================================================================================
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2002
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: 000-31155
EVOLVE SOFTWARE, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-3219745
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1400 65TH STREET, SUITE 100, EMERYVILLE, CA 94608
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (510) 428-6000
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.001
par value
------------------
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [_]
The aggregate market value of the voting common stock held by
non-affiliates of the registrant as of May 13, 2002 was approximately $7,264,316
based upon the closing sale price reported for that date on the NASDAQ National
Market. Shares of common stock held by each officer and director and by each
person who owns more than 5% or more of the outstanding common stock have been
excluded because such persons may be deemed to be affiliates. This determination
of affiliate status is not necessarily conclusive for other purposes.
The number of shares outstanding of the registrant's common stock as of May
13, 2002 was 44,836,414.
EVOLVE SOFTWARE, INC.
FORM 10-Q
TABLE OF CONTENTS
PAGE
----
PART I - FINANCIAL INFORMATION
Item 1 Financial Statements
Condensed Consolidated Balance Sheets (unaudited)
As of March 31, 2002 and June 30, 2001. . . . . . . . . . . . 2
Condensed Consolidated Statements of Operations (unaudited)
For the Three and Nine Months Ended March 31, 2002 and 2001 . 3
Consolidated Statements of Cash Flows (unaudited)
For the Nine Months Ended March 31, 2002 and 2001 . . . . . . 4
Notes to Condensed Consolidated Financial Statements. . . . . 5
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations. . . . . . . . . . . . . 15
Item 3 Quantitative and Qualitative Disclosures About Market Risk . 31
PART II - OTHER INFORMATION
Item 1 Legal Proceedings. . . . . . . . . . . . . . . . . . . . . . 32
Item 2 Changes in Securities and Use of Proceeds. . . . . . . . . . 32
Item 3 Defaults Upon Senior Securities. . . . . . . . . . . . . . . 32
Item 4 Submissions of Matters to a Vote of Security Holders . . . . 32
Item 5 Other Information. . . . . . . . . . . . . . . . . . . . . . 32
Item 6 Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . 32
Signature . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
1
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
EVOLVE SOFTWARE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
2002 2001
----------- ----------
MARCH 31, JUNE 30,
----------- ----------
ASSETS (unaudited)
Current assets:
Cash and cash equivalents. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 12,227 $ 19,914
Short-term investments - 2,840
Accounts receivable, net of allowance for doubtful
Accounts $455 and $730, respectively. . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,589 6,414
Prepaid expenses and other current assets. . . . . . . . . . . . . . . . . . . . . . . . . . . 2,280 2,454
Notes receivable from related party. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - 175
----------- ----------
Total current assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17,096 31,797
Restricted cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,901 -
Property and equipment, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,362 10,481
Deposits and other assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 319 1,617
Goodwill and other intangible assets, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,565 3,726
----------- ----------
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 30,243 $ 47,621
=========== ==========
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND PREFERRED STOCK WARRANTS,
AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 3,498 $ 5,670
Accrued liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,520 5,852
Deferred revenues. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,157 8,117
Capital lease obligations, current portion . . . . . . . . . . . . . . . . . . . . . . . . . . 364 646
Restructuring accrual, current portion . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,953 2,208
Short-term debt. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,376 2,178
----------- ----------
Total current liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18,868 24,671
Capital lease obligations, less current portion. . . . . . . . . . . . . . . . . . . . . . . . . . - 194
Restructuring accrual, less current portion. . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,067 4,651
Long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 792 2,575
Deferred rent. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 221 187
Common stock warrants. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 147 -
----------- ----------
Total liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21,095 32,278
----------- ----------
Redeemable convertible preferred stock and preferred stock warrants. . . . . . . . . . . . . . . . 1,454 -
Stockholders' equity:
Preferred stock. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 -
Common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45 40
Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 262,008 250,485
Notes receivable from stockholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,317) (7,795)
Unearned stock-based compensation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,424) (11,732)
Accumulated other comprehensive income . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82 95
Accumulated deficit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (250,701) (215,750)
----------- ----------
Total stockholders' equity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,694 15,343
----------- ----------
Total liabilities, redeemable convertible preferred stock and preferred stock warrants,
and stockholders' equity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 30,243 $ 47,621
=========== ==========
The accompanying notes are an integral part of these condensed consolidated financial statements.
2
EVOLVE SOFTWARE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED INE MONTHS ENDED
MARCH 31, MARCH 31,
------------------------ -----------------------
2002 2001 2002 2001
----------- ----------- ---------- -----------
(unaudited) (unaudited)
Revenues:
Solutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,994 $ 8,846 $ 5,391 $ 20,332
Subscriptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,470 2,417 4,007 7,145
----------- ----------- ---------- -----------
Total revenues. . . . . . . . . . . . . . . . . . . . . . . . . . 3,464 11,263 9,398 27,477
----------- ----------- ---------- -----------
Cost of revenues:
Solutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 879 3,347 3,243 9,455
Subscriptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . 286 1,246 1,067 3,616
Stock-based and related compensation charges. . . . . . . . . . . . . 138 394 - 1,760
----------- ----------- ---------- -----------
Total cost of revenues. . . . . . . . . . . . . . . . . . . . . . 1,303 4,987 4,310 14,831
----------- ----------- ---------- -----------
Gross profit. . . . . . . . . . . . . . . . . . . . . . . . . . . 2,161 6,276 5,088 12,646
Operating expenses:
Sales and marketing:
Other sales and marketing . . . . . . . . . . . . . . . . . . . . . 3,259 10,444 11,494 32,501
Stock-based and related compensation charges. . . . . . . . . . . . 547 578 2,403 5,480
Research and development:
Other research and development. . . . . . . . . . . . . . . . . . . 2,769 6,971 9,300 14,843
Stock-based and related compensation charges. . . . . . . . . . . . (463) 671 1,311 3,627
General and administrative:
Other general and administrative. . . . . . . . . . . . . . . . . . 1,753 3,080 5,872 8,283
Stock-based and related compensation charges. . . . . . . . . . . . 1,897 2,220 7,437 9,638
Amortization of goodwill and other intangible assets. . . . . . . . . 359 2,660 1,161 8,045
Restructuring charges, net. . . . . . . . . . . . . . . . . . . . . . (21) - 583 -
----------- ----------- ---------- -----------
Total operating expenses. . . . . . . . . . . . . . . . . . . . . 10,100 26,624 39,561 82,417
Operating loss. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (7,939) (20,348) (34,473) (69,771)
Other income, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,593 446 101 2,229
----------- ----------- ---------- -----------
Net loss. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (6,346) (19,902) (34,372) (67,542)
Beneficial conversion feature of preferred stock. . . . . . . . . . . . . (212) - (579) (5,977)
----------- ----------- ---------- -----------
Net loss attributable to common stockholders. . . . . . . . . . . . . . . $ (6,558) $ (19,902) $ (34,951) $ (73,519)
=========== =========== ========== ===========
Net loss per common share -- basic and diluted. . . . . . . . . . . . . . $ (0.15) $ (0.59) $ (0.89) $ (2.51)
=========== =========== ========== ===========
Shares used in net loss per common share calculation -- basic and diluted 43,715 33,976 39,442 29,301
=========== =========== ========== ===========
The accompanying notes are an integral part of these condensed consolidated financial statements.
3
EVOLVE SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
NINE MONTHS ENDED MARCH 31,
---------------------------------
2002 2001
--------------- ----------------
(unaudited)
Cash flows from operating activities:
Net loss. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (34,372) $ (67,542)
Adjustments to reconcile net loss to net cash used in operating activities:
Loss on disposal of fixed assets. . . . . . . . . . . . . . . . . . . . - 19
Allowance for doubtful accounts . . . . . . . . . . . . . . . . . . . . 885 420
Depreciation and amortization - fixed assets. . . . . . . . . . . . . . 2,730 2,741
Amortization of goodwill and other intangible assets. . . . . . . . . . 1,161 8,045
Non-cash restructuring charges. . . . . . . . . . . . . . . . . . . . . 1,132 -
Write-down of stockholders' loans and related interest. . . . . . . . . 7,120 -
Accrued interest. . . . . . . . . . . . . . . . . . . . . . . . . . . . - 102
Stock-based charges . . . . . . . . . . . . . . . . . . . . . . . . . . 4,032 20,506
Revaluation of common stock warrants. . . . . . . . . . . . . . . . . . 15 -
Changes in assets and liabilities:
Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . 2,976 (6,626)
Prepaid expenses and other current assets . . . . . . . . . . . . . . . 195 (529)
Deposits and other assets . . . . . . . . . . . . . . . . . . . . . . . 480 (691)
Accounts payable. . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,240) 832
Accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . (2,259) 1,149
Restructuring accrual . . . . . . . . . . . . . . . . . . . . . . . . . (4,150) -
Deferred revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . (991) 1,195
--------------- ----------------
NET CASH USED IN OPERATING ACTIVITIES . . . . . . . . . . . . . . . . . . . (23,286) (40,379)
--------------- ----------------
Cash flows from investing activities:
Purchases of short-term investments . . . . . . . . . . . . . . . . . . . (532) (22,035)
Maturities of short-term investments. . . . . . . . . . . . . . . . . . . 3,373 14,530
Purchases of property and equipment . . . . . . . . . . . . . . . . . . . (192) (8,125)
Proceeds from sale of property and equipment. . . . . . . . . . . . . . . - 13
Purchases of intangibles. . . . . . . . . . . . . . . . . . . . . . . . . - (700)
Restricted cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,901) 2,000
--------------- ----------------
NET CASH USED IN INVESTING ACTIVITIES . . . . . . . . . . . . . . . . . . . (252) (14,317)
--------------- ----------------
Cash flows from financing activities:
Payments under capital lease obligations. . . . . . . . . . . . . . . . . (476) (539)
Payments of long-term debt. . . . . . . . . . . . . . . . . . . . . . . . (1,584) (4,060)
Proceeds from initial public offering . . . . . . . . . . . . . . . . . . - 46,473
Proceeds from issuance of preferred stock, net of issuance costs. . . . . 17,899 12,577
Proceeds from exercise of common stock options. . . . . . . . . . . . . . - 864
Proceeds from exercise of common stock warrants . . . . . . . . . . . . . - 500
Proceeds from issuance of debt. . . . . . . . . . . . . . . . . . . . . . - 4,753
Proceeds from payment on note receivable. . . . . . . . . . . . . . . . . - 343
Proceeds from employee stock purchase plan. . . . . . . . . . . . . . . . 101 1,281
Payments on repurchase of common stock. . . . . . . . . . . . . . . . . . (13) (219)
--------------- ----------------
NET CASH PROVIDED BY FINANCING ACTIVITIES . . . . . . . . . . . . . . . . . 15,927 61,973
--------------- ----------------
Effect of exchange rate changes on cash and cash equivalents. . . . . . . . (76) 62
Increase (decrease) in cash and cash equivalents. . . . . . . . . . . . . . (7,687) 7,339
Cash and cash equivalents at beginning of period. . . . . . . . . . . . . . 19,914 18,660
--------------- ----------------
Cash and cash equivalents at end of period. . . . . . . . . . . . . . . . . $ 12,227 $ 25,999
=============== ================
The accompanying notes are an integral part of these condensed consolidated financial statements.
4
EVOLVE SOFTWARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
THE COMPANY
Evolve Software, Inc. (the "Company" or "Evolve") was incorporated under the
laws of the state of Delaware in February 1995 for the purpose of designing,
developing, marketing and supporting enterprise application software products.
The accompanying condensed consolidated financial statements include the
accounts of Evolve Software, Inc. and the Company's wholly-owned subsidiaries,
Evolve Software Europe Ltd., Evolve Software (India) Pvt. Ltd. and Evolve
Canada, Inc., which were incorporated in May 2000, December 2000 and April 2001,
respectively.
LIQUIDITY
The Company has sustained net losses and negative cash flows from operations
since its inception. The Company's ability to fund its obligations in the
ordinary course of business is dependent on its ability to increase revenues, to
manage net operating expenses and to raise additional financing through public
or private equity financing or other sources of financing. There is no
assurance that the Company will achieve a sufficient increase in revenues or
maintain a reduction of net operating expenses or that it will be able to raise
adequate financing from other sources.
BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and in accordance with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. All adjustments (including adjustments of a
normal recurring nature) considered necessary for a fair presentation have been
included. Operating results for the three- and nine-month periods ended March
31, 2002, are not necessarily indicative of the results that may be expected for
the year ending June 30, 2002. For further information, refer to the financial
statements and notes thereto included in the Company's Annual Report on Form
10K/A.
PRINCIPLES OF CONSOLIDATION
The condensed consolidated financial statements include the accounts of Evolve
and its wholly-owned subsidiaries. All significant intercompany balances and
transactions have been eliminated.
USE OF ESTIMATES
The Company has prepared these financial statements in conformity with generally
accepted accounting principles which require it to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
REVENUE RECOGNITION
The Company derives revenues from fees for licenses and implementation services
("Solutions revenue") and fees from maintenance, application service provider
("ASP") and subscription agreements ("Subscriptions revenue"). The Company
recognizes revenues in accordance with the provisions of American Institute of
Certified Public Accountants (AICPA) Statement of Position (SOP) 97-2, "Software
Revenue Recognition." The Company also follows the provisions of the Securities
Exchange Commission's Staff Accounting Bulletin No. 101 (SAB 101), "Revenue
Recognition in Financial Statements."
Under SOP 97-2 as amended, the Company recognizes revenues when all of the
following conditions are met:
- when persuasive evidence of a customer agreement exists;
- the delivery of the product or service subject to the agreement has
occurred;
- the associated fees are fixed or determinable; and
- the Company believes that collection of these fees is reasonably
assured.
5
The Company's customer agreements typically include arrangements for maintenance
services to be provided by the Company. Generally, the Company has vendor
specific objective evidence of fair value for the maintenance element of
software arrangements based on the renewal rates for maintenance in future years
as specified in the contracts. In those cases where first year maintenance
revenue is included in the license fee, the Company defers the fair value of the
first year maintenance revenue at the outset of the arrangement and recognizes
it ratably over the period during which the maintenance is to be provided, which
normally commences on the date the software is delivered.
The Company has established vendor specific objective evidence of fair value for
certain services. For these contracts, which involve significant implementation
or other services which are essential to the functionality of the software and
which are reasonably estimable, the license and services revenue is recognized
over the period of each implementation, primarily using the
percentage-of-completion method. Labor hours incurred are used as the measure
of progress towards completion. Revenue for these arrangements is classified as
Solutions revenue. A provision for estimated losses on engagements is made in
the period in which the loss becomes probable and can be reasonably estimated.
In cases where a sale of a license does not include implementation services
(e.g., a sale of additional seats or a sale of product to be implemented by a
third party), revenue is recorded upon delivery with an appropriate deferral for
maintenance services, if applicable, provided all of the other relevant
conditions have been met.
The Company generates revenue from its ASP business by hosting the software and
making the solution available to the customer via the Internet, as well as by
providing maintenance and other services to the customer. In such situations,
customers pay a monthly fee for the term of the contract in return for access to
the Company's software, maintenance and other services such as implementation,
training, consulting and hosting. For certain ASP software arrangements for
which the Company does not have vendor specific objective evidence of fair value
for the elements of the contract, fees are recognized on a monthly basis as the
hosting service is provided. In other circumstances where the customer has the
right to take delivery of the software and the Company has vendor specific
objective evidence of fair value for the hosting element of the contract, fees
are allocated between the elements based on the vendor specific objective
evidence. Revenue for these hosting arrangements is classified as Subscriptions
revenue.
License revenue includes product licenses to companies from which the Company
has purchased products and services under separate arrangements executed within
a short period of time ("reciprocal arrangements"). Products and services
purchased in reciprocal arrangements include: 1) software licensed for internal
use; 2) software licensed for resale or incorporation into the Company's
products; and 3) development or implementation services. For reciprocal
arrangements, the Company considers Accounting Principles Board (APB No. 29),
"Accounting for Nonmonetary Transactions," and Emerging Issues Task Force (EITF,
Issue No. 86-29), "Nonmonetary Transactions: Magnitude of Boot and Exceptions to
the Use of Fair Value, Interpretation of Accounting Principles Board No. 29,
Accounting for Nonmonetary Transactions" to determine whether the arrangement is
a monetary or nonmonetary transaction. In determining these fair values, the
Company considers the recent history of cash sales of the same products or
services in similar sized transactions. Revenues recognized under reciprocal
arrangements were $258,000 and $204,000 for the fiscal quarters ended March 31,
2002 and 2001, respectively, and $862,000 and $1.3 million for the nine months
ended March 31, 2002 and 2001, respectively.
Deferred revenue represents fees derived from maintenance, ASP and subscription
agreements that are being recognized ratably over the unexpired portion of the
underlying period of the agreements. Deferred revenue also represents amounts
billed to customers under license and service arrangements in excess of amounts
recognized as revenue to date from those arrangements. As work progresses
towards completion of these arrangements, a portion of the deferred revenue will
be recognized. Certain revenues will also be deferred, if other revenue
recognition criteria have not been met.
6
COMPREHENSIVE INCOME (LOSS)
The Company follows Statement of Financial Accounting Standards ("SFAS") No.
130, "Reporting Comprehensive Income." SFAS No. 130 establishes standards for
reporting and display of comprehensive income (loss) and its components in
financial statements. The statement of comprehensive loss is as follows (in
thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
------------------------ -----------------------
2002 2001 2002 2001
----------- ----------- ---------- -----------
Net loss $ (6,346) $ (19,902) $ (34,372) $ (67,542)
Unrealized loss on investments - (500) - (500)
Foreign currency translation adjustment 123 104 (12) 62
----------- ----------- ---------- -----------
Comprehensive loss $ (6,223) $ (20,298) $ (34,384) $ (67,980)
=========== =========== ========== ===========
SEGMENT INFORMATION
The Company operates in only one segment, namely workforce optimization software
and, as such, uses only one measure of profitability for internal reporting
purposes. To date, substantially all of the Company's revenues have been
derived from within the United States. Additionally, substantially all of the
Company's long-lived assets are located in the United States.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2001, the Securities and Exchange Commission ("SEC") issued Staff Topic
No. D-98, which provides clarification on the classification and measurement of
redeemable equity securities. This announcement provides clarification about
the balance sheet classification and measurement of securities subject to either
mandatory redemption features or whose redemption is outside the control of the
issuer. The Company has determined that, at issuance, the terms of the Series A
Preferred Stock that was issued in October 2001, qualified for presentation
outside of permanent equity, based on the guidance in Topic No. D-98. In March
2002, certain Series A Preferred stockholders agreed to waive the mandatory
redemption feature and other rights and, accordingly, in March, the amended
shares qualified for presentation as part of permanent equity.
In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No.
141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible
Assets." SFAS No. 141 requires business combinations initiated after June 30,
2001, to be accounted for using the purchase method of accounting, and broadens
the criteria for recording intangible assets separately from goodwill. Recorded
goodwill and intangibles will be evaluated against these new criteria and may
result in certain intangibles being subsumed into goodwill, or alternatively,
amounts initially recorded as goodwill may be separately identified and
recognized apart from goodwill. SFAS No. 142 requires the use of a
non-amortization approach to account for purchased goodwill and certain
intangibles. Under a non-amortization approach, goodwill and certain
intangibles will not be amortized into results of operations, but instead would
be reviewed for impairment and written-down and charged to results of operations
only in the periods in which the recorded value of goodwill and certain
intangibles is more than its fair value. Evolve will continue to amortize
goodwill and purchased intangible assets acquired prior to June 30, 2001, until
it adopts SFAS No. 142. For business combinations initiated after June 30,
2001, Evolve will follow the non-amortization method under SFAS No. 142. Evolve
is required to adopt the provisions of SFAS No. 142 on July 1, 2002. Evolve is
currently assessing SFAS No. 142 and has not determined the impact on Evolve's
condensed consolidated financial statements.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." SFAS No. 144 addresses financial accounting and
reporting for the impairment or disposal of long-lived assets to be held and
used, to be disposed of other than by sale and to be disposed of by sale.
Although SFAS No. 144 retains certain of the requirements of SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed of," it supersedes SFAS No. 121 and APB Opinion No. 30, "Reporting
the Results of Operations--Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions for the Disposal of a Segment of a Business." SFAS No. 144 also
amends Accounting Research Bulletin No. 51, "Consolidated Financial Statements,"
to eliminate the exception to consolidation for a subsidiary for which control
is likely to be temporary. The statement is effective for financial statements
issued for fiscal years beginning after December 15, 2001, and interim periods
within those fiscal years, with early adoption encouraged. The Company is
currently assessing the impact of adopting SFAS No. 144 on the Company's
financial position and results of operations.
7
NOTE 2. ACQUISITIONS
On June 29, 2001, Evolve acquired certain assets of Vivant! Corporation
("Vivant"). The total acquisition cost was approximately $3.1 million,
primarily comprised of $910,000 in cash, 1,553,254 shares of the Company's
common stock valued at $1.6 million, a future stock commitment valued at a
minimum of $525,000 and $137,000 for transaction related expenses. With the
assistance of an independent valuation, the Company recorded approximately $2.2
million in developed technology, $717,000 in goodwill and $187,000 in acquired
workforce upon this acquisition, which was accounted for as a purchase. The
number of shares issued to Vivant at the closing of the acquisition was subject
to adjustment by issuance of additional shares or redemption of existing shares
based on the market value of Evolve's common stock as of the time the
registration of such shares became effective. As a result, the Company
subsequently issued 663,495 shares to Vivant in September 2001 and 3,899,756
shares in January 2002 pursuant to the terms of the acquisition. The Company is
still refining its purchase price allocation, which may result in adjustments in
future periods. In addition, Evolve has agreed to issue to Vivant additional
shares of its common stock with a value of up to $525,000 within ten days after
the one-year anniversary of the closing of the acquisition (July 9, 2002) and
additional shares with a value up to $3,900,000 at specified times based on
receipts from the sale of Vivant's products for the shorter of twenty-four
months from the date of the agreement or eighteen months from the Company's
first customer contract that incorporates Vivant technology. However, the asset
acquisition agreement governing the purchase of the Vivant assets limits the
aggregate number of shares of common stock to be issued by the Company to not
exceed 7,661,097 shares or 1,544,592 shares in excess of those issued through
January 31, 2002. The results of Vivant's operations have been included in the
Company's condensed consolidated financial statements since the date of
acquisition.
The following unaudited pro forma consolidated financial information presents
the combined results of Evolve and Vivant as if the acquisition had occurred on
July 1, 2000, after giving effect to certain adjustments, principally the
amortization of goodwill and other intangible assets. The unaudited pro forma
consolidated financial information does not necessarily reflect the results of
operations that would have occurred had the acquisition been completed on July
1, 2000 (in thousands, except per share amounts).
NINE MONTHS
ENDED
MARCH 31, 2001
----------------
Pro forma total revenue $ 27,477
================
Pro forma net loss $ (76,007)
================
Basic and diluted pro forma net loss per share $ (2.15)
================
----------------
Shares used to compute basic and
diluted pro forma net loss per share 35,418
================
NOTE 3. STOCK-BASED AND RELATED COMPENSATION CHARGES
The Company incurred stock-based compensation charges in connection with stock
option grants and sales of restricted stock to employees at exercise or sales
prices below the deemed fair market value of its common stock for accounting
purposes. The cumulative difference between the deemed fair value of the
underlying stock at the date the options were granted and the exercise price of
the granted options was $40.3 million as of August 9, 2000, the date of the
Company's Initial Public Offering. This amount is being amortized, using the
accelerated method of FASB Interpretation No. 28, "Accounting for Stock
Appreciation Rights and Other Variable or Award Plans," over the four-year
vesting period of the granted options. Based on the unearned stock-based
compensation balance at March 31, 2002, the Company's results from operations
will include stock-based compensation expense, at a minimum, through 2004. The
Company recorded stock-based charges of $2.1 million and $11.2 million for the
three- and nine- months ended March 31, 2002, respectively, and $3.9 million and
$20.5 million for the three- and nine- months ended March 31, 2001,
respectively. Future terminations or modifications to existing awards will
impact future stock-based compensation expense.
8
In connection with the termination of employment of certain executive officers
in fiscal 2001, the Company entered into arrangements with those executive
officers to provide consulting services. For accounting purposes, this was
deemed to be a change in status of the employee and resulted in a new
measurement date for the amended equity awards in accordance with FIN No. 44,
"Accounting for Certain Transactions Involving Stock Compensation." In
addition, for other executive officers of Evolve whose employment was terminated
in fiscal 2001 and who had purchased restricted stock with full recourse notes,
the Company agreed, as part of their termination settlements, to allow them to
sell back to the Company their restricted shares in exchange for cancellation of
the notes. Accordingly, these notes are accounted for as non-recourse notes on
a variable basis such that the charge/credit arising from these notes will
fluctuate from period to period based on the Company's stock price. The
revaluation charge for the notes subject to remeasurement was not significant
for the quarter ended March 31, 2002. The financial impact of these
arrangements is included within stock-based compensation expense, which has been
allocated to the appropriate functional categories within the Statement of
Operations.
In October 2001, the Board of Directors voted to modify existing stockholder
loans, which were issued to allow board members, officers and selected employees
to exercise stock options and purchase restricted stock, from full-recourse to
non-recourse and to extend their due dates, in the event of termination, from
thirty days to fifteen months after the date of termination. The loans are
secured only by the underlying stock, which they were used to purchase. As a
result, the loans became subject to variable accounting and the outstanding
stockholder loans and related interest were revalued to their net realizable
value of $0.21 per share at March 28, 2002, resulting in charges of $710,000 and
$7.1 million for the three- and nine- months ended March 31, 2002, respectively.
Until they are due or repaid, if earlier, the loans will be revalued each
quarter to their net realizable value as determined by the stock price at that
time.
NOTE 4. LONG-TERM DEBT
On November 13, 2001, the Company revised an existing credit arrangement and
signed an amended Loan and Security Agreement to restructure its excess credit
facilities, to obtain a waiver of certain defaults under the previous credit
arrangement and to reduce the line-of-credit to $2.9 million and the term loan
credit facility to $4.4 million with interest accruing at the bank's prime rate
plus 0.75% and 1.00%, respectively. At March 31, 2002, these rates were 5.50%
and 5.75%, respectively. As of March 31, 2002, the Company had utilized $4.8
million of the term loan credit facility and had repaid $1.6 million. The loan
will be fully repaid by July 1, 2003. Both the line-of-credit and the term loan
credit facility are collateralized by all of the Company's assets, including
intellectual property, except for previously leased equipment. In connection
with the loan amendment the bank approved new financial covenants for the
periods commencing October 1, 2001. Under these covenants, the Company is
required to: (1) maintain at all times a minimum bank liquidity ratio of 1.50
to 1.00, reducing to a ratio of 1.25 to 1.00 on January 31, 2002, (the cash
component of this ratio is required to be held at the bank); (2) beginning with
the month ending December 31, 2001, maintain, on a monthly basis, the greater of
(a) a minimum company liquidity ratio of 1.75 to 1.00 or (b) $14,000,000 in
unrestricted cash (unrestricted cash will include any restricted cash held by
the bank) reducing to $8,000,000 on January 31, 2002; (3) beginning with the
month ending December 31, 2001, not exceed a leverage maximum of 2.25 to 1.00;
and (4) meet a milestone covenant of obtaining at least $10,000,000 in new
equity from investors acceptable to the bank by October 15, 2001.
The Company was in violation of the maximum leverage ratio financial covenant
from December 2001 through February 2002. However, the Company received a
waiver of all defaults in March 2002. On April 19, 2002, the Company signed a
first amendment to the amended and restated Loan and Security Agreement, which
amended certain financial covenants. In connection with the amendment, the bank
approved new financial covenants commencing April 1, 2002. Under the new
covenants, the Company is required to: (1) maintain, at all times, a minimum
bank liquidity ratio of not less than 1.25 to 1.00; (2) maintain, at all times,
unrestricted cash (unrestricted cash will include any restricted cash held by
the bank) of not less then $8,000,000; and (3) maintain minimum revenue targets
which increase quarterly.
At March 31, 2002, the Company was in compliance with all amended covenants.
NOTE 5. CONTINGENCIES
From time to time, the Company may become involved in litigation relating to
claims arising from the ordinary course of business. The Company is defending
against two claims filed by early customers, one an action filed in the federal
district court in Massachusetts and the other an action filed in the federal
district court in California. Both cases allege a variety of claims including
that the software and services purchased from the Company did not satisfy
certain contractual obligations and that the Company engaged in practices that
they allege were unfair or misrepresentative. Both of these proceedings are
still in the early stages of litigation, therefore, it is not possible to
estimate the outcome of these contingencies.
9
In November 2001, a complaint seeking class action status was filed, against the
Company, in the United States District Court for the Southern District of New
York. The complaint is purportedly brought on behalf of all persons who
purchased the Company's common stock from August 9, 2000, through December 6,
2000. The complaint names as defendants some of the Company's former and
current officers, and several investment banking firms that served as managing
underwriters of the Company's initial public offering. Among other claims, the
complaint alleges liability under the Securities Act of 1933 and the Securities
Exchange Act of 1934, on the grounds that the registration statement for the
Company's initial public offering did not disclose that: (1) the underwriters
had allegedly agreed to allow certain of their customers to purchase shares in
the offering in exchange for alleged excess commissions paid to the
underwriters; and (2) the underwriters had allegedly arranged for certain of
their customers to purchase additional shares in the aftermarket at
pre-determined prices under alleged arrangements to manipulate the price of the
stock in aftermarket trading. The Company is aware that similar allegations
have been made in numerous other lawsuits challenging initial public offerings
conducted in 1998, 1999 and 2000. No specific amount of damages is claimed in
the complaint involving the initial public offering. The Company intends to
contest the claims vigorously. The Company is unable, at this time, to
determine whether the outcome of the litigation will have a material impact on
its results of operations or financial condition in any future period.
The Company believes that there are no other claims or actions pending or
threatened against it, the ultimate disposition of which would have a material
adverse effect on the Company.
NOTE 6. RESTRUCTURING CHARGES
Beginning in the quarter ending June 30, 2001 through the quarter ending
December 31, 2001, the Company critically reviewed its operations and cost
structure, and took actions to reduce costs and strengthen its position in
executing its strategy. These decisions resulted in the involuntary termination
of 207 employees. The terminations were from all functions of the Company's
operations and included twenty-two employees from the closure of the India
research facility. As a result of the headcount reduction, the Company recorded
charges of $3.4 million in severance and related benefit charges. The Company
consolidated its facilities at its Emeryville headquarters, which resulted in a
total net charge of $4.6 million related to its excess facilities. These costs
included a reversal of $2.2 million of previously accrued restructuring charges
for the excess space at the Company's headquarters that resulted from amending
the original lease to relieve the Company from some future rental obligations.
The Company also recorded charges of $2.3 million consisting of impairment of
certain assets including leasehold improvements and furniture related to the
excess facilities, computer hardware and software, and telecommunications
equipment related to the workforce reduction. A rollforward of the
restructuring-related liabilities follows.
10
(in thousands) SEVERANCE FIXED
AND RELATED ASSET
CHARGES FACILITIES WRITE-OFF TOTALS
------------- ------------ ----------- --------
Restructuring charges $ 1,597 $ 6,433 $ 1,694 $ 9,724
Amount paid (817) (354) - (1,171)
Non-cash charges - - (1,694) (1,694)
------------- ------------ ----------- --------
Accrued liabilities at June 30, 2001 $ 780 $ 6,079 - $ 6,859
Restructuring charges 590 - 103 693
Amount paid (1,007) (405) - (1,412)
Non-cash charges - - (103) (103)
------------- ------------ ----------- --------
Accrued liabilities at September 30, 2001 $ 363 $ 5,674 $ - $ 6,037
Restructuring charges (reversals) 1,224 (1,836) 523 (89)
Amount paid (1,013) (529) (1,542)
Non-cash charges (191) (121) (463) (775)
------------- ------------ ----------- --------
Accrued liabilities at December 31, 2001 $ 383 $ 3,188 $ 60 $ 3,631
Restructuring charges (reversals) - - (21) (21)
Amount paid (127) (484) 21 (590)
Non-cash charges - - - -
------------- ------------ ----------- --------
Accrued liabilities at March 31, 2002 $ 256 $ 2,704 $ 60 $ 3,020
Short-term $ 256 $ 1,637 $ 60 $ 1,953
Long-term $ - $ 1,067 $ - $ 1,067
NOTE 7. NET LOSS PER SHARE
Basic and diluted net loss per share are computed using the weighted average
number of common shares outstanding during each period. Since the Company has
had a net loss for all periods presented, net loss per share on a diluted basis
is equivalent to basic net loss per share. Common shares issuable upon exercise
of stock options and warrants and upon conversion of convertible preferred stock
are excluded because the effect would be anti-dilutive. A reconciliation of the
numerator and denominator used in the calculation of basic and diluted net loss
per share follows:
(in thousands) THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
------------------------ -----------------------
2002 2001 2002 2001
----------- ----------- ---------- -----------
Numerator:
Net loss $ (6,346) $ (19,902) $ (34,372) $ (67,542)
Beneficial conversion feature of redeemable
convertible preferred stock (212) - (579) (5,977)
----------- ----------- ---------- -----------
Net loss attributable to common stockholders $ (6,558) $ (19,902) $ (34,951) $ (73,519)
=========== =========== ========== ===========
Denominator:
Weighted average common shares 44,670 38,621 41,865 34,680
Weighted average unvested common shares
subject to repurchase (955) (4,645) (2,423) (5,379)
Shares used in computing basic and diluted
----------- ----------- ---------- -----------
net loss per share 43,715 33,976 39,442 29,301
=========== =========== ========== ===========
11
At March 31, 2002 and 2001, options to purchase 14,258,175 and 3,510,205 shares
of common stock were outstanding with a weighted-average exercise price of $0.65
and $6.50, respectively. At March 31, 2002, the outstanding Series A Preferred
Stock was convertible into 37.0 million shares of common stock. Warrants to
purchase 600,000 shares of Series A Preferred Stock at $10.00 per share and 9.4
million shares of common stock at $1.00 per share, if exercised, were
convertible into 12 million and 9.4 million shares of common stock,
respectively, as of March 31, 2002. Providing that the remaining Series A
Preferred Stock warrants are exercised, the Company will issue additional common
stock warrants to purchase 2.9 million shares of common stock at $1.00 per
share. These common stock equivalents have been excluded from the computation
of diluted net loss per share because their effect would have been
anti-dilutive. The weighted-average purchase prices of stock subject to
repurchase were $2.32 and $2.14 as of March 31, 2002 and 2001, respectively.
NOTE 8. SERIES A PREFERRED STOCK FINANCING
The Company completed the sale of Series A Convertible Preferred Stock pursuant
to the Purchase Agreement (the "Series A Preferred Financing") with Warburg
Pincus Private Equity VIII L.P. and certain previous stockholders on October 9,
2001. The Company issued the following securities and rights to the investors
participating in the Series A Preferred Financing:
- an aggregate of 1.3 million shares of Evolve's Series A Preferred
Stock at a price of $10 per share;
- warrants to purchase up to an aggregate of 1.3 million additional
shares of Series A Preferred Stock at a price of $10 per share (the
"preferred stock warrants");
- warrants to purchase up to 6.5 million shares of common stock at a
price of $1.00 per share (the "common stock warrants"); and
- the right to receive additional common stock warrants to purchase a
number of shares of common stock equal to 25% of the number of shares
of common stock into which the shares of Series A Preferred Stock
issued upon exercise of the preferred stock warrants are convertible,
at the time such preferred stock warrants are exercised.
As this transaction resulted in significant changes to the Company's
stockholders' equity balances, the following table has been provided to
summarize the activity in the statement of stockholders' equity during the nine
months ended March 31, 2002.
(in thousands)
EQUITY UNEARNED
PREFERRED STOCK COMMON STOCK STOCK -
------------------ -------------- N/R FROM BASED
SHARES AMTS SHARES AMTS APIC S/H COMP
-------- -------- ------ ------ --------- ---------- ----------
Balances, June 30, 2001 - $ - 40,052 $ 40 $250,485 $ (7,795) $ (11,732)
Issuance of p/s & p/s warrants, as amended, net 1,100 1 - - 8,204 - -
Cancellation of preferred & commons stock warrants - - - - 209 - -
Issuance of common stock warrants, as amended - - - - 1,296 - -
Beneficial conversion feature on preferred stock - - - - 1,158 - -
Amortization of beneficial conversion feature on p/s - - - - 523 - -
Exercise of CEO p/s warrants in March 2002 550 - - - 5,500 - -
Issuance of common stock under stock purchase plans - - 221 - 101 - -
Issuance of common stock to Vivant! Corporation - - 4,563 5 (5) - -
Modification of s/h n/r and other stock option awards - - - - 100 6,478 (275)
Repurchase of common stock - - - - (12) - -
Reversal of unearned stock-based compensation - - - - (5,551) - 5,551
Amortization of stock-based compensation - - - - - - 4,032
Foreign currency translation adjustment - - - - - - -
Net loss - - - - - - -
-------- -------- ------ ------ --------- ---------- ----------
Balances, March 31, 2002 1,650 $ 1 44,836 $ 45 $262,008 $ (1,317) $ (2,424)
======== ======== ====== ====== ========= ========== ==========
(in thousands)
ACCUM
OTHER TOTAL
COMPRE ACCUM S/H
INCOME DEFICIT EQUITY
-------- ---------- ---------
Balances, June 30, 2001 $ 95 $(215,750) $ 15,343
Issuance of p/s & p/s warrants, as amended, net - - 8,205
Cancellation of preferred & commons stock warrants - - 209
Issuance of common stock warrants, as amended - - 1,296
Beneficial conversion feature on preferred stock - - 1,158
Amortization of beneficial conversion feature on p/s - (579) (56)
Exercise of CEO p/s warrants in March 2002 - - 5,500
Issuance of common stock under stock purchase plans - - 101
Issuance of common stock to Vivant! Corporation - - -
Modification of s/h n/r and other stock option awards - - 6,303
Repurchase of common stock - - (12)
Reversal of unearned stock-based compensation - - -
Amortization of stock-based compensation - - 4,032
Foreign currency translation adjustment (13) - (13)
Net loss - (34,372) (34,372)
-------- ---------- ---------
Balances, March 31, 2002 $ 82 $(250,701) $ 7,694
======== ========== =========
p/s = preferred stock; s/h = stockholder; n/r = notes receivable; apic = additional paid-in capital
12
On March 29, 2002, existing investors Warburg Pincus LLC and Sierra Ventures
VII, L.P, acquired 550,000 shares of Series A Preferred Stock at a price of $10
per share, for total proceeds of $5.5 million, via the exercise of preferred
stock warrants. As of March 31, 2002, the Company had received an aggregate of
$18.5 million, with net proceeds of $17.9 million, for 1.9 million shares of
Series A Preferred Stock. If the remaining preferred stock warrants and the
common stock warrants are exercised, in full for cash, the Company will receive
an additional $18.3 million in aggregate proceeds. The Company has no plans to
issue additional shares of Series A Preferred Stock, other than upon exercise of
the warrants described above. However, the Company has 200,000 additional
shares of Series A Preferred Stock authorized for issuance in addition to those
already issued or reserved for issuance pursuant to exercise of the warrants.
The issuance of the Series A Preferred Stock and the warrants was exempt from
the registration requirements of the Securities Act pursuant to Section 4(2) of
the Securities Act, and regulations promulgated thereunder. The Company relied
on the fact that the securities were offered to a small group of investors
without any public advertisement or solicitation, and on the fact that each of
the investors represented that it was an "accredited investor" within the
meaning of Rule 501 under the Securities Act and that it was purchasing the
securities for investment purposes and not with any present intent to further
distribute such securities.
Conversion Rights. Each share of Series A Preferred Stock is convertible into
common stock at an initial conversion price of $0.50, or at an initial
conversion rate of 20 shares of common stock for each share of Series A
Preferred Stock. The conversion rate accretes at a rate of 8.00% per annum,
compounded quarterly. The conversion rate is also subject to certain
adjustments as set forth in the Company's Certificate of Designation of Series A
Preferred Stock, in the event of dilutive stock issuances and in the event the
Company incurs litigation- or tax-related expenses in excess of certain
limitations. The Series A Preferred Stock may be converted at any time at the
election of each holder. The Company may cause all of the shares of Series A
Preferred Stock to be automatically converted into common stock at any time
after the fifth anniversary of the date of initial issuance of these shares,
provided that the common stock has been trading at a value of at least $5.00 for
a specified period.
Liquidation Preference. In the event of a transaction involving a dissolution
of the Company, the holders of Series A Preferred Stock will be entitled to
payment of a liquidation preference equal to the initial purchase price of their
shares of Series A Preferred Stock, plus an 8.00% annual rate of return,
compounded quarterly, prior to any payment to holders of common stock and other
junior securities. In the event of certain transactions involving a change of
control of the Company, a liquidation preference equal to the initial purchase
price of the Series A Preferred Stock shares held plus an 8.00% rate of return,
compounded quarterly, computed over a five-year period is payable to the holders
of Series A Preferred Stock, irrespective of when such a transaction occurs.
Voting Rights. Holders of Series A Preferred Stock are generally entitled to
one vote for each share of common stock into which their Series A Preferred
Stock is convertible. In addition, the Company may not, without the affirmative
vote of the holders of a majority of the outstanding shares of Series A
Preferred Stock:
- amend or repeal the provisions of the Certificate of Designation of
Series A Preferred Stock;
- enter into a transaction involving a change of control, unless such
transaction would result in aggregate consideration paid in respect of
all Series A Preferred Stock equal to the original purchase price of
these shares, plus an internal rate of return of at least 50%;
- authorize or issue any securities senior to the Series A Preferred
Stock;
- issue any debt obligations other than trade debt in the ordinary
course of business;
- pay any dividends on or repurchase any junior securities, subject to
certain exceptions;
- amend the Company's bylaws to increase the authorized number of
directors to more than eight; or
- authorize or issue any shares of any class or series of stock on
parity with the Series A Preferred Stock under certain circumstances.
Board Representation. The holders of the Series A Preferred Stock, voting as a
separate class, are entitled to elect three members to the Company's Board of
Directors. All other directors will be elected by the holders of the common
stock and the Series A Preferred Stock voting as a single class. The number of
directors appointed by the holders of Series A Preferred Stock is reduced as
follows:
- to two if less than 75% but at least 50% of the shares of Series A
Preferred Stock remain outstanding;
- to one if less than 50% but at least 25% of the shares of Series A
Preferred Stock remain outstanding; or
- to zero, if less than 25% of the shares of Series A Preferred Stock
remain outstanding.
Preferred Stock Warrants. The preferred stock warrants are exercisable to
purchase up to an aggregate of 1.3 million shares of Series A Preferred Stock at
a common stock-equivalent price of $0.50 per share, payable in cash. 50% of the
preferred stock warrants expire if not exercised by April 3, 2002, which was
thirty days after the appointment of a new permanent Chief Executive Officer.
550,000 of these warrants were exercised by March 31, 2002, 25,000 warrants were
exercised prior to expiration and 150,000 warrants were canceled. An additional
575,000 warrants may be exercised for up to one year after issuance, or October
9, 2002.
13
Common Stock Warrants. Common stock warrants that were issued to the investors
are exercisable for up to 6.5 million shares of common stock. Upon exercise of
the preferred stock warrants an additional 2.9 million common stock warrants
were issued. The Company will issue warrants to purchase an additional 2.9
million shares of common stock if the remaining preferred stock warrants are
exercised in full. The common stock warrants have an exercise price of $1.00
per share, which is subject to adjustment if the Company issues securities at
less than fair market value and under certain other circumstances. The common
stock warrants may be exercised for cash, or on a cashless basis by converting
the common stock warrants into a number of shares with a value equal to the
spread between the market value of the shares subject to the common stock
warrants and the exercise price. In addition, in the event of certain
transactions involving a change of control of Evolve, some holders of common
stock warrants will have the right to deliver these warrants to us in exchange
for payments equal to the market value of such warrants at the time of the
change of control transaction, payable in cash or, subject to certain
conditions, shares of common stock of Evolve. The common stock warrants have a
term of seven years.
In accordance with EITF Issue No. 00-19, "Determination of Whether Share
Settlement is Within the Control of the Issuer for Purposes of Applying Issue
No. 96-13, "Accounting for Derivative Financial Instruments Indexed to, and
Potentially Settled in, a Company's Own Stock,"" the Company determined, at the
time of issuance, that the outstanding warrants to purchase 6.5 million shares
of its common stock at $1.00 per share, as well as the contingently issuable
warrants to purchase an incremental 6.5 million shares of its common stock at
$1.00 per share should be accounted for as a liability, as a result of certain
rights of the common stock warrant holders to receive cash instead of stock in
the event of a change of control. Accordingly, the outstanding warrants were
recorded at fair value, as determined by the Black-Scholes pricing model, at
each exercise and reporting period date with any changes in the fair value
included in the results of operations. On October 9, 2001, the Company
calculated the fair value of these warrants, using the Black-Scholes option
pricing model, at approximately $1.5 million and recorded a corresponding
liability. On December 31, 2001 and March 31, 2002, the warrants were revalued
using the Black-Scholes pricing methodology. For the quarter ended March 31,
2002, the Company recognized a recovery of approximately $1.7 million in
expense, recognized in the previous quarter, related to the decrease in the fair
value of the warrants. For the nine months ended March 31, 2002, the net
revaluation expense was $15,000. These amounts are included in other income in
the Company's consolidated statement of operations for the three- and nine-
months ended March 31, 2002. The assumptions used to value the common stock
warrants were a risk-free rate of 4.7%, a dividend yield of 0%, volatility of
89% and a term of seven years.
On March 29, 2002, certain common stock warrants were amended to eliminate the
optionholders' right to demand cash upon a change of control. As a result, the
$1.4 million fair value of the affected common stock warrants was reclassified
from a liability to additional paid-in capital, leaving a liability balance of
$147,000 at March 31, 2002 for the fair value of the 1,250,000 common stock
warrants that were not amended. These warrants will continue to be revalued at
each reporting period date and any changes in fair value will be included in the
results of operations. Additionally, certain preferred stock and preferred
stock warrant holders waived the mandatory redemption feature of the Series A
Preferred Stock, allowing $8.6 million to be reclassified into permanent equity,
leaving a balance of $1.5 million of redeemable convertible preferred stock and
preferred stock warrants outside of permanent equity at March 31, 2002.
Beneficial Conversion Feature
At issuance on October 9, 2001, the Company allocated the net proceeds from the
issuance of the Series A Preferred Stock on a pro-rata basis as required by APB
14, "Accounting for Convertible Debt and Debt Issued with Stock Purchase
Warrants," between the preferred stock and the preferred stock warrants, after
deduction of the fair value of the common stock and contingent common stock
warrants. The fair value of the preferred stock warrants was determined based
on the Black-Scholes option pricing model and the following assumptions:
contractual term of one year, a risk free interest rate of 4.7%, a dividend
yield of 0% and volatility of 89%. As a result, the preferred stock warrants
were deemed to have an embedded beneficial conversion of approximately $1.2
million, which was recorded as an increase in additional paid-in capital and a
reduction in the carrying value of the preferred stock warrant. In accordance
with EITF 00-27, "Application of EITF Issued No. 98-5, "Accounting for
Convertible Securities with Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios," to Certain Convertible Instruments," the
beneficial conversion feature is being amortized over the term of the preferred
stock warrant of one year, resulting in a deemed dividend for the three- and
nine- months ended March 31, 2002 of $212,000 and $579,000, respectively.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
You should read the following discussion in conjunction with the interim
unaudited condensed consolidated financial statements and related notes included
in this report, and with Management's Discussion and Analysis of Financial
Condition and Results of Operations and related financial information contained
in our Annual Report on Form 10-K/A for the fiscal year ended June 30, 2001.
Except for historical information, this report contains forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934. These forward-looking
statements involve risks and uncertainties, including, among other things,
statements regarding our future financing needs, our future revenue growth
prospects and our expense projections for future periods. Our actual results
may differ significantly from those projected in the forward-looking statements.
Factors that might cause or contribute to these differences include, but are not
limited to, those discussed in the section below entitled "Factors That May
Affect Future Results of Operations." You should carefully review these risks
as well as the discussion of risks and uncertainties contained in our Annual
Report on Form 10-K/A under the caption "Business-Factors That May Affect Future
Results." You are cautioned not to place undue reliance on the forward-looking
statements, which speak only as of the date of this Quarterly Report on Form
10-Q. We undertake no obligation to publicly release any revisions to the
forward-looking statements or reflect subsequent events or circumstances after
the date of this document.
OVERVIEW
Evolve is a leading provider of service delivery solutions that optimize the way
organizations drive revenue and value through people and projects. Our Evolve 5
software suite integrates and streamlines the core processes that are critical
to services-oriented organizations, which center around managing project
portfolios, project opportunities, professional resources (including contract
workers) and service delivery. Our solution combines the efficiency gains of
automating core business processes with the benefits of on-line intercompany
collaboration, creating a service delivery platform for a variety of
project-driven services organizations.
We have licensed our solution to over one hundred customers who have
collectively purchased it to manage over 96,000 professionals. Our customers
include professional services firms such as EDS and Sogeti (division of Cap
Gemini SA), high tech professional services organizations at companies such as
Sun Microsystems, Novell and Cognos and corporate IT organizations in companies
such as DaimlerChrysler Services, American Electric Power, Pershing Technologies
(a Credit Suisse First Boston Company), Autodesk and Fleet Financial.
Evolve was founded in February 1995. From our inception through December 1998,
our activities, funded by the venture capital we raised, consisted primarily of
building our business infrastructure, recruiting personnel and developing our
software and service offerings. Our Evolve solution was first made commercially
available in early 1999. We recognized our first revenues from the Evolve
solution during the quarter ended March 31, 1999. We have incurred net losses
and negative cash flows from operations since inception. Our accumulated
deficit at March 31, 2002, was $250.7 million.
RESULTS OF OPERATIONS
REVENUES
Total revenues were $3.5 million for the three months ended March 31, 2002,
compared with revenues of $11.3 million for the comparable 2001 period,
representing a 69% decrease in total revenues. Total revenues were $9.4 million
for the nine months ended March 31, 2002, compared with revenues of $27.5
million for the comparable 2001 period, representing a 66% decrease in total
revenues. For the quarter ended March 31, 2002, revenue from two customers
accounted for 21% of total revenues. For the quarter ended March 31, 2001,
revenue from two customers accounted for 33% of total revenues.
The decrease in revenues is attributable to our effort to diversify our client
base to include global services companies, services divisions of technology
companies and Corporate IT organizations in Global 2000 companies and a
concurrent loss of revenues from our traditional client base of internet-focused
technology-oriented consultants and design and integration services providers.
The more recently targeted types of companies generally have extended sales
cycles. Additionally, sales across all customer segments have been impacted by
the recent downturn in the economy and reductions in corporate capital and IT
spending.
15
We classify our revenues as either Solutions revenues or Subscriptions revenues.
Solutions revenues consist principally of software licenses and implementation
services while Subscriptions revenues consist principally of maintenance
subscriptions and application service provider ("ASP") fees. For the three
months ended March 31, 2002, Solutions and Subscriptions revenues were $2.0
million or 58% of total revenues and $1.5 million, or 42% of total revenues,
respectively. For the three months ended March 31, 2001, Solutions revenues and
Subscriptions revenues were $8.8 million, or 79% of total revenues, and $2.4
million, or 21% of total revenues, respectively. For the nine months ended
March 31, 2002, Solutions revenues and Subscriptions revenues were $5.4 million,
or 57% of total revenues, and $4.0 million, or 43% of total revenues,
respectively. For the nine months ended March 31, 2001, Solutions revenues and
Subscriptions revenues were $20.3 million, or 74% of total revenues, and $7.1
million, or 26% of total revenues, respectively. We are actively encouraging
our ASP customers to convert to a self-host environment and anticipate that
future ASP revenues will be minimal.
COST OF REVENUES
Our cost of revenues includes the costs directly associated with our Solutions
and Subscriptions revenues, including stock-based compensation. The cost of our
Solutions revenues consists principally of payroll-related costs for employees
and consultants involved in providing services for implementation, training and
consulting; royalties due to third-parties for integrated third-party
technology; and, to a lesser extent, printing costs of product documentation,
duplication costs for software media and shipping costs. Cost of Subscriptions
revenues consists primarily of the payroll-related costs for employees involved
in providing support services to customers under maintenance contracts as well
as payroll costs for employees and consultants involved in providing services
for implementation, training and consulting for our ASP customers. Cost of
Subscriptions revenues also includes hosting fees required to service our ASP
customers.
Total cost of revenues, excluding stock-based compensation, was $1.2 million for
the three months ended March 31, 2002, compared with $4.6 million for the three
months ended March 31, 2001, representing a 75% decrease. As a percentage of
total revenues, total cost of revenues, excluding stock-based compensation, was
34% and 41% for the quarters ended March 31, 2002 and 2001, respectively. Total
cost of revenues, excluding stock-based compensation, was $4.3 million for the
nine months ended March 31, 2002, compared with $13.1 million for the nine
months ended March 31, 2001, representing a 67% decrease in cost of revenues.
As a percentage of total revenues, total cost of revenues, excluding stock-based
compensation, was 46% and 48% for the nine months ended March 31, 2002 and 2001,
respectively.
Cost of Solutions revenues was $879,000 and the cost of Subscriptions revenues
was $286,000 for the three months ended March 31, 2002. Cost of Solutions
revenues was $3.3 million and the cost of Subscriptions revenues was $1.2
million for the quarter ended March 31, 2001. As a percentage of Solutions
revenues, cost of Solutions revenues was 44% and 38% for the quarters ended
March 31, 2002 and 2001, respectively. As a percentage of Subscriptions
revenues, cost of Subscriptions revenues was 19% and 52% for the quarters ended
March 31, 2002 and 2001, respectively. Cost of Solutions revenues was $3.2
million and cost of Subscriptions revenues was $1.1 million for the nine months
ended March 31, 2002. Cost of Solutions revenues was $9.5 million and cost of
Subscriptions revenues was $3.6 million for the nine months ended March 31,
2001. As a percentage of Solutions revenues, cost of Solutions revenues was 60%
and 47% for the nine months ended March 31, 2002 and 2001, respectively. As a
percentage of Subscriptions revenues, cost of Subscriptions revenues was 27% and
51% for the nine months ended March 31, 2002 and 2001, respectively.
The decrease in cost of Solutions revenues, in absolute terms. was primarily
attributable to the decreased costs associated with employees and third-party
consultants involved in providing implementation, training and consulting
services to our customer base. The number of employees in our services
organization decreased by 85% from March 31, 2001, to March 31, 2002. The
decrease in cost of Subscriptions revenues was primarily due to decreased
payroll costs for employees and third-party consultants involved in providing
support services to customers under maintenance and application subscription
contracts. We are seeking to reduce our cost of Solutions revenues by having
our customers engage third-parties to provide a substantial portion of services
related to our applications.
OPERATING EXPENSES
SALES AND MARKETING. Sales and marketing expenses consist primarily of employee
salaries, benefits, commissions and stock-based compensation, as well as the
costs of advertising, public relations, website development, trade shows,
seminars, promotional materials and other sales and marketing programs.
Additionally, sales and marketing expenses include costs of service personnel
that have not been treated as part of cost of revenues. Sales and marketing
expenses, excluding stock-based compensation, decreased by 69% to $3.3 million
for the quarter ended March 31, 2002, from $10.4 million for the quarter ended
March 31, 2001. Sales and marketing expenses, excluding stock-based
16
compensation, decreased by 65% to $11.5 million for the nine months ended March
31, 2002, from $32.5 million for the nine months ended March 31, 2001. The
decrease in sales and marketing expenses resulted primarily from significant
workforce reductions beginning during the quarter ended June 30, 2001, and
continuing through the quarter ended December 31, 2001, and a decrease in
advertising and marketing initiatives. The number of employees in our sales and
marketing organization decreased by 65% from March 31, 2001, to March 31, 2002.
We expect that the level of sales and marketing expenses will remain stable in
the next quarter. However, management will continue to focus on managing
expenses and will invest or reduce expenses as deemed appropriate.
RESEARCH AND DEVELOPMENT. Research and development expenses consist primarily
of personnel and related costs, including stock-based compensation, associated
with our product development efforts, including fees paid to third-parties for
engineering consulting services. Research and development expenses, excluding
stock-based compensation, decreased 60% to $2.8 million for the three months
ended March 31, 2002, from $7.0 million for the three months ended March 31,
2001. Research and development expenses, excluding stock-based compensation,
decreased 37% to $9.3 million for the nine months ended March 31, 2002, from
$14.8 million for the nine months ended March 31, 2001. The decrease in
research and development expenses related primarily to a decreased reliance on
third-party consultants and our workforce reductions. The number of employees,
in our research and development organization, decreased by 42% from March 31,
2001, to March 31, 2002. The reduction in headcount includes the closure of our
India office and the discontinuance of our development efforts to support our
ASP business. We expect that the absolute dollar amount of research and
development expenses will remain stable in the next quarter. However,
management will continue to focus on managing expenses and will invest or reduce
expenses as deemed appropriate.
GENERAL AND ADMINISTRATIVE. General and administrative expenses consist
primarily of employee salaries and expenses, including stock-based compensation
related to executive, finance and administrative personnel, bad debt expense,
and professional service fees. General and administrative expenses, excluding
stock-based compensation, decreased 43% to $1.8 million for the three months
ended March 31, 2002, from $3.1 million for the three months ended March 31,
2001. General and administrative expenses, excluding stock-based compensation,
decreased 29% to $5.9 million for the nine months ended March 31, 2002, from
$8.3 million for the nine months ended March 31, 2001. The decrease in general
and administrative expenses resulted primarily from our workforce reductions and
a decrease in bad debt expense. The number of employees in our general and
administrative organization decreased by 56% from March 31, 2001, to March 31,
2002. We expect that general and administrative expenses will remain stable in
the next quarter. However, management will continue to focus on managing
expenses and will invest or reduce expenses as deemed appropriate.
STOCK-BASED AND RELATED COMPENSATION CHARGES. We incurred stock-based
compensation in connection with stock option grants and sales of restricted
stock to our employees at exercise or sales prices below the deemed fair market
value of our common stock for accounting purposes, as a result of amending
certain stockholder loans and accelerated vesting rights granted to terminated
executives and as a result of stock options issued to employees in November 2001
in conjunction with the initiation of a stock exchange program beginning January
2002. Based on the remaining balances at March 31, 2002, our results from
operations will include stock-based compensation expense, at a minimum, through
2004. We recorded stock-based charges of $2.1 million and $3.9 million for the
three months ended March 31, 2002, and March 31, 2001, respectively. We
recorded stock-based charges of $11.2 million and $20.5 million for the nine
months ended March 31, 2002, and March 31, 2001, respectively. Stock-based
charges are amortized on an accelerated basis and the decrease in stock-based
amortization resulted primarily from the resulting decline in the cost over
time. Additionally, amortization previously taken on an accelerated basis was
reversed for employees participating in the options exchange program and
employee terminations in the prior quarters reduced current quarter charges.
In October 2001, the Board of Directors voted to modify existing stockholder
loans, which were issued to allow board members, officers and selected employees
to exercise stock options and purchase restricted stock, from full-recourse to
non-recourse and to extend their due dates, in the event of termination, from
thirty days to fifteen months after the date of termination. The loans are
secured only by the underlying stock, which they were used to purchase. As a
result, outstanding stockholder loans and related interest were revalued to
their net realizable value of $0.21 per share at March 28, 2002, resulting in
charges of $710,000 and $7.1 million for the three and nine months ended March
31, 2002, respectively. Until they are repaid the loans will be revalued each
quarter to their net realizable value as determined by the stock price at that
time.
17
Amortization of stock-based compensation and the stockholder loan revaluation
consisted of the following (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
----------------------- ----------------------
2002 2001 2002 2001
----------- ---------- ---------- ----------
Cost of revenues:
Solutions
Stock-based charges $ 138 $ 394 $ - $ 1,760
Operating expenses
Sales and marketing
Stock-based charges 448 578 423 5,480
Stockholders' loan revaluation 99 - 1,980 -
Research and development
Stock-based charges (629) 671 (258) 3,627
Stockholders' loan revaluation 166 - 1,569 -
General and administrative
Stock-based charges 1,452 2,220 3,866 9,638
Stockholders' loan revaluation 445 - 3,571 -
----------- ---------- ---------- ----------
Totals $ 2,119 $ 3,863 $ 11,151 $ 20,505
=========== ========== ========== ==========
AMORTIZATION OF GOODWILL AND OTHER INTANGIBLE ASSETS. In connection with the
acquisition of certain assets of Vivant! Corporation on June 29, 2001, and, with
the assistance of an independent valuation, we recorded $2.2 million for
developed technology, $717,000 for goodwill and $187,000 for acquired workforce.
Additionally, in connection with the acquisition of InfoWide, Inc., on March 31,
2000, we recorded $32.6 million in goodwill, purchased technology and other
intangible assets including in-process technology of $3.1 million. During the
quarter ended June 30, 2001, our goodwill and other intangibles were
substantially reduced because of the write-off of $18.1 million resulting from
the impairment of all the intangible assets that remained from the InfoWide
acquisition. As a result of the acquisition of Vivant and the write-off of
InfoWide, charges for the amortization of goodwill and other intangible assets
declined to $359,000 for the quarter ended March 31, 2002, from $2.7 million for
the three months ended March 31, 2001. We recorded charges for amortization of
goodwill and other intangible assets of $1.2 million and $8.0 million for the
nine months ended March 31, 2002 and March 31, 2001, respectively. We amortize
goodwill and other intangible assets over periods not exceeding thirty-six
months.
We will adopt SFAS No. 142 effective July 1, 2002, which will result, among
other items, in no longer amortizing our existing goodwill. Other than goodwill
and acquired workforce in place, which will be subsumed into goodwill on
adoption, all identifiable intangible assets will continue to be amortized in
accordance with SFAS No. 142. We are currently reviewing the impact of the
adoption of SFAS No. 142, including the transition impairment tests. The
impairment, if any, resulting from these transition tests will be recorded in
the period it is determined and will be recognized as the cumulative effect of a
change in accounting principle.
RESTRUCTURING CHARGES, NET. We incurred restructuring charges in connection
with cost reductions implemented in the quarter ended June 30, 2001 through the
quarter ended December 31, 2001. For the three months ended March 31, 2002, we
recorded a reversal of $21,000 as a result of the sale of fixed assets
previously written-off. For the nine months ended March 31, 2002, we recorded
net restructuring charges of $583,000. These charges were comprised of
severance and related benefit charges of $1.8 million, the impairment of certain
fixed assets of $605,000 and a net reversal of $1.8 million of facilities
charges resulting from the reversal of previously accrued charges of $2.2
million relating to excess headquarters' space, partially offset by $316,000
relating to the closure of our India research facility.
18
OTHER INCOME (EXPENSE), NET. Other income (expense), net was $1.6 million and
$446,000 for the quarter ended March 31, 2002 and 2001, respectively. The
increase resulted primarily from the recovery of common stock warrant charges of
$1.7 million recorded in the prior quarter and partially offset by a decline in
interest income because of our reduced cash balance and lower bank interest
rates, which resulted in a $542,000 interest income reduction. Other income
(expense), net was $101,000 and $2.2 million for the nine months ended March 31,
2002 and 2001, respectively. The decrease resulted primarily from a $2.1
million reduction in interest income.
BENEFICIAL CONVERSION OF PREFERRED STOCK. We recorded a dividend charge of
$212,000 for the quarter ended March 31, 2002, in respect of a beneficial
conversion feature associated with the sale of 1,300,000 shares of our Series A
Preferred Stock in October 2001. The remaining beneficial conversion feature
balance of $579,000 will be amortized evenly over each of the next two quarters.
LIQUIDITY AND CAPITAL RESOURCES
Net cash used in operating activities for the nine months ended March 31, 2002,
was $23.3 million compared with net cash used for operating activities of $40.4
million for the same prior year period. Cash used for operating activities for
the nine months ended March 31, 2002, resulted primarily from a net loss of
$34.4 million and a net decrease in assets and liabilities of $5.1 million,
partially offset by stock-based charges and write-down of stockholder loans of
$11.2 million, amortization and depreciation of $3.9 million, and restructuring
charges of $1.1 million. Cash used for operating activities for the nine months
ended March 31, 2001, resulted primarily from a net loss of $67.5 and a net
decrease in assets and liabilities of $4.3 million, offset by amortization and
depreciation of $10.8 million and stock-based charges of $20.5 million.
Net cash used by investing activities for the nine months ended March 31, 2002,
was $252,000 compared with net cash used by investing activities of $14.3
million for the same prior year period. Cash used by investing activities for
the nine months ended March 31, 2002, resulted primarily from the purchase of
short-term investments of $532,000 and a commitment of restricted cash of $2.9
million to support our Emeryville lease, partially offset by the maturity of
$3.4 million of short-term investments. Cash used by investing activities for
the nine months ended March 31, 2001, resulted primarily from the purchase of
$22.0 million of short-term investments, the purchase of property and equipment
of $8.1 million and the purchase of intangibles of $700,000, partially offset by
the maturity of $14.5 million of short-term investments and the release of
restricted cash of $2.0 million related to our Emeryville lease.
Net cash provided by financing activities for the nine months ended March 31,
2002, was $15.9 million compared with net cash provided by financing activities
of $62.0 million for the same prior year period. Cash provided from financing
activities for the nine months ended March 31, 2002, resulted primarily from the
net proceeds of preferred stock issuances of $17.9 million, partially offset by
principal payments on our bank credit facility of $1.6 million and payments of
capital lease obligations of $476,000. Net cash provided by financing
activities for the nine months ended March 31, 2001, resulted principally from
the net proceeds of our initial public offering of $46.5 million and to a lesser
extent preferred and common stock issuances of $15.2 million, proceeds from debt
issuance of $4.8 million, partially offset by debt repayments of $4.0 million
and capital lease obligations of $539,000.
At March 31, 2002, we had cash and cash equivalents of $12.2 million and $2.9
million in long-term restricted cash. Pursuant to the term loan facility, we are
required to meet certain financial covenants, including maintaining a minimum
balance of $8.0 million in cash and cash equivalents, including restricted cash.
On November 13, 2001, we revised an existing credit arrangement and signed an
amended Loan and Security Agreement to restructure our excess credit facilities,
to obtain a waiver of certain defaults under the credit arrangement and to
reduce the line-of-credit to $2.9 million and the term loan credit facility to
$4.4 million with interest accruing at the rate of the bank's prime rate plus
0.75% and 1.00%, respectively. At March 31, 2002, these rates were 5.50% and
5.75%, respectively. As of March 31, 2002, we had utilized $4.8 million of the
term loan credit facility and had repaid $1.6 million. The loan will be fully
repaid by July 1, 2003. Both the line-of-credit and the term loan credit
facility are collateralized by all of our assets, including intellectual
property, except for previously leased equipment. In connection with the loan
amendment the bank approved new financial covenants for the periods commencing
October 1, 2001. Under these covenants, we are required to: (1) maintain at
all times a minimum bank liquidity ratio of 1.50 to 1.00, reducing to a ratio of
1.25 to 1.00 on January 31, 2002, (the cash component of this ratio is required
to be held at the bank); (2) beginning with the month ending December 31, 2001,
maintain on a monthly basis the greater of (a) a minimum company liquidity ratio
of 1.75 to 1.00 or (b) $14,000,000 in unrestricted cash (unrestricted cash will
include any restricted cash held by the bank) reducing to $8,000,000 on January
31, 2002; (3) beginning with the month ending December 31, 2001, not exceed a
leverage maximum of 2.25 to 1.00; and (4) meet a milestone covenant of obtaining
at least $10,000,000 in new equity from investors acceptable to the bank by
October 15, 2001.
19
We were in violation of the maximum leverage ratio financial covenant from
December 2001 through February 2002. However, we received a waiver of all
defaults in March 2002. On April 19, 2002, we signed a first amendment to the
amended and restated Loan and Security Agreement, which amended certain
financial covenants. In connection with the amendment, the bank approved new
financial covenants commencing April 1, 2002. Under the new covenants, we are
required to: (1) maintain at all times a minimum bank liquidity ratio of not
less than 1.25 to 1.00; (2) maintain, at all times, unrestricted cash
(unrestricted cash will include any restricted cash held by the bank) of not
less then $8,000,000; and (3) maintain minimum revenue targets which increase
quarterly.
At March 31, 2002, we were in compliance with all amended covenants. Based on
our current operating plan, we believe we will maintain compliance with the
foregoing covenants in the foreseeable future.
We have a facility lease agreement for our Emeryville headquarters, which
commenced upon possession of the facility in July 2000 and has a term of seven
years. As part of this agreement, we are required to maintain a
letter-of-credit in favor of the lessor totaling approximately $2.9 million,
collateralized by an equal amount of cash deposits, which we have classified as
restricted cash.
Future minimum lease payments under our headquarters' lease, including those
previously accrued under restructuring charges, and minimum required payments
under our bank facility were as follows as of March 31, 2002 (in thousands):
HEADQUARTERS' BANK
YEAR ENDED JUNE 30, LEASE FACILITY TOTAL
------------------- -------------- --------- -------
2002-Q4 $ 621 $ 594 $ 1,215
2003 2,530 2,376 4,906
2004 1,260 198 1,458
2005 1,259 - 1,259
2006 1,295 - 1,295
2007 1,332 - 1,332
2008 74 - 74
------------------- -------------- --------- -------
TOTAL PAYMENTS $ 8,371 $ 3,168 $11,539
=================== ============== ========= =======
We believe that cash from operations and existing cash will be sufficient to
meet our current expectations for working capital and expense requirements
through the end of the current fiscal year.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The discussion and analysis of our financial condition and results of operations
are based upon our consolidated financial statements, which have been prepared
in accordance with generally accepted accounting principles. The preparation of
these financial statements requires us to make estimates and judgments that
affect the reported amounts of assets, liabilities, revenues and expenses, and
related disclosure of contingent assets and liabilities. On an on-going basis,
we evaluate our estimates. We base our estimates on historical experience and
on various other assumptions that we believe to be reasonable under the
circumstances. Actual results may differ from these estimates under different
assumptions or conditions.
We believe that the following are critical accounting policies and estimates
used in the preparation of our condensed consolidated financial statements.
REVENUE RECOGNITION
We derive revenues from fees for licenses and implementation services
("Solutions revenue") and fees from maintenance, application service provider
("ASP") and subscription agreements ("Subscriptions revenue"). We recognize
revenues in accordance with the provisions of American Institute of Certified
Public Accountants (AICPA) Statement of Position (SOP) 97-2, "Software Revenue
Recognition." We also follow the provisions of the Securities Exchange
Commission's Staff Accounting Bulletin No. 101 (SAB 101), "Revenue Recognition
in Financial Statements."
20
Under SOP 97-2 as amended, we recognize revenues when all of the following
conditions are met:
- when persuasive evidence of a customer agreement exists;
- the delivery of the product or service subject to the agreement has
occurred;
- the associated fees are fixed or determinable; and
- we believe that collection of these fees is reasonably assured.
We have established vendor specific objective evidence of fair value for certain
services. Our implementation services are considered essential to the
functionality of our software because we do not have significant experience of
third party consultants implementing our software at customer sites. We are
investing in our partner strategy and expect, in the near future, to have our
customers to have the ability to purchase implementation services from trained
and certified partners. In the meantime, our implementation services are
essential to the functionality of the software and, for those contracts where
the services are reasonably estimable, the license and services revenue is
recognized over the period of each implementation, primarily using the
percentage-of-completion method. Labor hours incurred are used as the measure
of progress towards completion. A provision for estimated losses on engagements
is made in the period in which the loss becomes probable and can be reasonably
estimated. In the future, if our implementation services are no longer
considered essential to the functionality of the license, our revenue
recognition will be accelerated under these arrangements with license revenue
being recorded upon delivery assuming all other criteria are met. In cases
where a sale of a license does not include implementation services (e.g., a sale
of additional seats or a sale of product to be implemented by a third party),
revenue is recorded upon delivery with an appropriate deferral for maintenance
services, if applicable, provided all of the other relevant conditions have been
met.
We do not recognize revenue for refundable fees or agreements with cancellation
rights until such rights to refund or cancellation have expired.
Our customer agreements typically include arrangements for maintenance services
to be provided by us. Generally, we have vendor specific objective evidence of
fair value for the maintenance element of software arrangements based on the
renewal rates for maintenance in future years as specified in the contracts. In
those cases where first year maintenance revenue is included in the license fee,
we defer the fair value of the first year maintenance revenue at the outset of
the arrangement and recognize it ratably over the period during which the
maintenance is to be provided, which is generally twelve months.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
We make estimates as to the overall collectibility of accounts receivable and
provide an allowance for amounts deemed to be uncollectible. Specifically, we
analyze our accounts receivable and historical bad debt pattern, customer
concentrations, customer credit-worthiness, current economic and industry trends
and changes in our customer payment terms when evaluating the adequacy of our
allowance for doubtful accounts. We will continue to monitor our customers'
ability to pay throughout the term of the applicable arrangements and will
adjust the provision for bad debt allowance or defer revenue recognition, as
appropriate. These estimates could change if actual results differ materially
from those estimates based on more accurate information in the future.
CONTINGENCIES
Because of the uncertainties related to both the amount and range of loss on the
remaining pending litigation we are unable, at this time, to determine whether
the outcome of the litigation will have a material impact on our results of
operations or financial condition in any future period. As additional
information becomes available, we will assess the potential liability related to
our pending litigation.
GOODWILL AND OTHER INTANGIBLE ASSETS
We are required to regularly review all of our long-lived assets, including
goodwill and other intangible assets, for impairment whenever events or changes
in circumstances indicate that the carrying value may not be recoverable.
Factors we consider important which could trigger an impairment review include,
but are not limited to, significant underperformance relative to historical or
projected future operating results, significant changes in the manner of use of
the acquired assets or the strategy for our overall business, significant
negative industry or economic trends, a significant decline in our stock price
for a sustained period and our market capitalization relative to net book value.
When we determine that an impairment review is necessary based upon the
existence of one or more of the above indicators of impairment, we measure any
impairment based on a projected discounted cash flow method using a discount
rate commensurate with the risk inherent in its current business model.
21
Significant judgment is required in the development of projected cash flows for
these purposes including assumptions regarding the appropriate level of
aggregation of cash flows, their term and discount rate as well as the
underlying forecasts of expected future revenue and expense. We have recorded
significant impairment charges for goodwill and intangible assets in the past
and to the extent that events or circumstances cause our assumptions to change,
additional charges may be required which could be material. As of March 31,
2002, we are carrying balances of $538,000 relating to goodwill, $2.0 million
relating to acquired technologies, and $47,000 relating to other intangible
assets.
We will adopt SFAS No. 142 effective July 1, 2002, which will result, among
other items, in no longer amortizing our existing goodwill. Other than goodwill
and acquired workforce in place, which will be subsumed into goodwill on
adoption, all identifiable intangible assets will continue to be amortized in
accordance with SFAS No. 142. We are currently reviewing the impact of the
adoption of SFAS No. 142, including the transition impairment tests. The
impairment, if any, resulting from these transition tests will be recorded in
the period it is determined and will be recognized as the cumulative effect of a
change in accounting principle.
ACCOUNTING FOR INCOME TAXES
Significant management judgment is required in determining our provision for
income taxes, deferred tax assets and liabilities and any valuation allowance
recorded against net deferred tax assets. We have recorded a valuation
allowance due to uncertainties related to our ability to utilize our deferred
tax assets, primarily consisting of certain net operating losses carried
forward, before they expire. The valuation allowance is based on estimates of
taxable income by jurisdiction in which we operate and the period over which
these deferred tax assets will be recoverable. Should we determine that we
would be able to realize our deferred tax asset in the foreseeable future, an
adjustment to the deferred tax asset would increase income in the period such
determination was made.
22
FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS
OUR FUTURE OPERATING RESULTS MAY NOT MEET OUR CURRENT EXPECTATIONS DUE TO MANY
FACTORS, AND ANY OF THESE COULD CAUSE OUR STOCK PRICE TO FALL.
We believe that year-over-year comparisons of our operating results are not a
good indication of future performance. It is likely that in some future years
our operating results may be below the expectations of public market analysts
and investors because of factors beyond our control and, as a result, the price
of our common stock may fall.
Factors that may cause our future operating results to be below expectations and
cause our stock price to fall include:
- the lack of demand for and acceptance of our products, product
enhancements and services; for instance, as we expand our target
customer focus beyond the information technology service consultancies
and into internal information technology of corporate customers as
well as into overseas markets, we may encounter increased resistance
to adoption of our business process automation solutions;
- unexpected changes in the development, introduction, timing and
competitive pricing of our products and services or those of our
competitors;
- any inability to expand our direct sales force and indirect marketing
channels both domestically and internationally;
- difficulties in recruiting and retaining key personnel;
- lengthening of our sales cycles;
- unforeseen reductions or reallocations of our customers' information
technology infrastructure budgets; and
- any delays or unforeseen costs incurred in integrating technologies
and businesses we may acquire.
We plan to aggressively and prudently manage our operating expenses with a focus
on our research and development organization and our direct sales group. Our
operating expenses are based on our expectations of future revenues and are
relatively fixed in the short-term. If revenues fall below our expectations in
any quarter, and we are not able to quickly reduce our spending in response, our
operating results for that quarter would be lower than expected, and our stock
price may fall.
WE MAY NEED ADDITIONAL CAPITAL TO FUND CONTINUED BUSINESS OPERATIONS AT THEIR
CURRENT LEVELS IN FISCAL 2003 AND SUCH FINANCING MAY NOT BE AVAILABLE ON
FAVORABLE TERMS, IF AT ALL.
We may require additional capital to fund our business operations. The rate at
which our capital is utilized is affected by the level of our fixed expenses
(including employee related expenses and expenses relating to real estate) and
variable expenses. Substantial capital has been used to fund our operating
losses. Since inception, we have experienced negative cash flows from
operations and expect to experience negative cash flows from operations in the
near term. As a result, we may require additional financing to meet our
operating requirements. Of our cash and cash equivalents balance of $12.2
million, $3.2 million is held under a term loan facility. The term loan
facility could be called by the lender, if we do not meet certain financial
covenants, including a minimum cash balance covenant. If we must seek
additional capital investment, we cannot assure that such capital will be
available on acceptable terms, if at all. Additional capital may be required if
one or more of the following occur:
- our revenues from the sale of our products may fall below our current
expectations because of the current economic slowdown or otherwise.
- forecasted cash collections from customers may decline if some of our
customers become insolvent or encounter financial difficulties.
- we may be unable to comply with the financial and other covenants
required under our existing credit facilities, and these credit
facilities may be withdrawn as a result.
- we may encounter opportunities that we wish to pursue to acquire other
businesses or technologies for cash consideration.
Any additional shares of our capital stock that we may issue in any financings
may result in additional dilution, which may be substantial. If we need
additional funds and cannot raise them on acceptable terms, we may not be able
to continue our operations at the current level or at all.
23
WE HAVE INCURRED LOSSES SINCE INCEPTION, AND WE MAY NOT BE ABLE TO ACHIEVE
PROFITABILITY.
We have incurred net losses and losses from operations since our inception in
1995, and we may not be able to achieve profitability in the future. As of
March 31, 2002, we had an accumulated deficit of approximately $250.7 million.
Since inception, we have funded our business primarily from the sale of our
stock and by borrowing funds, not from cash generated by our business. Despite
recent cost reductions, we expect to continue to incur significant sales and
marketing, research and development, and general and administrative expenses.
As is the case with many enterprise software companies, we experienced a severe
decline in revenues during the 2001 calendar year and we may experience further
declines or insufficient revenue growth in future periods. As a result, we
expect to experience continued losses and negative cash flows from operations.
If we do achieve profitability, we may not be able to sustain or increase
profitability on a quarterly or annual basis in the future.
REDUCTIONS IN CAPITAL SPENDING BY CORPORATIONS COULD REDUCE DEMAND FOR OUR
PRODUCTS.
Historically, corporations and other organizations have tended to reduce or
defer major capital expenditures in response to slower economic growth or
recession. Market analysts have observed a significant reduction in the growth
of corporate spending on information technology projects, which may be due to a
growing reluctance by prospective customers to commit to large-scale capital
expenditures for information technology projects or which may be in response to
the current economic slowdown. To the extent that such reduction is due to
customer wariness of investing in large-scale information technology projects,
we may experience further constraints on our ability to price our offerings at
forecasted levels, or we may have to offer payment terms, which would delay our
ability to recognize revenue. To the extent that current economic uncertainty
persists, some of the prospective customers in our current sales pipeline could
choose to postpone or reduce orders for our products, or may delay implementing
our solutions within their organizations. In addition, existing customers
seeking to reduce capital expenditures may cancel or postpone plans to expand
use of our products in additional operating divisions, or may defer plans to
purchase additional modules of our solutions. Any of the foregoing would have
an adverse impact on our revenues and our operating results, particularly if the
current period of volatility in the stock market and the general economy is
prolonged.
IF THE MARKET FOR PROCESS AUTOMATION SOLUTIONS FOR PROFESSIONAL SERVICES
ORGANIZATIONS AND OTHER STRATEGIC WORKFORCES DOES NOT CONTINUE TO GROW, THE
GROWTH OF OUR BUSINESS WILL NOT BE SUSTAINABLE.
The future growth and success of our business is contingent on growing
acceptance of, and demand for, business process automation solutions for
professional services organizations and other strategic workforces.
Substantially all of our historical revenues have been attributable to the sale
of automation solutions for professional services organizations. This is a
relatively new enterprise application solution category, and it is uncertain
whether major services organizations as well as service departments and internal
departments of major corporations will choose to adopt process automation
systems. While we have devoted significant resources to promoting market
awareness of our products and the problems our products address, we do not know
whether these efforts will be sufficient to support significant growth in the
market for process automation products. Accordingly, the market for our
products may not continue to grow or, even if the market does grow in the
immediate term, that growth may not be sustainable.
OUR MARKETS ARE HIGHLY COMPETITIVE, AND COMPETITION COULD HARM OUR ABILITY TO
SELL PRODUCTS AND SERVICES AND REDUCE OUR MARKET SHARE.
Competition could seriously harm our ability to sell additional software
solutions and subscriptions on prices and terms favorable to us. The markets
for our products are intensely competitive and subject to rapidly changing
technology. We currently compete against providers of automation solutions for
professional services organizations, such as Novient, Changepoint and Niku as
well as providers of enterprise application software such as Peoplesoft, Siebel
and Oracle. Companies in each of these areas may expand their technologies or
acquire companies to support greater professional services automation
functionality and capabilities. In addition, "in-house" information technology
departments of potential customers have developed or may develop systems that
substitute for some of the functionality of our product line.
Some of our competitors' products may be more effective than our products at
performing particular functions or be more customized for particular customer
needs. Even if these functions are more limited than those provided by our
products, our competitors' software products could discourage potential
customers from purchasing our products. A software product that provides some
of the functions of our software solutions, but also performs other tasks may be
appealing to these vendors' customers because it would reduce the number of
different types of software necessary to effectively run their businesses.
Further, many of our competitors may be able to respond more quickly than we can
to changes in customer requirements.
24
Some of our competitors have longer operating histories, significantly greater
financial, technical, marketing or other resources, or greater name recognition
than we do. This may cause potential customers to purchase their products even
if they provide inferior features or functionality. In addition, given their
greater resources, our competitors may be able to respond more quickly than we
can to new or emerging technologies and changes in customer requirements. Our
competitors have made and may also continue to make strategic acquisitions or
establish cooperative relationships among themselves or with other software
vendors. They may also establish or strengthen cooperative relationships with
our current or future partners, limiting our ability to promote our products
through these partners and limiting the number of consultants available to
implement our software.
OUR REVENUES DEPEND ON ORDERS FROM OUR TOP CUSTOMERS, AND IF WE FAIL TO SECURE
ONE OR MORE ORDERS, OUR REVENUES WILL BE REDUCED.
Historically, we have received a significant portion of our revenues in each
fiscal period from a small number of customers. Accordingly, the loss of a
single customer or customer prospect may have an impact on our operating results
if we depended on the sale of our products to that customer to meet our
financial performance targets during a given fiscal period. Our agreements with
existing customers often do not include long-term commitments from customers to
continue to purchase our products. Moreover, a substantial percentage of new
customer contracts are typically signed in the last few weeks of each fiscal
quarter, and prospects we are pursuing have often made a decision not to
purchase our products in the final stages of the sales cycle. Accordingly, our
ability to meet our financial targets during each fiscal period is subject to
substantial variation and uncertainty, and the loss of one or more customers or
customer prospects can cause our operating results to fall below the
expectations of investors and analysts and adversely affect our stock price.
THE LENGTHY AND UNPREDICTABLE SALES CYCLES FOR OUR PRODUCTS AND RESISTANCE TO
ADOPTION OF OUR SOFTWARE COULD CAUSE OUR OPERATING RESULTS TO FALL BELOW
EXPECTATIONS.
Our operating results for future periods could be adversely affected because of
unpredictable increases in our sales cycles. Our products and services have
lengthy and unpredictable sales cycles varying from as little as three months to
as much as nine months, which could cause our operating results to be below the
expectations of analysts and investors. Since we are unable to control many of
the factors that will influence our customers' buying decisions, it is difficult
for us to forecast the timing and recognition of revenues from sales of our
solutions.
Customers in our target market often take an extended time evaluating our
products before purchasing them. Our products may have an even longer sales
cycle in international markets. During the evaluation period, a variety of
factors, including the introduction of new products or aggressive discounting by
competitors and changes in our customers' budgets and purchasing priorities, may
lead customers to not purchase or to scale down orders for our products.
As we target industry sectors and types of organizations beyond our core market
of IT services consultancies, we may encounter increased resistance to use of
business process automation solutions, which may further increase the length of
our sales cycles, increase our marketing costs and reduce our revenues. Because
we are pioneering a new solution category, we often must educate our prospective
customers on the use and benefit of our solutions, which may cause additional
delays during the evaluation process. These companies may be reluctant to
abandon investments they have made in other systems in favor of our solution.
In addition, IT departments of potential customers may resist purchasing our
solutions for a variety of other reasons, particularly the potential
displacement of their historical role in creating and running software, and
concerns that packaged software products are not sufficiently customizable for
their enterprises.
WE MUST DIVERSIFY OUR CUSTOMER BASE IN ORDER TO ENHANCE OUR REVENUE AND MEET OUR
GROWTH TARGETS.
We have historically derived a substantial percentage of our revenues from sales
of our products and services to firms that provide technology-oriented
consulting, design and integration services, including a number of firms
specializing in Website design and e-commerce application development. Growth
among these "e-business" consultancies has slowed dramatically, and many such
firms have ceased operations or have encountered substantial difficulties in
raising capital to fund their operations. In anticipation of these
developments, we commenced a program to aggressively diversify our client base,
targeting both established consulting services companies and in-house service
departments of large corporations. While we have recorded a number of
significant customer wins in these areas, we may, in the future, encounter
25
significant challenges in further expanding our customer base. More established
corporations are often more reluctant to implement innovative enterprise
technologies such as ours, in part because they often have made substantial
investments in legacy applications and information systems. We may also
encounter extended sales cycles with such prospective customers, and slower
rates of adoption of our solutions within their organizations. All of these
factors may adversely affect our ability to sustain our revenue growth and
attain profitable operations.
FINANCIAL DIFFICULTIES OF SOME OF OUR CUSTOMERS MAY ADVERSELY AFFECT OUR
OPERATING RESULTS.
Some of our customers may encounter difficulties in securing additional
financing to meet their obligations, or may seek to limit expenditures to
conserve their cash resources. As a result, we may encounter difficulties in
securing payment of certain customer obligations, when due, and may be compelled
to increase our bad debt reserves. Any difficulties encountered in collections
from customers would also adversely affect our cash flow, and would adversely
impact our operating results.
WE MAY LOSE EXISTING CUSTOMERS, OR BE UNABLE TO ATTRACT NEW CUSTOMERS, IF WE DO
NOT DEVELOP NEW PRODUCTS OR ENHANCE OUR EXISTING PRODUCTS.
If we are not able to maintain and improve our product-line and develop new
products, we may lose existing customers or be unable to attract new customers.
We may not be successful in developing and marketing product enhancements or new
products on a timely or cost-effective basis. These products, if developed, may
not achieve market acceptance.
A limited number of our customers expect us to develop product enhancements that
may address their specific needs. If we fail to deliver these enhancements on
a timely basis, we risk damaging our relationship with these customers. We have
experienced delays in the past in releasing new products and product
enhancements and may experience similar delays in the future. These delays or
problems in the installation or implementation of our new releases may cause
some of these customers to forego additional purchases of our products or to
purchase those of our competitors.
WE MAY NOT BE ABLE TO INCREASE OUR REVENUES OR MANAGE OUR OPERATING EXPENDITURES
AND WE MAY NEED TO IMPLEMENT ADDITIONAL RESTRUCTURING ACTIVITIES.
We are attempting to increase our revenues through marketing initiatives as well
as increasing the scope of our customer base to include Global 2000 companies
and internal IT organizations. We will need this revenue growth to meet our
cash flow breakeven targets. Because of market uncertainties and a highly
competitive environment, we cannot be certain we will achieve these targets.
In response to the current uncertain economic environment and volatility in the
public equity markets, we implemented significant measures designed to reduce
our operating expenses and enhance our ability to attain operating
profitability. For example, from the quarter ended March 31, 2001 compared with
the quarter ended March 31, 2002, we reduced our non stock-based recurring
departmental expenses 64% from $25.1 million to $8.9 million.
In order to achieve operating profitability, we will need to achieve our revenue
growth targets and maintain the foregoing cost savings in future quarters. If
our revenue growth targets cannot be achieved, we would be forced to seek
expense reductions, which may not be achievable. Any of these developments
could impede our ability to achieve profitable operations.
WE REDUCED OUR WORKFORCE DURING CALENDAR YEAR 2001, AND, IF WE FAIL TO MANAGE
THIS REDUCTION IN WORKFORCE, OUR ABILITY TO GENERATE NEW REVENUE, ACHIEVE
PROFITABILITY AND SATISFY OUR CUSTOMERS COULD BE HARMED.
We reduced our workforce during calendar year 2001 after growing significantly
the first half of fiscal year 2001 and in previous years. Any failure to manage
this reduction in workforce could impede our ability to increase revenues and
achieve profitability. We reduced our number of employees from 326 at June 30,
2000, to 131 as of March 31, 2002.
Since we reduced our sales force headcount in order to reduce expenses, our
sales capacity is reduced which may impact our revenue growth and our ability to
attract qualified sales professionals for future expansion. Since we reduced
our service employee headcount, including our consulting services, training and
technical support personnel, we may not be able to provide the same level of
customer responsiveness or expertise, and customer satisfaction may be impacted
as a result.
26
In order to manage our reduced workforce, we must:
- hire, train and integrate new personnel in response to attrition;
- continue to augment our management information systems;
- manage our sales and services operations, which are in several
locations; and
- expand and improve our systems and facilities.
ANY INABILITY TO RETAIN SENIOR EXECUTIVE OFFICERS AND ADDITIONAL PERSONNEL COULD
AFFECT OUR ABILITY TO SUCCESSFULLY GROW OUR BUSINESS.
Our future performance will depend, in significant measure, on the ability of
our recently appointed executive officers to work effectively with other members
of our management team as well as key employees, customers and partners. In
addition, if we are unable to hire and retain a sufficient number of qualified
personnel, particularly in sales, marketing, research and development, services
and support, our ability to grow our business could be affected. The loss of
the services of our key engineering, sales, services or marketing personnel
would harm our operations. For instance, loss of sales and customer service
representatives could harm our relationship with the customers they serve, loss
of engineers and development personnel could impede the development of product
releases and enhancements and decrease our competitiveness, and departure of
senior management personnel could result in a loss of confidence in our company
by customers, suppliers and partners. None of our key personnel is bound by an
employment agreement, and we do not maintain key person insurance on any of our
employees. Because we, like many other technology companies, rely on stock
options as a component of our employee compensation, if the market price of our
common stock decreases or increases substantially, some current or potential
employees may perceive our equity incentives as less attractive. In that case,
our ability to attract and retain employees may be adversely affected.
IF WE FAIL TO EXPAND OUR RELATIONSHIPS WITH THIRD-PARTY RESELLERS AND
INTEGRATORS, OUR ABILITY TO GROW REVENUES COULD BE HARMED.
In order to grow our business, we must establish, maintain and strengthen
relationships with third-parties, such as information technology ("IT")
consultants and systems integrators as implementation and resell partners, and
hardware and software vendors as marketing partners. If these parties do not
provide sufficient, high-quality service or integrate and support our software
correctly, our revenues may be harmed. In addition, these parties may offer
products of other companies, including products that compete with our products.
Our contracts with third-parties may not require these third-parties to devote
resources to promoting, selling and supporting our solutions. Therefore, we may
have little control over these third-parties. We cannot assure you that we can
generate and maintain relationships that offset the significant time and effort
that are necessary to develop these relationships, or that, even if we are able
to develop such relationships, these third-parties will perform adequately.
OUR SERVICES REVENUES HAVE A SUBSTANTIALLY LOWER MARGIN THAN OUR SOFTWARE
LICENSE REVENUES, AND AN INCREASE IN SERVICES REVENUES RELATIVE TO LICENSE
REVENUES COULD HARM OUR GROSS MARGINS.
A significant shift in our revenue mix away from license revenues to service
revenues would adversely affect our gross margins. Revenues derived from the
services we provide have substantially lower gross margins than revenues we
derive from licensing our software. The relative contribution of services we
provide to our overall revenues is subject to significant variation based on the
structure and pricing of arrangements we enter into with customers in the
future, and the extent to which our partners provide implementation,
integration, training and maintenance services required by our customers. An
increase in the percentage of total revenues generated by the services we
provide could adversely affect our overall gross margins.
IF OUR PRODUCTS CONTAIN SIGNIFICANT DEFECTS OR OUR SERVICES ARE NOT PERCEIVED AS
HIGH QUALITY, WE COULD LOSE POTENTIAL CUSTOMERS OR BE SUBJECT TO DAMAGES.
Our products are complex and may contain currently unknown errors, defects,
integration problems or other types of failures, particularly since new versions
are frequently released. In the past we have discovered software errors in some
of our products after introduction. We may not be able to detect and correct
errors before releasing our products commercially. If our commercial products
contain errors, we may:
- need to expend significant resources to locate and correct the errors;
- be required to delay introduction of new products or commercial
shipment of products; or
- experience reduced sales and harm to our reputation from dissatisfied
customers.
27
Our customers also may encounter system configuration problems that require us
to spend additional consulting or support resources to resolve these problems.
Some of our customers have indicated to us that they want a completely
integrated solution, including a single user interface and single database
platform. While our product roadmap calls for such an integrated solution, any
delays in delivering such a solution to our customers may cause them to
downgrade their opinion of our software or to abandon our software.
Because our customers use our software products for critical operational and
decision-making processes, product defects may also give rise to product
liability claims. Although our license agreements with customers typically
contain provisions designed to limit our exposure, some courts may not enforce
all or part of these limitations. Although we have not experienced any product
liability claims to date, we may encounter these claims in the future. Product
liability claims, whether or not they have merit, could:
- divert the attention of our management and key personnel from our
business;
- be expensive to defend; and
- result in large damage awards.
We do not have product liability insurance, and even if we obtain product
liability insurance, it may not be adequate to cover all of the expenses
resulting from such a claim.
THE COST AND DIFFICULTIES OF IMPLEMENTING OUR PRODUCTS COULD SIGNIFICANTLY HARM
OUR REPUTATION WITH CUSTOMERS AND HARM OUR FUTURE SALES.
If our customers encounter unforeseen difficulties or delays in deploying our
products and integrating them with their other systems, they may reverse their
decision to use our solutions, which would reduce our future revenues, could
impact the collection of outstanding receivables, and potentially damage our
reputation. Factors that could delay or complicate the process of deploying our
solutions include:
- customers may need to modify significant elements of their existing IT
systems in order to effectively integrate them with our solutions;
- customers may need to establish and implement internal business
processes within their organizations before they can make effective
use of our software;
- customers may need to purchase and deploy significant additional
hardware and software resources and may need to make significant
investments in consulting and training services; and
- customers may rely on third-party systems integrators to perform all
or a portion of the deployment and integration work, which reduces the
control we have over the implementation process and the quality of
customer service provided to the customer.
IF OUR PRODUCTS DO NOT STAY COMPATIBLE WITH WIDELY USED SOFTWARE PROGRAMS, OUR
REVENUES MAY BE ADVERSELY AFFECTED.
Our software products must work with widely used software programs. If these
software programs and operating environments do not remain widely used, or we do
not update our software to be compatible with newer versions of these programs
and systems, we may lose customers.
Our software operates only on a computer server running both the Microsoft
Windows NT or Sun Solaris operating system and database software from Microsoft
or Oracle. In order to increase the flexibility of our solution and expand our
client base, we must be able to successfully adapt it to work with other
applications and operating systems.
Our software connects to and uses data from a variety of our customers' existing
software systems, including systems from Oracle and SAP. If we fail to enhance
our software to connect to and use data from new systems of these products, we
may lose potential customers.
OUR BUSINESS MAY SUFFER IF WE ARE NOT ABLE TO PROTECT OUR INTELLECTUAL PROPERTY.
Our success is dependent on our ability to develop and protect our proprietary
technology and intellectual property rights. We seek to protect our software,
documentation and other written materials primarily through a combination of
patent, trade secret, trademark and copyright laws, confidentiality procedures
and contractual provisions. While we have attempted to safeguard and maintain
our proprietary rights, we do not know whether we have been or will be
completely successful in doing so. Further, our competitors may independently
develop or patent technologies that are equivalent or superior to ours.
28
We have been issued a patent in the United States covering the enablement of
dynamically configurable software systems by our Evolve software server. We
also have two patent applications pending in the United States with respect to
the "Team Builder" functionality in our Resource Manager module and the time and
expense functionality of our Time and Expense module. There can be no assurance
that either of these two applications would survive a legal challenge to its
validity or provide significant protection to us. Despite our efforts to
protect our proprietary rights, unauthorized parties may attempt to copy aspects
of our products or obtain and use information that we regard as proprietary.
Policing unauthorized use of our products is difficult. While we are unable to
determine the extent to which piracy of our software products exists, software
piracy can be expected to be a persistent problem, particularly in foreign
countries where the laws may not protect proprietary rights as fully as in the
United States. We can offer no assurance that our means of protecting its
proprietary rights will be adequate or that our competitors will not reverse
engineer or independently develop similar technology.
IF OTHERS CLAIM THAT WE ARE INFRINGING THEIR INTELLECTUAL PROPERTY, WE COULD
INCUR SIGNIFICANT EXPENSES OR BE PREVENTED FROM SELLING OUR PRODUCTS.
We cannot provide assurance that others will not claim that we are infringing
their intellectual property rights or that we do not in fact infringe those
intellectual property rights. We have not conducted a search for existing
intellectual property registrations, and we may be unaware of intellectual
property rights of others that may cover some of our technology.
Any litigation regarding intellectual property rights could be costly and
time-consuming and divert the attention of our management and key personnel from
our business operations. The complexity of the technology involved and the
uncertainty of intellectual property litigation increase these risks. Claims of
intellectual property infringement might also require us to enter into costly
royalty or license agreements.
We may not be able to obtain royalty or license agreements on terms acceptable
to us, or at all. We also may be subject to significant damages or an
injunction against use of our products. A successful claim of patent or other
intellectual property infringement against us would have an immediate material
adverse effect on our business and financial condition.
WE CONTINUE TO OPERATE INTERNATIONALLY, BUT WE MAY ENCOUNTER A NUMBER OF
PROBLEMS IN DOING SO WHICH COULD LIMIT OUR FUTURE GROWTH.
We may not be able to successfully market, sell, deliver and support our
products and services internationally. Any failure to build and manage
effective international operations could limit the future growth of our
business. Expansion into international markets will require significant
management attention and financial resources to open additional international
offices and hire international sales and support personnel. Localizing our
products is difficult and may take longer than we anticipate because of
difficulties in translation and delays we may experience in recruiting and
training international staff. We are in the process of enhancing local versions
of our products, and we have limited experience in marketing, selling and
supporting our products and services overseas. Doing business internationally
involves greater expense and many additional risks, particularly:
- differences and unexpected changes in regulatory requirements, taxes,
trade laws, tariffs, intellectual property rights and labor
regulations;
- changes in a specific country's or region's political or economic
conditions;
- greater difficulty in establishing, staffing and managing foreign
operations; and
- fluctuating exchange rates.
SECURITY CONCERNS, PARTICULARLY RELATED TO THE USE OF OUR SOFTWARE ON THE
INTERNET, MAY LIMIT THE EFFECTIVENESS OF AND REDUCE THE DEMAND FOR OUR PRODUCTS.
Despite our efforts to protect the confidential and proprietary information of
our customers stored on our Evolve ASP solution via virtual private networks and
other security devices, there is a risk that this information will be disclosed
to unintended third-party recipients. To the extent our ability to implement
secure private networks, on our Evolve ASP service, is impaired by technical
problems, or by improper or incomplete procedural diligence by either ourselves
or our customers, sensitive information could be exposed to inappropriate
third-parties such as competitors of our customers, which may in turn expose us
to liability and detrimentally impact our customers' confidence in our ASP
service.
29
DIFFICULTIES WITH THIRD-PARTY SERVICES AND TECHNOLOGIES, AS WELL AS POWER
INTERRUPTIONS, COULD DISRUPT OUR BUSINESS, AND MANY OF OUR COMMUNICATION AND
HOSTING SYSTEMS DO NOT HAVE BACKUP SYSTEMS.
Many of our communications and hosting systems do not have backup systems
capable of mitigating the effect of service disruptions. This requires that we
provide continuous and error-free access to our systems and network
infrastructure. We rely on third-parties to provide key components of our
networks and systems. For instance, we rely on third-party Internet service
providers to host applications for our customers who purchased our solutions on
an ASP basis. We also rely on third-party communications services providers for
the high-speed connections that link our Web servers and office systems to the
Internet. Any Internet or communications systems failure or interruption could
result in disruption of our service or loss or compromise of customer orders and
data. These failures, especially if they are prolonged or repeated, would make
our services less attractive to customers and tarnish our reputation.
RESISTANCE TO ONLINE USE OF PERSONAL INFORMATION REGARDING EMPLOYEES AND
CONSULTANTS MAY HINDER THE EFFECTIVENESS OF AND REDUCE DEMAND FOR OUR PRODUCTS
AND SERVICES.
Companies store information on our ASP offering and on online networks created
by our customers, which may include personal information of their employees,
including employee backgrounds, skills, and other details. These employees may
object to online compilation, transmission and storage of such information. To
the extent that European companies and customers will have access to it (given
the global nature of the Internet), and to the extent that our services are
utilized by Europeans, legal action grounded in European privacy laws could
prevent our solution from succeeding in the European market.
RISKS RELATED TO OUR STOCK
OUR OFFICERS, DIRECTORS AND AFFILIATED ENTITIES HAVE SIGNIFICANT CONTROL OVER US
AND MAY APPROVE OR REJECT MATTERS CONTRARY TO YOUR VOTE OR INTERESTS.
As of April 30, 2002, our executive officers and directors together with their
affiliates beneficially own, or have rights to acquire, an aggregate of
approximately 67.3% of our outstanding capital stock. These stockholders, if
acting together, will be able to significantly influence all matters requiring
approval by our stockholders, including the election of directors and the
approval of mergers or similar transactions, even if other stockholders
disagree. In particular, Warburg Pincus Private Equity VIII, L.P. ("Warburg")
owns or has the right to acquire securities with voting power equivalent to
52.7% of our outstanding capital stock. Furthermore, certain actions that we
may wish to undertake require the consent of holders of a majority of our
outstanding shares of Series A Preferred Stock, voting as a separate class.
These actions include authorization and sale of certain senior securities,
certain transactions involving a change of control of Evolve, the incurrence of
significant indebtedness and the payment of dividends. With respect to these
and other matters, the interests of the holders of our Series A Preferred Stock
will not necessarily be identical to those of holders of our common stock. For
instance, in the event of certain change of control transactions, the holders of
Series A Preferred Stock are entitled to payment of a liquidation preference
prior to payment of any consideration to the holders of our common stock. This
may cause the holders of Series A Preferred Stock generally, and Warburg in
particular, to favor or oppose a merger or sale of the Company or its assets in
circumstances where many holders of common stock have a contrary desire. In
such an instance, we may not be able to pursue a transaction even if it is
supported by many or most holders of our common stock. Alternatively, we may
pursue a transaction that is not supported by, or may be detrimental to, the
holders of our common stock.
THE SALE OF A SUBSTANTIAL NUMBER OF SHARES OF COMMON STOCK COULD CAUSE THE
MARKET PRICE OF OUR COMMON STOCK TO DECLINE.
Sales of a substantial number of shares of our common stock in the public
market, or the appearance that such shares are available for sale, could
adversely affect the market price for our common stock. The market price of our
stock could also decline if one or more of our significant stockholders decided
for any reason to sell substantial amounts of our stock in the public market.
As of April 30, 2002, we had 44,836,414 shares of common stock outstanding. Of
these shares, 44,174,546 were freely tradable in the public market, either
without restriction or subject, in some cases, only to S-3 or S-8/S-3 prospectus
delivery requirements, and, in some cases, only to either manner of sale,
volume, or notice requirements of Rule 144 under the Securities Act of 1933, as
amended. An additional 661,868 shares will become eligible for sale, subject
only to the manner of sale requirements of Rule 144, as our right to repurchase
these shares lapses over time with the continued employment by Evolve of these
stockholders. As of April 30, 2002, we also had 16,533,939 shares subject to
outstanding options under our stock option plans (plus 15,000 options issued
outside of any plan), and 3,869,864 shares are available for future issuance
under these plans. We have registered a portion of the shares of common stock
subject to outstanding options and reserved for issuance under our stock option
plans and 1,778,793 remaining shares of common stock are reserved for issuance
under our 2000 Employee Stock Purchase Plan. Accordingly, shares underlying
vested options will be eligible for resale in the public market as soon as they
are purchased. We also have 1,875,000 shares of Series A Preferred Stock
outstanding, which are convertible into a maximum of 41,771,372 shares of common
stock, inclusive of all known anti-dilutive adjustments. As of April 30, 2002,
30
we also had warrants outstanding to purchase a total of 9,379,167 shares of our
common stock and warrants to purchase up to 575,000 shares of Series A
Convertible Preferred Stock, which in turn is convertible to up to 12,809,887
shares of common stock, inclusive of all known anti-dilutive adjustments. If
all the warrants for the Series A Convertible Stock are exercised, an additional
common stock warrant for up to 3,202,472 shares of our common stock will be
issued, inclusive of all known anti-dilutive adjustments.
NASDAQ LISTING MAY BE AT RISK.
Since January 2, 2002, we failed to maintain the minimum closing bid price of
$1.00 over 30 consecutive trading days as required by the Nasdaq National
Market. In order to maintain compliance with the Nasdaq listing requirements,
we may be required to take various measures including raising additional capital
and effecting a reverse split of our common stock. Certain of such measures,
including any reverse stock split, would require stockholder approval. If we
are unable to demonstrate compliance with any Nasdaq requirement, the Nasdaq
staff may take further action with respect to a potential delisting of our
stock. We may appeal any such decision by the Nasdaq staff to the Nasdaq
Listing Qualifications Panel.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following discusses our exposure to market risk related to changes in
foreign currency exchange rates, interest rates, and equity prices. This
discussion contains forward-looking statements that are subject to risks and
uncertainties. Actual results could vary materially as a result of a number of
factors including those set forth in the risk factors section of this document.
FOREIGN CURRENCY EXCHANGE RATE RISK
To date, all our product sales have been made in North America and to a smaller
extent, Europe. To the extent that our international operations become
meaningful, our financial results could be affected by a variety of factors,
including changes in foreign currency exchange rates or weak economic conditions
in foreign markets. The strengthening of the U.S. dollar could make our
products less competitive in foreign markets given that sales are currently made
in U.S. dollars.
INTEREST RATE RISK
At March 31, 2002, we had cash, cash equivalents, restricted cash, and
investments of $15.1 million. Included in this balance is $2.9 million in
long-term restricted cash. Declines in interest rates over time would reduce
our interest income. Interest rate fluctuations would also affect interest paid
on our line-of-credit and term loan credit facility.
Funds in excess of current operating requirements are invested in money-market
accounts. Because of the nature of our investments, we have concluded that
there is no material market risk exposure at March 31, 2002. Therefore, no
quantitative tabular disclosures are presented.
The basic objectives of our investment program are to ensure:
- safety and preservation of capital;
- sufficient liquidity to meet cash flow requirements;
- attainment of a consistent market rate of return on invested funds;
and
- avoiding inappropriate concentrations of investments.
EQUITY RISK
We do not own any marketable equity securities. Therefore, we are not subject
to any direct equity price risk.
31
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time, we may become involved in litigation relating to claims
arising from the ordinary course of business. We are defending two claims filed
by early customers; one an action filed in the federal district court in
Massachusetts and the other an action filed in federal district court in
California. Both cases allege a variety of claims including that the software
and services purchased from us did not satisfy certain contractual obligations
and that we engaged in practices that they allege were unfair or
misrepresentative. Both of these proceedings are still in the early stages of
litigation; therefore, it is not possible to estimate the outcome of these
contingencies.
In November 2001, a complaint seeking class action status was filed, against us,
in the United States District Court for the Southern District of New York. The
complaint is purportedly brought on behalf of all persons who purchased our
common stock from August 9, 2000, through December 6, 2000. The complaint names
as defendants some of our former and current officers, and several investment
banking firms that served as managing underwriters of our initial public
offering. Among other claims, the complaint alleges liability under the
Securities Act of 1933 and the Securities Exchange Act of 1934, on the grounds
that the registration statement for our initial public offering did not disclose
that: (1) the underwriters had allegedly agreed to allow certain of their
customers to purchase shares in the offering in exchange for alleged excess
commissions paid to the underwriters; and (2) the underwriters had allegedly
arranged for certain of their customers to purchase additional shares in the
aftermarket at pre-determined prices under alleged arrangements to manipulate
the price of the stock in aftermarket trading. We are aware that similar
allegations have been made in numerous other lawsuits challenging initial public
offerings conducted in 1998, 1999 and 2000. No specific amount of damages is
claimed in the complaint involving our initial public offering. We intend to
contest the claims vigorously. We are unable, at this time, to determine
whether the outcome of the litigation will have a material impact on our results
of operations or financial condition in any future period.
We believe that there are no other claims or actions pending or threatened
against us, the ultimate disposition of which would have a material adverse
effect on us.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
SERIES A PREFERRED STOCK FINANCING
On March 29, 2002 Warburg Pincus LLC and Sierra Ventures VII, L.P. and/or their
affiliates acquired 550,000 shares of Series A Preferred Stock at a price of $10
per share, for total proceeds of $5.5 million via the exercise of preferred
stock warrants.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Index to Exhibits
EXHIBIT
-------
NO.
---
10.20 Employment Offer Letter for Robert Gillette
10.21 Employment Offer Letter for Linda Zecher
32
10.22 Employment Offer Letter for Tim Cannon
10.23 Employment Offer Letter for Lisa Campbell
10.24 Employment Offer Letter for Dale Royal
10.25 First Amendment to the Amended and Restated Loan and Security Agreement
(b) Reports on Form 8-K
No reports were filed on Form 8-K or Form 8K/A during the quarter ended March
31, 2002.
SIGNATURE
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: May 14, 2002 /s/ Kenneth J. Bozzini
----------------------------------------------
Kenneth J. Bozzini
Chief Financial Officer and Vice President of
Finance (Duly Authorized Officer and Principal
Financial and Accounting Officer)
33