===============================================================================
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, 2001
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________ to _______________
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
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO ___
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date:
Shares Outstanding
Class May 8, 2001
----- -----------
Common stock, $0.001 par value 38,498,702
================================================================================
TABLE OF CONTENTS
Page
----
PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets
As of March 31, 2001 and June 30, 2000.................................. 3
Condensed Consolidated Statements of Operations
For the Three and Nine months ended March 31, 2001 and 2000............. 4
Condensed Consolidated Statements of Cash Flows
For the Nine months ended March 31, 2001 and 2000....................... 5
Notes to Condensed Consolidated Financial Statements.................... 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations..................................... 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk.............. 22
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings....................................................... 22
Item 2. Changes in Securities and Use of Proceeds............................... 23
Item 3. Defaults Upon Senior Securities......................................... 23
Item 4. Submissions of Matters to a Vote of Security Holders.................... 23
Item 5. Other Information....................................................... 23
Item 6. Exhibits and Reports on Form 8-K........................................ 23
Signatures......................................................................... 24
PART I -- FINANCIAL INFORMATION
EVOLVE SOFTWARE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
March 31, June 30,
2001 2000
------------ -----------
ASSETS (unaudited) (audited)
Current assets:
Cash and cash equivalents............................................. $ 25,999 $ 18,660
Short term investments................................................ 7,006 --
Accounts receivable, net.............................................. 10,157 3,952
Prepaid expenses and other current assets............................. 2,804 2,273
--------- ---------
Total current assets............................................. 45,966 24,885
Property and equipment, net................................................ 14,182 8,830
Restricted cash............................................................ -- 2,000
Deposits and other assets.................................................. 1,903 1,213
Note receivable from related party......................................... 100 100
Goodwill and other intangible assets, net.................................. 19,607 26,951
--------- ---------
Total assets..................................................... $ 81,758 $ 63,979
========= =========
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND
STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable...................................................... $ 7,299 $ 6,467
Accrued liabilities................................................... 6,949 5,965
Capital lease obligations, current portion............................ 708 762
Deferred revenues..................................................... 8,288 7,093
Short term debt....................................................... 1,485 --
--------- ---------
Total current liabilities........................................ 24,729 20,287
Capital lease obligations, less current portion............................ 367 852
Long term debt............................................................. 3,267 3,958
Deferred rent.............................................................. 166 --
--------- ---------
Total liabilities................................................ 28,529 25,097
--------- ---------
Redeemable convertible preferred stock..................................... -- 79,514
Stockholders' equity (deficit)
Common stock.......................................................... 34 10
Additional paid-in capital............................................ 261,703 113,210
Notes receivable from stockholders.................................... (10,539) (9,174)
Unearned stock-based compensation..................................... (19,629) (40,295)
Accumulated other comprehensive loss.................................. (438) --
Accumulated deficit................................................... (177,902) (104,383)
--------- ---------
Total stockholders' equity (deficit)............................. 53,229 (40,632)
--------- ---------
Total liabilities, redeemable convertible preferred stock and
stockholders' equity (deficit)................................ $ 81,758 $ 63,979
========= =========
The accompanying notes are an integral part of these consolidated
condensed financial statements
3
EVOLVE SOFTWARE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
Three months ended Nine months ended
March 31, March 31,
------------------------ -----------------------
2001 2000 2001 2000
-------- -------- -------- --------
(unaudited)
Revenues:
Solutions...................................................... $ 8,846 $ 2,331 $ 20,332 $ 3,748
Subscriptions.................................................. 2,417 1,178 7,145 1,848
-------- -------- -------- --------
Total revenues............................................ 11,263 3,509 27,477 5,596
-------- -------- -------- --------
Cost of revenues:
Solutions...................................................... 3,347 989 9,455 1,633
Subscriptions.................................................. 1,246 535 3,616 1,257
-------- -------- -------- --------
Total cost of revenues.................................... 4,593 1,524 13,071 2,890
-------- -------- -------- --------
Gross profit.............................................. 6,670 1,985 14,406 2,706
Operating expenses:
Sales and marketing............................................ 10,444 7,357 32,501 12,082
Research and development....................................... 6,971 2,701 14,843 6,248
General and administrative..................................... 3,080 1,596 8,283 3,253
Stock-based charges............................................ 3,863 7,173 20,505 11,045
In-process technology write-off................................ - 3,126 - 3,126
Amortization of goodwill and other intangible assets........... 2,660 - 8,045 -
-------- -------- -------- --------
Total operating expenses.................................. 27,018 21,953 84,177 35,754
Operating loss.................................................... (20,348) (19,968) (69,771) (33,048)
Other income, net................................................. 446 267 2,229 486
-------- -------- -------- --------
Net loss.......................................................... (19,902) (19,701) (67,542) (32,562)
Beneficial conversion feature of Series I
redeemable convertible preferred stock....................... - - 5,977 -
-------- -------- -------- --------
Net loss attributable to common stockholders...................... $(19,902) $(19,701) $(73,519) $(32,562)
======== ======== ======== ========
Net loss per common share -- basic and diluted.................... $ (0.59) $ (7.04) $ (2.51) $ (13.56)
======== ======== ======== ========
Shares used in net loss per common share
calculation -- basic and diluted............................. 33,976 2,800 29,301 2,402
======== ======== ======== ========
The accompanying notes are an integral part of these consolidated
condensed financial statements
4
EVOLVE SOFTWARE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF
CASH FLOWS (in thousands)
Nine months ended
March 31,
------------------------
2001 2000
-------- --------
(unaudited)
Cash flows from operating activities:
Net loss................................................................................ $(67,542) $(32,562)
Adjustments to reconcile net loss to net cash used in operating activities:
Loss on disposal of fixed assets...................................................... 19 -
Common stock options issued to non-employees.......................................... - 23
Allowance for doubtful accounts....................................................... 420 126
Depreciation and amortization......................................................... 10,786 374
In-process technology write-off....................................................... - 3,126
Accrued interest...................................................................... 102 224
Stock-based charges................................................................... 20,506 11,044
Changes in assets and liabilities:...................................................
Accounts receivable................................................................ (6,626) (5,148)
Prepaid expenses and other current assets.......................................... (529) (1,178)
Note receivable from related party................................................. - (40)
Deposits and other assets.......................................................... (691) (417)
Accounts payable................................................................... 832 2,796
Accrued liabilities and deferred rent.............................................. 1,149 2,093
Deferred revenues.................................................................. 1,195 4,304
-------- --------
Net cash used in operating activities........................................... (40,379) (15,235)
-------- --------
Cash flows from investing activities:
Purchase of short term investments...................................................... (22,035) (2,264)
Purchases of property and equipment..................................................... (8,125) (2,415)
Purchase of intangibles................................................................. (700) (300)
Restricted cash on lease................................................................ 2,000 (2,000)
Proceeds from sale of property and equipment............................................ 13 -
Proceeds from maturity/sale of short-term investments................................... 14,530 966
Cash acquired upon acquisition of InfoWide.............................................. - 292
-------- --------
Net cash used in investing activities........................................... (14,317) (5,721)
-------- --------
Cash flows from financing activities:
Payments on debt........................................................................ (4,060) -
Payments under capital lease obligations................................................ (539) (302)
Repurchase of common stock.............................................................. (219) (6)
Proceeds from issuance of debt.......................................................... 4,753 -
Proceeds from payment on notes receivable............................................... 343 39
Proceeds from exercise of common stock warrants......................................... 500 -
Proceeds from exercise of stock options................................................. 864 1,100
Proceeds from employee stock purchase plan.............................................. 1,281 -
Proceeds from issuance of preferred stock, net of issuance costs........................ 12,577 29,911
Proceeds from initial public offering, net.............................................. 46,473 -
-------- --------
Net cash provided by financing activities....................................... 61,973 30,742
-------- --------
Effect of currency exchange rate change.................................................... 62 -
Increase in cash and cash equivalents...................................................... 7,339 9,786
Cash and cash equivalents at beginning of period........................................... 18,660 2,840
-------- --------
Cash and cash equivalents at end of period................................................. $ 25,999 $ 12,626
======== ========
The accompanying notes are an integral part of these consolidated condensed
financial statements
5
EVOLVE SOFTWARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Evolve Software, Inc. ("the Company" or "Evolve") was incorporated in the state
of Delaware in 1995. Evolve provides software solutions for integrating and
streamlining the core business processes that are critical to service
organizations: managing project opportunities, resources and service delivery.
Note 1. Summary of significant accounting policies
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 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 (consisting only of 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,
2001 are not necessarily indicative of the results that may be expected for the
year ending June 30, 2001. For further information, refer to the financial
statements and notes thereto included in our Registration Statement filed on
Form S-1, effective August 9, 2000.
Principles of consolidated financial statements
These 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 the Company 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
and subscription agreements ("Subscription 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 an agreement exists;
. the delivery of the product has occurred;
. the fee is fixed or determinable; and
. the Company believes that collection of these fees is probable.
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 imputed 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. Historically, the Company did not have vendor specific objective
evidence of fair value for services specified in certain software arrangements,
6
as the services were never sold separately. Accordingly the remaining software
revenue allocated to such software licenses and services was recognized ratably
on a straight-line basis over the period during which the services were
provided, which was generally between six and nine months. More recently, 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 engagement, 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 (i.e., 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.
The Company generates revenue from its application service provider ("ASP")
business, by hosting the software, and making the solution available to the
customer via the Internet, as well as 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
such ASP software arrangements the Company does not have vendor specific
objective evidence of fair value for the elements of the contract and,
accordingly, fees from such arrangements will be recognized on a monthly basis
as the hosting service is provided.
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 their components in
financial statements. During the quarter ended September 30, 2000, the Company
began recording comprehensive income (loss) related to translation adjustments
from its international operations. The statement of comprehensive loss follows
(in thousands):
Three months ended Nine months ended
March 31, March 31,
------------------------ ---------------------------
2001 2000 2001 2000
----------- ---------- ----------- -----------
(unaudited)
Net loss attributable to common stockholders................. $ (19,902) $ (19,701) $ (73,519) $ (32,562)
Unrealized loss on investments............................... (500) - (500) -
Foreign currency translation adjustment...................... 104 - 62 -
----------- ---------- ----------- -----------
Comprehensive loss........................................... $ (20,298) $ (19,701) $ (73,957) $ (32,562)
=========== ========== =========== ===========
Segment information
The Company operates in only one segment, namely professional services software
and, as such, use 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.
Note 2. Acquisition of InfoWide, Inc.
On March 31, 2000, the Company acquired all the common stock of InfoWide, Inc.
for a total consideration of 1.8 million shares of common stock and related
expenses. The acquisition consideration, together with transaction expenses, was
valued at $33.0 million. InfoWide was incorporated on April 15, 1998 under the
laws of the state of Delaware. InfoWide provides a web-hosted, financial
management package designed for professional services organizations. The
acquisition was accounted for as a purchase and the results of operations of
InfoWide have been included in the consolidated financial statements from the
date of acquisition.
The following unaudited pro forma consolidated financial information presents
the combined results of Evolve and InfoWide as if the acquisition had occurred
on July 1, 1999, after giving effect to certain adjustments, principally the
amortization of goodwill and other intangible assets (in thousands, except per
share amounts). The unaudited pro forma
7
consolidated financial information does not necessarily reflect the results of
operations that would have occurred had the acquisition been completed on July
1, 1999.
Three months Nine months
ended ended
Mar. 31, 2000 Mar. 31, 2000
------------- -------------
Pro forma total revenues............................ $ 3,544 $ 5,657
============= =============
Pro forma net loss.................................. $ (19,871) $ (39,031)
============= =============
Basic and diluted pro forma net loss per share...... $ (4.29) $ (9.62)
============= =============
Shares used to compute basic and
diluted pro forma net loss per share............ 4,633 4,058
============= =============
Note 3. Stock-based charges
In connection with stock option grants, sales of restricted stock subject to
vesting rights and modifications of option awards, the Company has recorded
stock-based charges of $3.9 million and $20.5 million for the three and nine
months ended March 31, 2001, respectively, and $7.2 million and $11.0 million
for the three and nine months ended March 31, 2000, respectively. Stock-based
charges, if allocated across our functional areas, would affect the following
items in the condensed consolidated statements of operations (in thousands):
Three months ended Nine months ended
March 31, March 31,
---------------------- ----------------------
2001 2000 2001 2000
--------- --------- --------- ---------
(unaudited)
Cost of revenues:
Solutions.......................... $ 394 $ 578 $ 1,760 $ 715
Operating expenses:
Sales and marketing................ 578 2,089 5,480 2,867
Research and development........... 671 1,365 3,626 1,884
General and administrative......... 2,220 3,141 9,639 5,579
--------- --------- --------- ---------
Totals................................. $ 3,863 $ 7,173 $ 20,505 $ 11,045
========= ========= ========= =========
In connection with the termination of two employees, in February 2001, the
Company modified the remaining vesting provisions of the stock option awards for
a total of 177,084 shares with a weighted average exercise price of $1.03. As a
result of the award modification and change to non-employee status, the value of
these awards was determined using the Black-Scholes option pricing model and are
subject to revision each financial reporting period until the shares are vested.
The related adjustment reduced additional paid-in capital, unearned stock-
based compensation and stock-based charges by $1.7 million, $659,000 and $1.1
million, respectively. The stock option awards will continue to vest during
the consulting periods ranging from six to twelve months from date of
separation. As a result, the charge may be subject to substantial increase or
decrease based on future changes in the market price of the Company's common
stock.
Note 4. Issuance of Debt
In January 2001, the Company entered into a credit arrangement providing a line
of credit of $7.5 million and a $7.5 million term loan credit facility with
interest accruing at the rate of the bank's prime rate plus 0.75% and 1.00%,
respectively. As of March 31, 2001, the Company had utilized $4.8 million of the
term loan credit facility. The loan is collateralized by all of the Company's
assets including Intellectual Property. Previously leased equipment is
excluded. The credit facility also includes a $5.0 million sublimit to secure
commercial and/or standby letters of credit of which $2.9 million has been
utilized to support letters of credit issued to the landlord of the Company's
Emeryville facility. Any advances on the revolving line of credit mature one
year from the loan documents with interest due monthly. Advances on the term
loan facility are due twenty-eight months from the advance with interest only
payments for the first four months and then equal payments of interest and
principal amortized over the remaining twenty-four months. The Company is
required to maintain certain financial ratios as part of the loan covenants.
8
Note 5. Contingencies
From time to time, the Company may become involved in litigation relating to
claims arising from the ordinary course of business.
In February 2001, one of the Company's early customers, filed an action in the
United States District Court alleging claims that certain software and services
purchased from the Company did not satisfy certain contractual obligations. The
lawsuit further alleges that the Company engaged in unfair or deceptive
practices in violation of state law and is seeking treble damages. The Company
believes the claims are without merit and plans to vigorously defend the case.
The Company believes 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 the Company.
Note 6. Net Loss per Share
Basic and diluted net loss per share is computed using the weighted average
number of common shares outstanding during each period. Since we have 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 (both in thousands) used in the calculation of basic
and diluted net loss per share follows:
Three months ended Nine months ended
March 31, March 31,
----------------------- ------------------------
2001 2000 2001 2000
---------- --------- ---------- ----------
(unaudited)
Numerator:
Net loss.......................................... $ (19,902) $ (19,701) $ (67,542) $ (32,562)
Beneficial conversion feature of Series I
redeemable convertible preferred stock.......... - - 5,977 -
---------- --------- ---------- ----------
Net loss attributable to common stockholders...... $ (19,902) $ (19,701) $ (73,519) $ (32,562)
========== ========= ========== ==========
Denominator:
Weighted average common shares.................... 38,621 7,935 34,680 5,952
Weighted average unvested common shares
subject to repurchase........................... (4,645) (5,135) (5,379) (3,550)
---------- --------- ---------- ----------
Shares used in computing basic and diluted
net loss per share.............................. 33,976 2,800 29,301 2,402
========== ========= ========== ==========
At March 31, 2001 and 2000, options to purchase 3,510,205 and 1,600,203 shares
of common stock were outstanding with a weighted-average exercise price of $6.50
and $2.98, respectively. These common stock equivalents have been excluded
from the computation of diluted net loss per share because the effect would
have been antidilutive. The weighted-average purchase price of stock subject
to repurchase was $2.14 and $1.58 as of March 31, 2001 and 2000, respectively.
9
Note 7. Recent Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities," that
requires companies to record derivative financial instruments on their balance
sheets as assets or liabilities, measured at fair value. Gains or losses
resulting from changes in the values of those derivatives would be accounted for
depending on the use of the derivative instrument and whether it qualifies for
hedge accounting. The key criterion for hedge accounting is that the hedging
relationship must be highly effective in achieving offsetting changes in fair
value or cash flows. In June 1999, the FASB issued SFAS No. 137, "Accounting for
Derivative Instruments and Hedging Activities--Deferral of the Effective Date of
FASB Statement No. 133," that amends SFAS No. 133 to be effective for all fiscal
quarters of fiscal years beginning after June 15, 2000. In June 2000, the FASB
issued SFAS No. 138, "Accounting for Derivative Instruments and Hedging
Activities--An Amendment of FASB No. 133." SFAS 138 amends the accounting and
reporting standards for certain derivatives and hedging activities such as net
settlement contracts, foreign currency translations and intercompany
derivatives. The Company does not currently hold derivative instruments or
engage in hedging activities. Management's adoption of SFAS 133 did not have a
material effect on our consolidated financial statements.
In March 2000, the FASB issued FASB Interpretation No. 44 ("FIN 44"),
"Accounting for Certain Transactions involving Stock Compensation," an
interpretation of Accounting Principles Board ("APB") Opinion No. 25. FIN 44
clarifies the application of Opinion 25 for the definition of employee for
purposes of applying Opinion 25, the criteria for determining whether a plan
qualifies as a noncompensatory plan, the accounting consequence of various
modifications to the terms of a previously fixed stock option or award, and the
accounting for an exchange of stock compensation awards in a business
combination. FIN 44 became effective July 1, 2000, but certain conclusions cover
specific events that occurred after either December 15, 1998, or January 12,
2000. The adoption of FIN 44 did not have a material impact on the consolidated
financial statements.
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 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 the
Company's Registration Statement on Form S-1 (Registration No. 333-32796).
Except for historical information, this Report may contain 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 anticipated costs and expenses. 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 the risks
described in our Registration Statement filed on Form S-1 under "Risk Factors."
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 events or circumstances after the date of this document.
10
Overview
We are a leading provider of Internet-based end-to-end solutions for automating
professional service organizations and optimizing the efforts of other strategic
workforces including the internal IT departments of Global 2000 companies. Our
ServiceSphere software suite integrates and streamlines the core processes that
are critical to such organizations: managing project opportunities, professional
resources and service delivery. We license our ServiceSphere solution directly
to these organizations and provide them related implementation, integration,
training, maintenance and hosting with services.
Evolve was founded in February 1995. From our inception through December 1998
our activities, funded by the capital we raised, consisted primarily of building
our business infrastructure, recruiting personnel and developing our software
and service offerings. The ServiceSphere product suite was first made
commercially available in March 1999 and we recognized our first revenues from
ServiceSphere sales during the quarter ended March 31, 1999. Our revenues
increased during each sequential quarter for the remainder of 1999 and 2000. We
have incurred substantial losses since inception and we anticipate that we will
continue to incur operating losses as we make the investments necessary to
expand our business. Our accumulated deficit at March 31, 2001, was $177.9
million.
Our headcount increased from 198 employees at December 31, 1999 to 365 employees
at March 31, 2001, as we continued to invest in developing our technology and
building a direct sales force, a marketing group and a professional services
organization. Our infrastructure expenditures also increased significantly in
2000 and 2001, as we expanded our facilities domestically and internationally
and enhanced our information systems. Looking forward we will focus on continued
investment in developing our technology and building our direct sales force.
In August 2000, we completed an initial public offering of 5,750,000 shares of
our common stock, resulting in proceeds of approximately $46.5 million, net of
offering costs.
Results of Operations
Three and nine months ended March 31, 2001 and 2000.
Revenues
Total revenues were $11.3 million for the three months ended March 31, 2001, as
compared to revenues of $3.5 million for the comparable 2000 period. Total
revenues increased to $27.5 million for the nine months ended March 31, 2001
from $5.6 million for the same period in 2000. The increase in revenues reflects
the growth of sales of our software and services subsequent to the first
commercial sale of ServiceSphere during the quarter ended March 31, 1999.
Solutions revenue principally consists of software licenses and implementation
services while Subscriptions revenue is principally composed of applications and
maintenance subscriptions. 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 three months
ended March 31, 2000, Solutions revenues and Subscriptions revenues were $2.3
million, or 66% of total revenues, and $1.2 million, or 34% of total revenues,
respectively. For the nine months ended March 31, 2001, Solutions and
Subscriptions revenues were $20.3 million, or 74% of total revenues, and $7.1
million, or 26% of total revenues, respectively. For the nine months ended March
31, 2000, Solutions and Subscriptions revenues were $3.7 million, or 67% of
total revenues, and $1.8 million, or 33% of total revenues, respectively.
Cost of Revenues
Our cost of revenues includes the costs directly associated with our Solutions
and Subscriptions revenues. 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. The cost of our
Solutions revenues also includes royalties due to third-parties for integrated
technology, printing costs of product documentation, duplication costs for
software media and shipping costs. The cost of our 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 ASP customers. Cost of Subscriptions
also includes hosting fees required to service our ASP customers.
Total cost of revenues was $4.6 million for the three months ended March 31,
2001 compared to $1.5 million for the three months ended March 31, 2000. Cost of
Solutions revenues was $3.3 million and the
11
cost of Subscriptions revenues was $1.2 million for the three months ended March
31, 2001. Cost of Solutions revenues was $989,000 and the cost of Subscriptions
revenues was $535,000 for the quarter ended March 31, 2000. For the nine months
ended March 31, 2001, total cost of revenues was $13.1 million compared to $2.9
million for the nine months ended March 31, 2000. Cost of Solutions revenues was
$9.5 million and the cost of Subscriptions revenues was $3.6 million for the
nine months ended March 31, 2001. Cost of Solutions revenues was $1.6 million
and the cost of Subscriptions revenues was $1.3 million for the nine months
ended March 31, 2000.
The increase in cost of Solutions revenues was primarily attributable to
increased costs associated with employees and third-party consultants involved
in providing implementation, training and consulting services to our expanded
customer base. The number of employees in our services organization has
increased to 121 as of March 31, 2001 from 56 at March 31, 2000. The increase in
total cost of Subscriptions revenues was primarily due to increased 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 and are also seeking to
engage third-parties to provide a substantial portion of services related to
our applications.
For the nine months ended March 31, 2001, gross margins improved to 52% from 48%
in the prior year. The improvement in gross margins was attributable to an
increase in total revenues and the increase in the number of time and material
consulting engagements as opposed to lower margin fixed fee arrangements.
Operating Expenses
Sales and Marketing. Sales and marketing expenses consist primarily of employee
salaries, benefits and commissions, and 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 increased to $10.4 million for the
quarter ended March 31, 2001, from $7.4 million for the quarter ended March 31,
2000. Sales and marketing expenses for the nine months ended March 31, 2001
increased to $32.5 million from $12.1 million for the same period in the prior
year. The increase in sales and marketing expenses resulted primarily from
building our domestic and international direct sales force, investing in our
sales and marketing infrastructure and increasing our marketing initiatives. The
number of employees in our sales and marketing organization increased to 97
as of March 31, 2001 from 46 at March 31, 2000. As a result of a recent
restructuring completed in April 2001, which included a significant workforce
reduction, we expect that the level of sales and marketing expenses will
decline, giving effect to any one-off charges related to such restructuring
charges.
Research and Development. Research and development expenses consist primarily of
personnel and related costs associated with our product development efforts,
including fees paid to third-parties for consulting services. Research and
development expenses increased to $7.0 million for the three months ended March
31, 2001, from $2.7 million for three months ended March 31, 2000. Research and
development expenses for the nine months ended March 31, 2001 and 2000, were
$14.8 million and $6.2 million, respectively. The increase in research and
development expenses related primarily to an increase in research and
development personnel to 106 at March 31, 2001 from 63 at March 31, 2000. Fees
paid to third-party consultants increased in 2001 as specialized technical
experts were utilized to accelerate the delivery of some of our development
initiatives. We believe that an essential part of our future success is the
investment we make in our research and development organization. We expect that
the absolute dollar amount of research and development expenses will not
increase in the next few quarters.
General and Administrative. General and administrative expenses consist
primarily of employee salaries and expenses related to executive, finance and
administrative personnel, bad debt expense, and professional service fees.
General and administrative expenses increased to $3.1 million for the three
months ended March 31, 2001, from $1.6 million for the three months ended March
31, 2000. For the nine months ended March 31, 2001, general and administrative
expenses were $8.3 million compared to $3.3 million for the comparable prior
year period. The increase in general and administrative expenses resulted
primarily from the addition of executive, finance and administrative personnel
to support the growth of our business. Legal fees related to our litigation
with PeopleSoft, which was settled in March 2001, further contributed to an
increase in General and Administrative expenses in fiscal 2001. The number of
executive, finance and administrative employees increased to 41 at March 31,
2001 from 33 at March 31, 2000. We expect that general and administrative
expenses relating to personnel will not increase in the next few quarters.
Stock-Based Charges. Stock-based charges consist of amortization of deferred
compensation in connection with stock option grants and sales of restricted
stock to our employees at exercise or sales prices below the deemed accounting
fair market value of our common stock. We recorded stock-based charges of $3.9
million and $20.5 million for the three and nine months ended March 31, 2001,
respectively, and $7.2 million and $11.0 million for the three and nine months
ended March 31, 2000, respectively. Stock-based charges, if allocated across our
functional areas, would affect the following items in the condensed consolidated
statements of operations (in thousands):
Three months ended Nine months ended
March 31, March 31,
------------------------------ ------------------------------
2001 2000 2001 2000
------------- ------------- ------------- -------------
(unaudited)
Cost of revenues:
Solutions.................... $ 394 $ 578 $ 1,760 $ 715
Operating expenses:
Sales and marketing.......... 578 2,089 5,480 2,867
Research and development..... 671 1,365 3,626 1,884
General and administrative... 2,220 3,141 9,639 5,579
------------- ------------- ------------- -------------
Totals.................... $ 3,863 $ 7,173 $ 20,505 $ 11,045
============= ============= ============= =============
12
In connection with the termination of two employees, in February 2001, the
Company modified the remaining vesting provisions of the stock option awards for
a total of 177,084 shares with a weighted average exercise price of $1.03. As a
result of the award modification and change to non-employee status, the value of
these awards was determined using the Black-Scholes option pricing model and are
subject to revision each financial reporting period until the shares are vested.
The related adjustment reduced additional paid-in capital, unearned stock-based
compensation and stock-based charges by $1.7 million, $659,000 and $1.1 million,
respectively. The stock option awards will continue to vest during the
consulting periods ranging from six to twelve months from date of separation. As
a result, the charge may be subject to substantial increase or decrease based on
future changes in the market price of the Company's common stock.
In-process Technology Write-off. In conjunction with the March 31, 2000,
acquisition of InfoWide, Inc., the Company acquired $3.1 million of in-
process technology which was immediately expensed because technological
feasibility had not been established and no future alternative uses of the
technology existed.
Amortization of Goodwill and Other Intangible Assets. 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 three and nine months ended March, 2001,
we expensed $2.7 million and $8.0 million, respectively, associated with the
amortization of these and other intangible assets which are being amortized over
periods not exceeding thirty-six months. During the fourth quarter of fiscal
2001, the Company anticipates material restructuring charges related to a
labor force reduction and a write-off of intangible assets associated with
this reduction along with the associated business restructuring.
Other Income, net. The increase in other income, net for the three and nine
months ended March 31, 2001, as compared to the same periods in the previous
year, is primarily attributable to interest income derived from increased cash
balances resulting from the completion of our Series I Preferred Stock issuances
in June and July 2000 and our initial public offering in August 2000.
Liquidity And Capital Resources
Net cash used in operations for the nine months ended March 31, 2001 was $40.4
million compared to net cash used by operations of $15.2 million for the
comparable period of the prior year. Net cash used by operating activities,
after adjustment for non-cash items, for the nine months ended March 31, 2001
resulted primarily from net losses during the period.
Net cash used in investing activities for the nine months ended March 31, 2001
was $14.3 million compared to net cash used by investing activities of $5.7
million for the same period in 2000. Cash used by investing activities in the
nine months ended March 31, 2001 resulted primarily from the purchase of
short-term investments of $22.0 million and the purchase of property and
equipment of $8.1 million partially offset by proceeds from the sale/maturity of
short-term investments of $14.5 million. Additions to property and equipment
were primarily related to a move of our corporate offices to a new facility in
July 2000.
Net cash provided from financing activities for the nine months ended March 31,
2001 was $62.0 million compared to $30.7 million in the same prior year period.
Current year activity was primarily attributable to proceeds from the issuance
of common stock in our initial public offering completed in August 2000, and to
a lesser extent from issuance of preferred shares under our Series I funding
round in July 2000.
At March 31, 2001, we had cash, cash equivalents and investments of $33.0
million. Included in this balance is a short-term investment of $1.5 million,
which is net of a $0.5 million unrealized loss. This loss was recorded in other
comprehensive loss and was associated with commercial paper issued by Pacific
Gas & Electric which matured on January 18, 2001 and was in default at March 31,
2001. On April 30, 2001 the Company recovered the full $2.0 million value of
this investment.
13
In January 2001, we entered into a credit arrangement providing a line of credit
of $7.5 million and a $7.5 million term loan credit facility. As of March 31,
2001 we had utilized $4.8 million of the term loan credit facility to finance
certain capital expenditures. The credit facility also includes a $5.0 million
sublimit to secure commercial and/or standby letters of credit of which $2.9
million has been utilized to support letters of credit issued to the landlord of
the Company's Emeryville facility. Any advances on the revolving line of credit
mature one year from the loan documents with interest due monthly. Advances
on the term loan facility are due twenty-eight months from the advance with
interest-only payments for the first four months and then equal payments of
interest and principal amortized over the remaining twenty-four months. We
believe that our current cash and investment balances, cash flow from
operations and accessibility of funds from our credit arrangements will be
sufficient to meet our working capital and capital expenditure requirements
for at least the next twelve months. We may utilize cash to acquire or invest
in complementary businesses or to obtain the right to use complementary
technologies.
Factors That May Affect Future Results of Operations
Our business is difficult to evaluate because our operating history is limited.
It is difficult to evaluate our business and our prospects because our revenue
and income potential are unproven. We commenced recognizing sales revenues in
the first quarter of 1999. Because of our limited operating history, there may
not be an adequate basis for forecasts of future operating results, and we have
only limited insight into the trends that may emerge in our business and affect
our financial performance.
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, 2001, we had an accumulated deficit of approximately $177.9 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. We expect to
continue to incur significant sales and marketing, research and development, and
general and administrative expenses. 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.
Our future operating results may not follow past trends due to many factors, and
any of these could cause our stock price to fall.
We believe that quarter-to-quarter comparisons of our operating results are not
a good indication of future performance. Although our operating results have
generally improved from quarter to quarter in the recent past, our future
operating results may not follow past trends. It is likely that in some future
quarters our operating results may be below the expectations of public market
analysts and investors due to 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 in a highly
competitive recruiting environment;
. 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.
14
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. As an example, we have added service delivery
management functions to our ServiceSphere suite and we have built enhanced
delivery management functionality in part through integration of the technology
of InfoWide, Inc.
A limited number of our customers expect us to develop product enhancements that
may address their specific needs. For instance, we have shared with some of our
customers our internal product roadmap which includes descriptions of new
functional enhancements such as improved time and expense management for future
releases of our software. 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 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 recently 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
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.
As discussed above, a substantial portion of our early customers were e-business
consultancies focusing on Web development and e-commerce integration. As public
valuations for many such businesses have declined substantially in recent
months, 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.
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 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.
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 in response to the
current economic slowdown. 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 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 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 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 parties will perform adequately.
We may not be able to reduce our operating expenditures as aggressively as
planned, which may delay our ability to attain profitability.
In response to the current uncertain economic environment and volatility in the
public equity markets, we recently implemented significant measures designed to
reduce our operating expenses and enhance our ability to attain operating
profitability. For example, from January 1, 2001 through April 30, 2001, we
reduced our employee headcount in excess of 100 persons, with reductions in
virtually all areas of operations. We expect that our workforce reductions and
other expense containment measures will enhance our operating results in
future periods. However, in order to achieve operating profitability, we will
need to achieve significant additional cost savings in future quarters, without
adversely affecting our revenue growth. Numerous factors could impede our
ability to further reduce our operating expenses. For instance, we currently
expect to achieve significant expense reductions by limiting the headcount of
services organization; however, we may not be able to achieve the desired
savings if we cannot engage and qualify third-party integration and support
partners as rapidly as we hope. In addition, if our revenue growth fails to meet
our current expectations, we would be forced to seek expense reductions in
excess of our current plans, which may not be achievable. Any of these
developments could impede our ability to achieve profitable operations in
accordance with current expectations.
15
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
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.
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. Our success in
attracting and retaining customers for our ServiceSphere application service
provider ("ASP") offering and convincing them to increase their reliance on this
solution depends on our ability to offer customers reliable, secure and
continuous service. 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 customers who
purchase 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.
In addition, California has recently been experiencing electric power supply
shortages that has resulted in intermittent loss of power in the form of rolling
blackouts. While neither we nor our third-party Internet service providers or
communications services providers have experienced any power failures to date
that have prevented us from continuing our operations, the recurrence of
blackouts may affect our ability to operate our business.
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 Changepoint and Niku. In addition,
we may, in the future, face competition from providers of enterprise application
software or electronic marketplaces. 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.
Some of our competitors have longer operating histories, significantly greater
financial, technical, marketing or other resources, or greater name recognition
than we do. 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 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.
16
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.
Our revenues depend on orders from our top customers, and if we fail to complete
one or more orders, our revenues will be reduced.
Historically, we have received a significant portion of our revenues from a
small number of customers. For the nine months ended March 31, 2001, no single
customer accounted for more than 10% of revenue. For the quarter ended March
31, 2001, two customers represented more than 33% of our total revenues. One of
these customers is anticipated to represent more than 10% of our total revenues
for the next quarter. Our future operating results may be harmed if we are not
able to complete one or more substantial product sales in any future period or
attract new customers, or if a significant number of customers terminate their
relationship with us.
We depend on the continued services of our executive officers, and the loss of
key personnel or any inability to attract and retain additional personnel could
affect our ability to successfully grow our business.
If we are unable to hire and retain a sufficient number of qualified personnel,
particularly in sales, marketing, research and development, service and support,
our ability to grow our business could be affected. Competition for qualified
personnel in high technology is intense, particularly in the San Francisco Bay
Area where our principal office is located. The loss of the services of our key
engineering, sales, service 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.
Our future success depends upon the continued service of our executive officers,
particularly John Bantleman, our President and Chief Executive Officer, who is
critical to determining our broad business strategy, and to James Bozzini, our
Chief Operating Officer, who is critical to our ability to execute on that
strategy. None of our executive officers is bound by an employment agreement for
any specific term. Our business could be harmed if we lost the services of one
or more of our executive officers or key employees, or if one or more of them
decide to join a competitor or otherwise compete directly or indirectly with us.
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
17
work with other applications and operating systems. For example, we are in the
early stages of customer deployment on the Sun Solaris operating system. Because
this development effort is not complete, we cannot be certain that we will avoid
significant technical difficulties which could delay or prevent completion of
the development effort.
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.
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 which 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.
Our sales are concentrated in the IT services consulting industry, and if our
customers in this industry decrease their infrastructure spending, or we fail to
penetrate other industries, our revenues may decline.
Sales to customers in the IT services consulting industry accounted for a
substantial portion of our revenues in fiscal 2000 and 2001. Given the high
degree of competition and the rapidly changing environment in this industry,
there is no assurance that we will be able to continue sales in this industry at
current levels. Many of our customers and potential customers in the IT services
consultancy industry have witnessed drastic declines in their stock prices,
which could limit our current customers from purchasing additional licenses of
our software, and could prevent potential customers from making the kinds of
infrastructure investments that would allow them to purchase our software in the
first place. In addition, we intend to market our products to professional
services organizations in other industries. Customers in these new industries
are likely to have different requirements and may require us to change our
product design or features, sales methods, support capabilities or pricing
policies. If we fail to successfully address the needs of these customers, we
may experience decreased sales in future periods.
If we lose key licenses, we may be required to develop or license alternatives
which may cause delays or reductions in sales or shipments.
We rely on software that we have licensed from third-parties, including Poet
Software, Inprise/Borland, ProSight, Actuate, Autonomy, & Allaire to perform key
functions of our Evolve ServiceSphere ePlatform, and we rely on these and other
third-parties to support their products for our development and customer support
efforts. These companies could terminate our licenses if we breach our
agreements with them, or they could discontinue support of the products we
license from them. This could result in delays or reductions of sales or
shipments of our ePlatform until alternative software can be developed or
licensed.
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:
18
. 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.
Our customers also may encounter system configuration problems that require us
to spend additional consulting or support resources to resolve these problems.
Our customers may 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 software products are used for critical operational and
decision-making processes by our customers, 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.
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 substantially equivalent or superior to
ours.
We have three patent applications pending in the United States with respect to
the "Team Builder" functionality in our Resource Manager module, the time and
expense functionality of our Time and Expense module; and the enablement of
dynamically configurable software systems by our ServiceSphere software server.
While the first two of these applications have not been issued, we have received
notice from the U.S. Patent Office that the latter application has been allowed.
However, there can be no assurance that any of these 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.
19
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 have grown very quickly, and if we fail to manage our growth, our ability to
generate new revenues and achieve profitability would be harmed.
We have grown significantly since our inception and will continue to manage our
growth effectively with a focus in our research and development organization and
our direct sales groups. Any failure to manage this growth could impede our
ability to increase revenues and achieve profitability. Evolve has increased its
number of employees from 198 at March 31, 2000 to 365 as of March 31, 2001. In
order to manage growth effectively, we must:
. hire, train and integrate new personnel;
. 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.
We intend to further expand operations 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 due to difficulties in
translation and delays we may experience in recruiting and training
international staff. We currently have no experience in developing local
versions of our products, and 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 confidential and proprietary information of our
customers stored on our ServiceSphere 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 ServiceSphere 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.
Resistance to online use of personal information regarding employees and
consultants may hinder the effectiveness of and reduce demand for our products
and services.
20
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,
or, despite our efforts to keep such personal information secure, this
information may be delivered unintentionally to inappropriate third-parties
such as recruiters. Enterprise applications like ServiceSphere have always run
on secure company intranets. The information contained in ServiceSphere
databases will be exposed to the unpredictable security of the Internet, which
may create unforeseen liabilities for us. ServiceSphere is currently targeted
primarily to the North American market, but 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 ASP service
from succeeding in the European market.
Potential imposition of governmental regulation or taxation on electronic
commerce could limit our growth.
The adoption of new laws or the adaptation of existing laws to the Internet may
decrease the growth in the use of the Internet, which could in turn decrease the
demand for our solutions, increase our cost of doing business or otherwise have
a material adverse impact on our business. Few laws or regulations currently
directly apply to access commerce on the Internet. Federal, state, local and
foreign governments are considering a number of legislative and regulatory
proposals relating to Internet commerce. As a result, a number of laws or
regulations may be adopted regarding Internet user privacy, taxation, pricing,
quality of products and services and intellectual property ownership. How
existing laws will be applied to the Internet in areas such as property
ownership, copyright, trademark, trade secret and defamation is uncertain. The
recent growth of Internet commerce has been attributed by some to the lack of
sales and value-added taxes on interstate sales of goods and services over the
Internet. Numerous state and local authorities have expressed a desire to impose
such taxes on sales to businesses in their jurisdictions. The Internet Tax
Freedom Act of 1998 prevents imposition of such taxes through October 2001. If
the federal moratorium on state and local taxes on Internet sales is not
renewed, or if it is terminated before its expiration, sales of goods and
services over the Internet could be subject to multiple overlapping tax schemes,
which could substantially hinder the growth of Internet-based commerce.
If we need additional financing to maintain and expand our business, financing
may not be available on favorable terms, if at all.
We expect to incur net losses before amortization charges for the foreseeable
future. We may need additional funds to expand or meet all of our operating
needs. If we need additional financing, we cannot be certain that it will be
available on favorable terms, if at all. Further, if we issue additional shares
of our capital stock, stockholders will experience additional dilution, which
may be substantial. If we need funds and cannot raise them on acceptable terms,
we may not be able to continue our operations at the current level or at all.
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 May 8, 2001, we had 38,498,702 shares of common stock outstanding. Of these
shares, 28,693,496 are freely tradable in the public market, either without
restriction or subject in some cases only to S-8/S-3 prospectus delivery
requirements and, in some cases, only to either manner of sale, volume, and
notice requirements of Rule 144 under the Securities Act of 1933, as amended.
The majority of these shares had been subject to lock-up agreements that expired
on February 5, 2001. Of the remaining 9,805,206 shares, eligibility for resale
will be as follows:
. A total of 4,805,206 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.
. On June 28, 2001, and July 13, 2001, respectively, aggregate amounts
of 3,007,775 shares and 1,992,225 shares, acquired through the
conversion of preferred stock, will become eligible for sale, subject
only to these same Rule 144 requirements.
21
As of May 1, 2001, we also have 3,862,605 shares subject to outstanding options
under our stock option plans (plus 224,167 options and warrants issued outside
of any plan), and 2,103,212 shares are available for future issuance under these
plans. We have registered the shares of common stock subject to outstanding
options and reserved for issuance under our stock option plans and the 2,000,000
shares of common stock 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.
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
prospectus.
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, 2001, we had cash, cash equivalents and investments of $33.0
million. Included in this balance is a short-term investment of $1.5 million,
which is net of a $0.5 million unrealized loss. This loss was recorded in
other comprehensive loss and was associated with commercial paper issued by
Pacific Gas & Electric which matured on January 18, 2001 and was in default at
March 31, 2001. On April 30, 2001 the Company recovered the full $2.0 million
value of this investment. 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 obligations of
the U.S. government and its agencies and investment grade obligations of state
and local governments and large corporations. Due to the nature of our
investments, excluding the since-recovered $2.0 million in commercial paper
issued by Pacific Gas & Electric, we have concluded that there is no material
market risk exposure at March 31, 2001. 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.
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time, the Company may become involved in litigation relating to
claims arising from our ordinary course of business. As previously reported in
our Forms 10-Q for the quarters ended December 31, 2000 and September 30, 2000,
in January 2000, PeopleSoft, Inc. filed an action in the California Superior
22
Court, Alameda County, alleging claims arising out of our employment of former
employees of PeopleSoft, and seeking preliminary and permanent injunctions to
preclude additional hiring of PeopleSoft employees. PeopleSoft's claims included
our inducing breach of contract of their employees and unfair competition.
Evolve filed a counter complaint against PeopleSoft in California Superior
Court, Alameda County, in April, 2000. In March 2001, Peoplesoft and the Company
executed a Confidential Settlement Agreement and Mutual General Release in which
both parties, in their desire to avoid further expense associated with
maintaining and/or defending the claims and defenses in the forgoing actions,
agreed to fully and finally settle both claims as well as any future claims
which could be asserted without making any admissions or concessions to the
other party regarding the merits of the claims or defenses. The terms of the
settlement were confidential, but did not have a material financial impact on
the Company.
In February 2001, one of the Company's early customers, filed an action in the
United States District Court alleging claims that certain software and services
purchased from the Company did not satisfy certain contractual obligations. The
lawsuit further alleges that the Company engaged in unfair or deceptive
practices in violation of state law and is seeking treble damages. The Company
believes the claims are without merit and plans to vigorously defend the case.
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
None.
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
None.
(b) Reports on Form 8-K
No reports were filed on Form 8-K or Form 8-K/A during the quarter ended March
31, 2001.
23
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
EVOLVE SOFTWARE, INC.
Date: May 08, 2001 By: /s/ JOHN P. BANTLEMAN
-----------------------------------------
John P. Bantleman
President and
Chief Executive Officer
(Principal Executive Officer)
Date: May 08, 2001 By: /s/ DOUGLAS S. SINCLAIR
-----------------------------------------
Douglas S. Sinclair
Chief Financial Officer,
Corporate Secretary and Treasurer
(Principal Financial Officer)
24