491) 0 0 0 (4,491) (.37) (.37)
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